Parag: Ideas for Profit

Share Price: 296.80

52 Week High: 368.95

52 Week Low: 219.95

I have spent the past several weeks asking people about their dairy preferences. "What is your preferred brand of milk?" "Do you prefer Gowardhan Ghee or Amul Ghee?" "Do you buy curd or make it at home?" After chatting with several people, at work, at casual parties, and at not so casual parties, I convinced people that I was a dairy salesman/mad woman. I came out of this convinced that people have started spending more on value-added dairy products. There is a shift in the Indian consumer, and as we continue to emulate the West, the demand for premium cheeses, flavored yogurt, whey protein like products is set to rise. Furthermore, the Indian housewife is extinct. The Indian woman will not be making ghee, or curd, or paneer at home, she will go to the store after a long day of work and buy them. 

So, as an investor, I was inclined to bet on this trend of growing demand for dairy value-added products. I made a list of companies and tried to find the one which had a solid brand (in value added products specifically) and which was currently trading at cheap valuations. That is what every consumer looks for, and so should the investor. 

Okay, so the first thing that jumps at you after looking at this graph is Kwality, right? You must be wondering, "what is up with Kwality? I love their ice cream." (yes, me too but that is owned by HUL now) As an investor, that looks like a great bet and it probably is. However, not right now. The company had some corporate governance issues recently and was put under ASM (Additional Surveillance Measures). Indian Markets are quite ruthless with that sort of stuff. A good time to look at Kwality would be after it comes out of ASM and when management clears the air. It could drop some more and stay there (for a long time). Check kwality share price if you are too tempted. 

So yes, moving on to Parag. I ran the numbers first. It is currently trading at 30x trailing P/E while the median P/E in the Industry is 40x. Furthermore, this EPS is set to increase going forward, and hence it is trading at 25x FY19E and 20x FYE. The math here is quite simple, even if Parag continues to trade at a discount to peers, there is profit to be made. If there is multiple expansion, there is more profit to be made. If there is multiple expansion, and if eps rises more than expectations, there is even more profit to be made. Below are two sensitivity tables with different forward eps expectations (FY19 and FY20) and expected P/E multiples. The values in the table represent potential upside from CMP (current market price).

	12	12.1	12.2	12.3	12.4	12.5
10	-60%	-59%	-59%	-59%	-58%	-58%
20	-19%	-18%	-18%	-17%	-16%	-16%
30	21%	22%	23%	24%	25%	26%
40	62%	63%	64%	66%	67%	68%
50	102%	104%	106%	107%	109%	111%
60	143%	145%	147%	149%	151%	153%

	13.5	14	14.5	15	15.5	16
10	-55%	-53%	-51%	-49%	-48%	-46%
20	-9%	-6%	-2%	1%	4%	8%
30	36%	42%	47%	52%	57%	62%
40	82%	89%	95%	102%	109%	116%
50	127%	136%	144%	153%	161%	170%
60	173%	183%	193%	203%	213%	223%

Yes, the math looks good, but there are two key assumptions at play here: increasing eps and P/E expansion. So let us take a deeper dive into both.

But before that, a little bit about the company: Parag Milk Foods (PMF), incorporated in 1992 with operations in just collection and distribution of milk, has now developed into a FMCG dairy company. It has diversified its product portfolio with 170 plus SKUs to cater to a wide range of customers via 6 brands—Gowardhan, Go, Pride Of Cows, ToppUp, Milkrich and Avvatar. The company has recently ventured into the whey consumer protein powder segment with Avvatar brand and fruit beverages category with Slurp brand. Parag Milk Foods (Parag) has made a leap in a short span by capturing leading market share in high-margin value-added products (VADP)—No. 2 in cheese (32% market share) and largest cow ghee brand in India. Parag boasts of strongest value-added portfolio contributing 64% to sales, way ahead industry’s 34%. This has resulted in it gaining leading market share in VADP (cheese, ghee) in record time. The company’s biggest competitive advantage is the scale created—invested INR3.5 bn over FY08-17 on high-margin cheese and whey. 

