Prof. Aswath Damodaran, Stern School of Business at New York University teaches corporate finance and valuation and wrote a blog on weekend about his views on the valuation of Adani’s group share.
Prof. Damodaran in his blog writes the fair value of Adani Enterprises at Rs 945, he said even at Rs 1,531, Friday’s closing price for Adani Enterprises on NSE, the company is priced too high, given its fundamentals that includes cash flows, growth expectations and risks involved.
In his value estimation, Prof.Damodaran did not factor in the damage that might have been done to the company’s reputation and long-term value by the Hindenburg episode. Damodaran’s share price estimate for Adani Enterprises, he said, are based on upbeat assumptions on revenue growth and operating margins.
Prof Damodaran wrote that each of Adani’s businesses is operated by a standalone Adani company, but the businesses flow through Adani Enterprises, the holding company.
He broke down Adani Enterprises’ 20-year history into three sub-periods. three sub-periods, the 2022-2015 time period, where the company grew its revenues steadily and reported solid, albeit low, profitability, the 2016-2021 time period after a major restructuring in 2015 that spun off Adani Ports Adani Power and Adani Transmission, as separate companies, and the most recent year and a half (from March 2021 to September 2022), where the company reported a quantum leap in revenues. During that most recent period, the Adanis acquired a stake in the cement business, another capital-intensive and low-profitability business, when they bought Hochim’s stake in ACC and Ambuja Cements.
Prof. Damodaran writes that while the revenue part of the Adani Enterprises story is one of almost unstoppable growth, it is worth noting that throughout its entire operating history, the Adani Group has had low operating margins, with the trend lines in the wrong direction.
“While some of the decline can be attributed to the revving up of reinvestment in new businesses, it is also worth emphasizing that even when these investments start paying off, these will remain low-margin businesses,” he said.
Damodaran said the Adani Enterprises’ return on invested capital has steadily declined, even as it has scaled up, hovering just over 3 percent in 2021-2022.
“Again, it is true that in infrastructure businesses, returns on capital improve as assets age, partly driven by higher operating income and partly by declining invested capital, but as with margins, the reality check is that these businesses will struggle to earn their costs of capital,” he said.
Prof.Damodaran said it is incontestable that Adani Enterprises funded almost all of its growth with debt through this period. In fact, the company continued to pay dividends to shareholders, even as it raised fresh debt to keep growing, in effect using debt to pay dividends during the 2016-2021 time period, he said.
“In the most recent period (2021-22), there does seem to be a push to raise fresh equity, and that may or may not be in response to pressures from investors and lenders to reduce the debt burden,” he said. Prof. Damodaran said the PE ratio for Adani Enterprises stock has gone from a modest 15 times earnings in the 2016-21 period to 214 times earnings in the most recent two years, and the enterprise value has jumped from about 12 times Ebitda during the 2016-21 to 53 times Ebitda in the most recent two years.
“You see similar movements in the price to book, where the stock has gone from trading under book value to 6.7 times book value, and the enterprise value, which was less than revenue in 2016-21 to 2.71 times revenues in the most recent two years,” he said. Prof. Damodaran said, the surge in pricing multiples is a feature of volatile markets, and it is a phenomenon that we saw with technology companies in the last decade.
“What makes it surprising at Adani is the fact that this is an infrastructure company, and the irrational exuberance that animates pricing in tech or software usually has little play in this sector. In addition, the question of which group of investors is leading the push to higher prices is a puzzle, since, unlike an Agatha Christie mystery, the list of suspects is short,” he said.
One benign explanation, Damodaran said is that foreign institutional investors are using Adani-listed shares to make a joint bet on Indian growth, infrastructure investment, and Indian politics and that the pricing is being pushed up because of the limited float.
“But as we will see when we get to the short sellers’ thesis, there are more malignant explanations, as well,” he said.
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