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
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.
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!
thanks for this amazing article keep it up
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