Reasons for Growth:

1. Growing Industry

The Value Added Products segement is the fastest growing segment in the dairy industry. According to a crisil report, it has almost doubled in the past three years and this is likely to continue growing at 10.4% going forward due to increasing urbanization, rising income, vast vegetarian population and growing health consciousness. 

Furthermore, according to Parag, traditional products industry (milk, ghee, paneer, butter) is growing at a 15% CAGR while the modern value-added products industry is growing at 26% (UTH milk, cheese, flavored milk, whey protein). Parag is well positioned to capture on these industry tailwinds with 64% of its revenue coming from value-added products.

2. Continuing Product Innovation

PMF is the only dairy player that is integrated across the value chain from dairy farming to milk procurement, processing, distribution as well as branding. The company has historically been successful in introducing new products to tap new consumers. It has entered new segments with Avvatar (whey protein), GO protein powder, Slurp (milk based mango drink), premium ghee (Aurum), and Gowardhan Paneer with a 75-day shelf life. In the long term, this new product innovation strategy should provide it an edge over other dairy players. Apart from expanding its cheese portfolio, the company is also developing a premiumization strategy for its cheese products. This allows the company to grow topline and increase its margins, which leads to eps growth. 

3. Growing of Health and Nutrition Segment

The company's strategy going forward is to scale up presence in health & nutrition segment through a widening product portfolio. As imports in the segment make up for ~50% of the industry, PMF sees a huge opportunity to drive growth. On the portfolio front, the company has seen healthy traction in the whey protein segment and plans to widen its product range in the sports nutrition segment under the Avvatar brand through the launch of variants (Muscle gainer, mass gainer, Runnners formula, etc). The product is India’s first Muscle Gainer to be certified by Informed Sports from a WADA approved lab in UK. PMF also recently entered the milk protein segment  with the launch of Go Protein power (a 100% cow milk product with the highest protein content (~44%) among the products available in the segment). This is a INR14-16 bn category with other products like Proteinix with INR6bn sales and Ensure (Abbott’s brand) at INR3bn sales. 

Furthermore, given the nature and limited distributors in the segment, PMF has set up a separate sales team for Avvatar portfolio. Moreover, to drive growth, the company has launched bonding programs with gym trainers who are key influencers in this segment. 

PMF is targeting ~7% market share in the segment over the next 2 years and expects to generate revenues of ~Rs1.2bn from the whey protein segment. The health & nutrition segment currently accounts for 2% of sales; which the company is targeting to increase to 7% by FY21E through the launch of new products and ramp up in reach. 

As there is increasing awareness on health and nutrition, these segments are expected to keep growing. Furthermore, the company has an early mover advantage in the segment. A lot of the international products are difficult to find and do not have a good distribution network. If Parag is able to implement successfully, it will be able to rapidly gain market share (the cheese segment gained 33% market share in 5 years and became second in the segment after Amul). Furthermore, products like these are meant to cater to the upper middle class (which continues to keep growing) and the demand for these products also tends to be sticky and price inelastic. Once the company has developed its brand, it will be able to marginally increase the price of its products over time and continue top line growth.

4. Increasing Margins

Management aims to increase EBITDA margin from ~10.5% currently to 11-12% by FY20E, supported by improved mix and cost efficiencies. The company intends to drive mix improvement through growth in value-added products and scaling up presence in the nutrition segment. On the cost efficiency front, PMF is focusing on 3 components - ensuring efficiency of trade promotions, curtailing inflation in non-milk cost of goods sold (COGS) through value engineering and operating efficiencies across the value chain. 

5. Growth in Distribution

PMF derives a larger proportion (65%) of sales from West & South India, where company’s procurement and manufacturing is present, while the remaining (35%) comes from the North & East. The company recently acquired Danone’s facility in Sonipat, Haryana to scale up presence in the Northern & Eastern markets. Moreover, the company expects to achieve cost benefits through logistics and better inventory management, once the facility starts commercial production. Currently, PMF is focusing on a) setting up additional lines in the plant as well as testing existing lines in order to ensure the quality of output and b) setting up procurement and distribution network. The company has spent Rs. 140mn on the plant already and is expected to spend another Rs. 160mn to add new equipment to make pouch milk, butter milk, flavored milk, mishit doi and expand the yogurt capacity.
The company has also set up a team to build sourcing network from states like Madhya Pradesh, Rajasthan and Uttar Pradesh.

