Adani Group: Modified boost, can it last?

While the fundamentals of Adani Group stocks have also improved, the run up in the stocks has been sharp and valuations factor in the near-term upsides

Investors have been warming up to the Adani Group companies on optimism that the new government would be favourable and business issues which have been plaguing the group could get resolved. The three listed entities---Adani Enterprises, Adani Power and Adani Ports have seen gains of 35-175% jump since September 2013, when Narendra Modi was anointed the prime ministerial candidate. Given the landslide mandate to the BJP and Narendra Modi at the helm, investors are expecting more. But, there is a need to be cautious as the share prices are already factoring in the near-term positives with valuations ahead of consensus target prices.

Adani Power
Adani Power has suffered setbacks in the past as a result of the de-rating of the sector as well as its own issues pertaining to the Mundra project and the resultant losses. However, led by hopes and now the change at the Centre, the stock has risen to Rs 57, which is way ahead of the analysts’ target price of about Rs 36 per share. "It is difficult to point how much of the recent rally is because of the political factors, but we believe if the strong government is in place that will have positive impact on the power companies particularly Adani Power. It will be the biggest beneficiary because of the litigations and the issues of the coal availability," said Abhishek Patel, who is tracking the company at KR Choksey.

There are others like Girish Nair of BNP Paribas who wrote in his note that "Adani Power’s stock price has outperformed the MSCI Index 33% in the past three months on expectations that a stable government post-election would resolve problems at its power projects. However, as Indian courts will decide on the dispute over tariff resets for Adani’s projects, we believe the government will have no say in the issue."

Fundamentally, though, most analysts believe that if the benefits of the recent development where the CERC (relating to Mundra Project) and MERC recently allowed to raise tariff to compensate the depreciation and higher cost of the fuel, the company will immensely benefit. "If we include these two benefits our target price stands at Rs 51 per share as against Rs 32 currently," said Patel of K R Choksey. Even then, the stock factors in the gains.

Adani Ports and SEZ
Unlike the other two listed group companies, the Street is quite hopeful about the prospects of Adani Ports and SEZ, which is expected to gain further business momentum led by higher volumes and on-going expansions. "We have revised cargo volumes and tariffs across ports as well as land sales revenues based on recent contracts or sale deeds and incorporated Kandla and Ennore ports. Utilisation of surplus cash towards next phase of expansion through inorganic or organic route remains the key," said Shankar K of Edelweiss Securities in a note. Part of this Street's optimism is also visible in the March quarter results.

Recently, the management said that 90% of Abbot (in Australia) sale proceeds have been received. Along the lines of expectations, on Friday, the company announced the acquisition of 100% stake in Dhamra Port located in Orissa from L&T Infrastructure Development Projects and Tata Steel at an enterprise value of Rs 5,500 crore. This is part of company's pan India presence strategy, leveraging on its experience of Mundra in Gujarat. Dhamra, which handled total cargo of 14.3 million tonne in FY14 aims to take this to 100 million tonne by the year 2020. Meanwhile, the stock has gained about 16% in a month and is currently trading at 4.4 times its FY15 estimated book value. Investors could use correction to enter the stock.

Adani Enterprises
Adani Enterprises, which is largely a coal trading company and holds stake in Adani Power and Adani Ports, is no exception and has also seen a huge spurt in its share price. On the business side, though, it has seen a large dip in coal trading volumes during the recent quarters. Also, issues such as losses in fixed-price coal agreements and growing receivables in the books have been raised by the Street. However, if the demand in the country for imported coal improves and some of the issues relating to receivables eases, it will have a positive impact on the company. Also, incremental growth in its listed subsidiaries like expansion of the port capacity and better cash flows in the power business (Adani Power) could further ease the Street's concern.

During the March quarter, the company reported strong five-fold in increase in profit to Rs 2,848 crore led by significant improvement in operating margins by 967 basis points to 26.2%. This is largely driven by the performance of its power business, which recognised additional revenues because of compensatory tariff for two projects. During the quarter, contribution of power business grew 200% compared to corresponding quarter last year, which is also a reason that overall sales of the company grew by a strong 40% to Rs 16,171 crore.

Some of the optimism in the stock is due to the new government and is reflected in the share price. The stock is currently trading at Rs 539, much higher than the consensus target price of Rs 395.