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Why Is Operating Leverage Missing From Reliance Jio Financials?

Reliance Jio Infocomm Ltd’s Ebitda margin has hovered around the 38-39% mark for six quarters now. This despite the fact that revenues have risen from Rs. 6,879 crore in the December 2017 quarter to Rs. 11,106 crore in the March 2019 quarter (Q4), an increase of more than 60%.

Normally, a rise of this magnitude would have resulted in gains from operating leverage. Why are Reliance Jio’s margins stuck at the same levels?

While nearly all other costs have fallen, network operating expenditure (opex) has risen as a percentage of revenues. In the December 2017 quarter, network opex amounted to Rs. 1737 crore, or 25.2% of the company’s revenue. In the recently concluded March quarter, it nearly doubled to Rs. 3401 crore, and amounted to 30.6% of revenue.

“The lack of operating leverage in earnings prints continues to surprise as network opex per unit of data carried on the network stayed flat. This challenges our understanding of the wireless business being an inherently high operating leverage one,” analysts at Kotak Institutional Equities wrote in a note to clients after Q4 results of parent Reliance Industries Ltd (RIL)were announced last week.

The head of research at an institutional brokerage firm says, “The benign view is that Jio’s network coverage has been rising even in recent quarters, which will naturally result in higher network opex. Another view, however, is that Jio is now capitalizing a lower proportion of its expenses, now that its revenues have risen meaningfully.”

For perspective, Reliance Jio continues to capitalize a portion of its expenses, citing that these pertain to non-wireless businesses that are yet to be commercially launched. But some analysts have had questions about the wireless expenses that were reflecting in the profit and loss statement, which seemed low. The rise in network opex in the past few quarters now makes wireless costs look more realistic.

Now, with Reliance Jio saying it is close to network coverage of 99% of the population, it is likely that both network opex and capital expenditure will grow at a slower pace. As such, the benefits of operating leverage may well start being visible in a few quarters.

As things stand, the lack of operating leverage has been a dampener on RIL Q4 results. Despite rising revenues, Jio’s pre-tax profits were flat at December 2018 levels. Apart from flat Ebitda margin, profits were also hit by an increase in interest costs. For investors who are highly enthused about Reliance Jio’s prospects, it’s imperative that signs of operating leverage start becoming visible soon.―Livemint

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