Distribution expansion remains a key focus area for the company. PMF is working on a two-pronged strategy, which involves expanding its product range/outlets as well as adding new outlets. The company plans to increase its retail footprint by 3-3.5x from 2.5 lakh outlets to 7.5 lakh outlets (targeting addition of 7,000-8,000 outlets/month). It also plans to increase its distributors chain by 2.5-3x from current 3000+ and super stockists by 1.5-2x from 140+.

6. Growth in FCF

Management targets to reduce working capital from ~19.5% of sales currently to ~17-17.5% of sales in FY19. Management expects to improve working capital by reducing losses on expiry/aging products, better inventory management post recalibration of network and through SAP implementation. Further, PMF does not require any major capacity expansion over next 2-3 years and capEx requorement will largely pertain to maintenance capEx (2.5% of Sales) which will lead to an improvement in the return profile.

7. Change in Processes

Change in processes are likely to be driven by new management, and suggestions from Vector Consulting.

The company has recently made key changes to management as it has added several FMCG professionals to its leadership team. For the CFO position, Parag brought in Vimal Agarwal, from pepsico India (after 17 years there). Amarendra Sathe from Kimberly-Clark India, was brought in by the firm as CCO and Harshad Joshi, a dairy technologist with long stints at companies like Mother Dairy, joined as COO. 

Furthermore, Parag has also hired an external agency, Vector Consulting, to drive improvements in its supply chain processes and enable higher sales with limited additional capex. Pilot project shows impressive results with average daily sales increasing by 53%, repeat orders increasing by 170%, number of unique SKUs increasing by 31% and number of outlets billed increasing by 200% 

Reasons for Multiple Expansion:

1. FMCG Company

Parag has recently started rebrading itself as an FMCG company instead of a dairy company as it explands the value added products segment, enters other segments such as health and nutrition, and hires managers from FMCG.
Most FMCG companies trade at 40-60x earnings even with their earnings growing at low/mid single digits. With Parag showing a ~20% growth, if the market starts pricing Parag as an FMCG company, multiples are likely to expand.

(Parag is almost obsessed with rebranding itself as an FMCG company. Check out their most recent presentation.)

2. Market Leader

Parag is also a market leader in the value added products segment with its rapidly increasing market share. There is no reason for the company to trade at a discount. As the share price grows, it should start getting more attention from investors, and start trading at the median industry multiple.

Risks:

1. Volatility in Milk Prices

Any material and sudden rise in milk prices may impact Parag’s margin if it is not able to absorb. Milk procurement prices jumped 27% in FY17. However, Parag was able to absorb due to premiumisation as demonstrated by 39bps rise in gross margin. 

2. Competition

This is one of the biggest risks in all consumer-focused companies. The domestic dairy products industry is highly competitive with presence of large multinational companies as well as regional and local players. The company also competes with large dairy cooperatives; incentives offered by central or state governments to these could benefit such entities. Any steep increase in competitive pressure (such as mul getting aggressive in the value-added products segment) may impact Parag’s revenue growth prospects.

Conclusion:

Given these strong trends, and factoring in the risks, Parag is a good long term. I personally bought to stock at 281, and plan to hold it for the next 2-3 years. 

Should you chose to buy the stock, I would recommend celebrating your purchase with some Gowardhan Mishti Doi. It is really quite delicious.

Sintex Industries trading at low valuations (for a reason)

Share Price: 14.20
52-week high: 38.55(20-Jul-17)
52-week low: 14.05 (03-Jul-18)

I came across Sintex Industries (textile business) during my search for bargain stocks. At first glance, I thought I had landed on a hidden treasure. A stock trading significantly lower than book value (~0.2x P/BV) and a ~6x P/E with industry P/E at ~20x. (!!)

However, after about a day of exuberance, I reminded myself that the stock must be trading this way for a reason and my job was to assess if the reason was valid because:

• 6x was the trailing eps. Perhaps the market was factoring in forward eps which could be expected to be lower
• The industry is not in a good place with rising cotton prices, and it is possible that industry valuations may go down in the coming quarters

So I started doing the work, studying the financials, presentations, and all that good stuff. However, finding information on the company gave me a serious headache, which is never a good sign. I also emailed investor relations (two weeks ago) and have not heard back.

I found that sintex industries had spun off into sintex plastics and sintex industries (textile business) about a year ago. I looked at both and decided to pass on both.

Sintex plastics has shown declining profits and revenues (and share price) for the past couple of quarters, and even though research reports indicate a buy rating with attractive valuations, there is no explanation except for the KKR debt financing, and I did not quite understand why that is a catalyst. KKR has not made an equity investment, it has refinanced a loan. The company's custom molding business is not doing well, and neither is the prefab and infra business. They had also recently wound down their US subsidiary. The company is also highly levered with a net debt/EBITDA at 4.1x for FY18. I did not need to read further, I knew this was a pass, despite IDFC and Phillips capital suggesting a 49% and 45% upside respectively. (Sidetone: people tend to underestimate how easy it is for research houses to change target when the price goes down, without changing upside)

Let's talk about sintex industries now. Sintex Industries is a textile company that produces multiple varieties of blended high-end shirting (cotton linen, cotton-silk, cotton lycra and cotton- linen-lycra)."It enjoys a major share of the structured fabric market in India by addressing the growing needs of premium men’s shirt brands" - Annual Report FY17

I do not see this need increasing much. In fact, with the younger generation moving to casual clothing, this is not a segment that I see growing in the apparel space. 

Sintex is also one of the largest corduroy manufacturers in Asia. It manufactures a range of corduroy fabrics, including yarn dyed corduroy and ultima cotton yarn based corduroy. I had to use google to figure out what corduroy is. I do not know about you guys, but I do not know anyone who wears corduroy so that was another negative for me.

The company supplies its products to renowned retailers, both domestic and international, such as Triber, Gap, DKNY, Ralph Lauren, Marks & Spencer (international) and Arrow, Zodiac, Van Huesen, Louis Phillipe (domestic). Last time I checked, these company's were not growing too rapidly and retail has not really been doing so well. 

The company has also recently created a retail distribution channel (18% revenue) in pan-India which markets ready-to-stitch fabric packs. It also has stores in Bangladesh and Dubai. I have personally not seen these stores. Furthermore, there is no information on the margins for this business or the demand for ready-to-stitch fabrics. The retail stores require investment, and it is possible that the company might end up increasing leverage as they pursue this business. 

Lastly, about 1/2 of the MD&A on their Annual report is about cotton prices. Hence, I am assuming that they are very sensitive to volatility in cotton prices. Furthermore, since all of their products are cotton-based, they are not diversified at all (compared to peers) and could be hit hard with increase in cotton prices as they have been on an upward trend due to increase in MSP by the government and decreased supply. The MSP increase also creates bottlenecks in the supply chain as the textile manufacturers will have to buy from the government post procurement.

The company also says that their margins are being hurt due to the trade war and depreciation in Asian currencies, and this shall continue. The company is also highly levered, and that is never good for margins.However, there are some tailwinds which could end up turning things around but it is very difficult to assess how much impact it will have. Tailwinds:
- Rupee depreciation could increase exports
- SGST compensation to increase income
- Government recently doubled import duty on textiles which could increase topline

Note that these are all industry headwinds. So if you'd really like to invest in textiles, the best strategy would thus be to invest in a company with less exposure to cotton and a more diversified portfolio. If you find a good one, let me know.

Now you might say, "but their results have been good?". Yes, Q1 FY19 results are good, but damn that presentation looks lousy. Also, can someone help me find the balance sheet on this? I thought they had to disclose this stuff.

Pass. Pass. Pass.

If you are too tempted, try to find the Q1 FY19 balance sheet.

Dalal Street Over Wall Street

Investing in the Indian Equity Market is More Fun (and Profitable) than the US

I started investing in equities during my Freshman year of college. I was in love as soon as I understood that it was a way for me to own part of a company and I could end up owning parts of multiple companies at 19!(Beat that Zuckerberg!)

I knew that I wanted to invest in India because having grown up there, I knew exactly what kinds of companies I would like to own. However, I also wanted to bank on some of the opportunities that I had come across in the United States as I was working as a research analyst for a small cap fund. I got a job only so so I can could my SSN for the sole reason of being able to open a trading account.

However, over time, as I have gotten more experience, I have realized that a better strategy is to invest more heavily in India. Consequently, I have ended up at a place where over 90% of the stocks that I own are Indian and the rest of my portfolio is invested in the US. I do not pursue opportunities in any other regions because that would be outside of my "circle of competence".

Why do I think that India is more fun (and profitable) than the US?

Mispricing Exists:

It has become extremely difficult to find mispriced publicly traded companies in the United States as the market has become saturated with sophisticated institutional investors scrutinizing these securities with a better skill set and (sometimes) access to more information. There is also an increase in retail investors entering the market looking actively pick stocks. In such a situation, it has become challenging to find mispriced equity investment opportunities. Additionally, as Mohnish Pabria mentioned in a sumzero interview, the number of public companies listed on US stock exchanges has gone from 8000 to 3500 while the number of intelligent investors with increased capital (due to low-interest rates and fewer places to park money) have gone up leading to a diminishing pool of good business that are trading at a discount.

It is not like the good old warren buffet days where you could look through the newspapers and find statistically cheap stocks. With the advent of high-frequency trading and quant finance, it is almost impossible to find anything that would be statistically cheap.

In India, on the other hand, the market is not as developed and a lot of inefficiencies exist. Furthermore, when you have high growth there is a higher probability of mispricing since different people’s perspectives on growth can express itself as different outcomes in terms of price. There is also a tremendous use of technical analysis when it comes to investing since people continue to call brokers, to buy and sell equities, who make money based on volume, and hence a lot of the trading is based on technical analysis. Even the news channels have guests come and advice on stocks based on technical analysis which in turn leads to stocks being mispriced (by a lot!). Lastly, there is an increase of retail investors in India as well but most of them but the inflow is mostly in mutual fund securities and most mutual fund managers focus on only a select number of stocks. Even if these new retail investors are investing in individual securities, most of them are part the class that trades off of advice from news channels. Furthermore, the niche small to mid-cap space remains uncovered and provides a lot of opportunities.

Lastly, the level of education in these countries is very different and this reflects in stocks as well. A finance degree in the united states can teach you to invest independently and analyze and value stocks, which does not happen in Indian universities. One of my friends who has gotten a BCom degree with a concentration in Finance from a prominent Indian business school did not even know what options are or what a DCF is. Sophisticated investors in a market are inversely proportional to portfolio returns.

Predictable Future:

Investing in India is like living in the present knowing full well what is going to happen in the future. The only uncertainty is how and when, which is relatively easier to figure out. My friend and I used to joke that India is US - 50 years. Now I have realized that if you use that as your mantra for Indian investing, it can be quite lucrative. Industry trends that have already materialized in the United States happen in India a couple of years later and investing in the market leader in that industry, ends up being a lucrative bet.

Some examples:

- 4G in India is a recent phenomenon (Reliance Jio growth story)

- Electric Vehicles are still not a thing in India, companies have only recently started research and development in that space

- Streaming services have been popular in the United States with "Netflix and chill" being a thing for as long as one can remember, but that industry has also only recently started to get disrupted in India

So what's next? Mobile payments? Cybersecurity? Healthy beverages? Self-driving cars?

Growth Rate

The economy grows at a rate of around 7-8% while that in the united states grows at around 2-3%. Therefore, even if you park your money in a large cap boring old industrials stock in India, you'll be able to make high single-digit returns compared to a similar company in the U.S. where it will be close to low single-digit. Thus, the risk reward scenario is highly favorable. The inflation in the country is higher as well so one could argue that in the "real" sense, it is no different. However, if you live in the united states (like I do now), the math will be different.

Then why do I still have a portion of my income invested in the United States?

Technology

All of my US investments are in the technology sector. It is what the country does best and what the country does first. The sector has outperformed the S&P 500 and the tech "bubble" fears do not hold up.

There is a strong first mover advantage in the space and it is much easier to find "monopolies" with durable moats. There is also much more uncertainty when it comes to valuations, which makes it easier to find some mispricing. Since many of these technologies are new, the valuation is strictly forward-looking and if you have a view that is different from the markets', you can find several multi-bagger stocks. There are also a lot of good investments in the smaller cap space in particular. However, with fewer companies going public, it is definitely getting harder.

---

So yes, I do find Indian Equities more lucrative compared to American. However, in times like now when both markets have been on a bullish trajectory for a (very) long time and valuations are stretched, a correction is expected sometime soon and investing in cash and gold (though not much fun) could end up being fairly profitable.

Adani Power: This might not be the rock bottom

NSE: ADANIPOWER
BOM: 533096

Share Price: Rs. 16.10

52-week High: Rs. 47.80

52-week Low: Rs. 15.25

Target Price Range: Rs. 3.45 - 8.00



This past week, Adani Power hit its new 52-week low at Rs. 15.25. A week ago, the 52-week low was 17.50 and I had thought that that was the rock bottom. After a preliminary analysis of the stock price chart and all the sell-side equity research reports from a month ago (May 2018), I had reached the conclusion that this was an unwarranted sell-off. Most sell-side equity research reports had a hold or sell but their valuations were based off the company price in May (when it was trading around 22) and their target prices were in the mid to high 20's range. I looked at the Sotp (Sum of the parts) valuations (without fully understanding how they arrived at it) and consequently figured that the valuation would not have changed since it was based on the most recent financials(Q4 2018) which would imply that the stock was undervalued That was when I started considering the investment. Afterall, one must buy when the price is low. I checked the price of the stock every day after that and saw it emerge from its 52-week low and go up to 19.55. This is when I thought that perhaps the market had caught on and the stock was on an upward trajectory. Therefore, the fear of "missing out" led to my hasty purchase. The stock kept moving around by a percent or two every day and I checked my account every day. I kept buying more every time the price dropped, until I ran out of money.

This past week, I started assessing the financial statements. I did not bother with this earlier since I figured that the experts at the banks and brokerages could be trusted. However, as I kept digging deeper I realized that I had made a huge mistake. After beating myself up about it for some time, I decided to learn from it and move on. (Pain + Reflection = Progress)

Here is my take on why Adani Power might be far hitting the rock bottom.

Summary:

• Stock trading at a 7x price/bv, much higher than peers and historical average
• The company has been loss-making for the past 5 years and is highly levered (16x D/E)
• The company recently shut down its Mundra plant, and the Mundra subsidiary may move to NCTL for bankruptcy protection 

Industry:

Adani Power is in the business of power generation, transmission and gas distribution. The sector has been under distress for quite some time due to a high price of imported coal and shortage of domestic coal. Most companies have seen their stock price tumble over the past couple of years and so has Adani Power. It is easy to come the conclusion that this is a cyclical price trend, and be tempted to buy more at distressed rates. However, there might be no reversal because coal is limited in supply and the demand for it continues to increase; especially in a country like India. Industry reports suggest that the demand for electricity in the country is expected to rise which could lead to top line growth for companies in the industry, but these reports do not discuss the supply. The margin squeeze due to high coal prices is prohibiting some companies from operating profitably, and compelling them to operate at lower PLF's (plant load factor) or completely shut down its units to avoid losses. Since these companies have PPAs (purchase price agreements) with governments, the price is inelastic. Furthermore, with elections coming up, it does not seem as though the government would be willing to increase electricity prices anytime soon. The government is trying to help these distressed assets by buying them some more time to restructure but it seems as though that may not come through because RBI is putting its foot down on this one.

Therefore, the trend going forward is that, in the long run, the number of players in the industry will decrease and only the players with a diversified portfolio and strong balance sheets will remain taking over the distressed power assets at discounted prices.

Another major trend in the industry is the shift towards renewable energy, which is expected to increase by 27% this upcoming year, with support from several government schemes, which seems like the way forward for the industry.

Company summary and history:

Adani Power Ltd is engaged in power generation and setting up of power projects. The company produces most of its energy using thermal fuel sources such as coal but also has facilities that utilize solar and steam generation. Adani Power generates most of its through a sale of electicity to state distribution companies and the transmission of energy to state and central utilities. Adani Power is the largest power producer and owns the worlds largest coal based power plant and is part of the congrmerate, Adani Group that is India's largest importer of coal. The company is currently operating an aggregate of 10,480 megawatts (MW) generation capacity comprising of 4,620 MW at Mundra, Gujarat, 3,300 MW at Tiroda, Maharashtra, 1,320 MW at Kawai, Rajasthan, 1,200 MW at Udupi, Karnataka and 40 MW (solar) at Kutch, Gujarat.

Recent Acquisition: 

On 7 November 2017, Adani Power announced that the company's wholly-owned subsidiary Adani Power (Jharkhand) Limited had signed a long-term Power Purchase Agreement (PPA) as it got special treatment from the government to make it happen. The PPA has been signed for a net capacity of 1496 MW with Bangladesh Power Development Board for 25 years. Power supply under the PPA will be made from a new 1600 MW Ultra-supercritical coal-based power plant to be set up by Adani Power (Jharkhand) Limited at Godda, Jharkhand, at the estimated project cost of Rs 13,450, which is likely to be funded by additional debt. The project is expected to achieve Commercial Operation Date by May 2022, and supply power to the Bangladesh Power Development Board under a PPA for net capacity of 1,496 MW for 25 years.

Recent Troubles and Triggers for Price Decline:

- Mundra Shutdown: Adani Power’s took a commercial shutdown at Mundra since the penalty on non-supply of power, which could be imposed as per the PPA, will be lower than the losses which would be incurred on operating Mundra at current international coal prices. In FY18, Gujarat imposed a penalty of Rs 970mn for not meeting the minimum power supply norms under the PPA. Though management during the Q4 FY18 earnings call urged that it would not remain non operational for the entire year, it seems improbable given the political risk. Therefore, it seems that with no bailout option, Adani Power Mundra will move to NCLT for bankruptcy protection.

- Korba West Power Plant: Adani Power had acquired Avantha Power’s Korba West 600MW power plant in Mar’15 after paying Rs 159 cr. However, before a transfer of the stake could take place, lenders of Avantha Power converted part of their debt into equity, taking over 51% controlling stake of the plant. Adani Power was offered 49% stake and operational control of the power plant, which the company accepted. However, with the increased possibility of Korba West power plant going to NCLT for resolution (becoming a non-performing asset), Adani Power as part-owner would not have been eligible to participate in the bidding process. Hence, it will take over the stake in the asset only after (and if) the resolution is completed.

Management:

Upon investigation, it seems as though management is not focused on creating shareholder value.

The lousy acquisition of Korba West and the decreasing PLF at all the plants, along with the shutdown of the Mundra plant shows that the company is not too operationally efficient.
Furthermore, management is much less visible and does not appear in the media to give any explanation or guidance to shareholders. Tata Power, a leading company in the sector, and a direct competitor, is much more interactive with the media and more transparent with shareholders.
Another indicator of management's commitment to shareholders is the website, where the financials have not been updated since FY15.
Lastly, it seems as though management does not have much integrity. Though the acquisition of the Jharkhand land might be good news for the market, it was not so great for the residents of Jharkhand.

Therefore, I am not convinced that management has the commitment or ability to create shareholder value and I am also not comfortable investing in a company without integrity.


Competition and Peer Analysis:

Adani Power competes mainly with the state-owned power companies (NTPC, CESC, PowerGrid), and it is tough competition because these companies receive priority in domestic coal supply.

Within the private space, Adani competes with Tata Power which is much more diversified and has been changing its focus to renewables. You must now wonder, why does Adani Power no do renewables? Well, they do, but as a separate business, Adani Green Energy. Therefore, Adani Power does not even benefit from the tailwinds in the industry.

From the comps table below, it is clear that Adani Power is the worst of the lot (by a huge margin). It is trading at a much higher valuation on a P/BV basis compared to peers and it is also highly levered which shows the inefficiency on the part of management in terms of managing debt and finance costs. It should also be noted that it is the only company in the peer set that is loss-making and has been that way for several years now leading to a decreasing net worth over time.

Company	P/E	P/B	Debt/Equity
Adani Power	N/A	7.08	16.41
Power Grid Corp	11.85	1.79	2.26
NTPC	12.72	1.27	1.1
CESC	13.88	0.92	1.32
Tata Power	18.59	1.2	3.52

Price History:

The sharp selloff over the past couple of days is not an isolated incident. The entire market has been performing poorly and several stocks (esp midcap) are in the red. However, the if we zoom out (just a little bit), the price has fallen from 25 in May to around 16.10 now, which ~35% decline in two months. When I bought the stock at 19.25, that was a ~25% decline in a month, and I thought that was a bit too much. Therefore, this price decline since Q4 results shows that market is pricing in the possibility of Adani Power Mundra going bankrupt.

Any triggers for reversal?

- Revival of Mundra Power Plant would lead to reversal and a bump in share price. However, the chances are slim since coal prices would have to decrease substantially for that to happen or the Gujarat government would have to give them a compensatory tariff like they did in Maharastra and Rajasthan. The Gujarat government has been focusing on these stressed assets as it has set up a committee to look into it.

- Sale of the Mundra plant to the government. However, Tata Power is looking to sell its Mundra unit to the government as well so it is highly uncertain how this will pan out.

- Resolution of Korba West Acquisition

- Deleveraging since the holding company is selling its stake in other companies to pay off APL debt


Market View:

Market sentiment on the stock is bearish. All brokerages and sell side reports have a sell/reduce rating for the company but have target prices in the mid-twenties. Edelweiss has a target price of 29, ICICI has a target price of 24, Axis bank has a target of 22. There are also more puts than calls on Adani Power, indicating that most investors expect the price to go further down.

Valuation:

With negative cash flows, which are very difficult to predict, one cannot value the company using a discounted cash flow. Furthermore, since most of its competitors are more profitable and more diversified, it is also difficult to value it on a comparable companies basis. However, one can value the company based on its own past performance and since it is a power business with a lot of fixed assets and debt, it seems as though using price/BV would be a good approach to valuation. The company is highly levered and has been loss-making for the past couple of years which signals a decrease in net worth. The book value of the stock using Q4 balance sheet data is about 2.30, suggesting that the company is currently trading at a multiple of 7 times. Historically, the stock has traded at a price to book of around 2.5x and 7.11x is a historical high point. All the competitors in the industry are trading around 1.5x. Using the 1.5x - 3.5x range, we come to a valuation range of 3.45 - 8.00 suggesting that the stock is a strong sell.

Worst case scenario: From a forward perspective, the consensus estimate for book value per share is Rs. 1.6 so you can do the math.

Recommendation:

If you do not own the stock, do not buy the stock. Buy put options expiring on 30th of August, that should be the best way to make money on this.
However, if you currently own the stock, do not sell just yet. Let the market normalize. The stock rose ~3% on Friday with the nifty and Sensex rising by about a percent. Sell within a couple of weeks to get better pricing (this depends on your cost price). However, if it continues to go on a downward trajectory, cut your losses.

This chart will remind you of how important it is to cut your losses:

Good luck investing, and do not forget that it is more important to not be wrong than it is to be right. More power to you!