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Adani Enterprises Ltd
Neutral
ADEL.BO, ADE IN
All dressed up, but the ball is still a while away.
Maintain N.
• Outperforms the pack, given fewer regulatory hiccups and value
unlocking: While infra asset owners had a bad run in 2010, ADE
outperformed the market and peers on account of: (1) Value unlocking at
two key verticals (70% of SOTP, Adani Power listing in 2H09 and
amalgamation of MP in 1H10) (2) simplified business model into three
key verticals: power, ports, and mining. (3) More visible earnings streams
and better execution in ports and power (4) A change in earnings and
return profile as ADE transformed into an asset owner from a trader (est
earnings CAGR of 70% thru FY14E and ROE of 29% vs. 20% in FY10).
• Coal mining the next kicker, but still two years out, in our view: We
foresee the next leg up to come via value unlocking in the coal mining
business, which is still two years away. According to management, peak
production of 110mtpa from current MDO contracts should be achieved
by FY18 with ADE’s target to ramp up to 200mtpa by 2020, competition
still being limited. While we expect continuous capex to develop mines,
we see an inflection in OCF in FY13. Meanwhile, the bread and butter
coal trading business continues to be a key contributor to earnings.
• Value accretion from overseas assets will take a while to play out:
Coal production from Galilee (Aust) is still at least five years away, in our
view, with evacuation infrastructure being a bottleneck. However, in the
long term the asset is a good synergistic fit with the power and trading
businesses. Similarly, the agreement with Bukit Asam, Indonesia to
develop a railway line in exchange for coal will take ~4 years execution.
• Increase PT to Rs665, maintain Neutral: In our view, with ~70% of
value already being discovered, we'd rather play the individual stocks for
any upsides there. We recommend switching to Mundra Port (N, PT
Rs161), given the recent correction post the recent MoEF show cause
notice. Our SOTP includes 36% for power, 34% for ports, 13% for coal
mining, 21% for coal trading, the balance coming from smaller
businesses along with a 10% conglomerate discount
Outperformed the pack with fewer regulatory hiccups and
value unlocking
While infra conglomerates had a bad run in 2010, ADE outperformed the market and
its peers on account of: (1) Listing of its two key verticals (70% of SOTP, Adani
Power listing in 2H09 and amalgamation of MP in 1H10) has aided value discovery.
(2) With value being less opaque, the business model has also been simplified into
three key verticals: power, ports and mining. (3) Fewer regulatory hurdles in ports
and power as opposed to the airports and more certainty of execution than real estate,
which are large contributors for its peers. (4) A change in earnings and return
profile beginning to come through as it transforms into an asset owner from a trader
(JPMe earnings CAGR of 165% thru FY14E and ROE of 29% vs. 20% in FY10).
In our view with ~70% of value already being discovered, we'd rather play the
individual stocks for any upsides there. We maintain our Neutral rating and
recommend switching to Mundra Port (N, PT Rs161), given the recent correction
post the recent MoEF show cause notice.
Coal mining to give the next boost, but value unlocking still
two years out, in our view
We foresee the next leg up for ADE to come via value unlocking in the coal mining
business, which we think is still two years away. The three coal blocks with 1.8B
tons of reserves contribute Rs84.3B to value or Rs12.6/share to our SOTP value of
Rs668/share. We currently do not include the recent 1.6B tonne Chendipada coal
block, given the pending financial closure, land acquisition, and procurement of
clearances.
Current mines: Peak production of 110mtpa by FY18, target: 200mtpa by 2020
Management expects the Parsa Kente block to be the first to commence production in
June 2011, followed by Machhakatta in FY13, Parsa and Chendipada by FY14. We
model peak production of 70mtpa in FY18 i.e., excluding Chendipada. While we
expect continuous capex investments to develop mines, we see an inflection in OCF
in FY13. ADE has already bid for the Mahanadi block in Chhatisgarh (next to
Machhakatta) with a peak production capacity of ~30mtpa.
Coal trading: A bread and butter business but a large
contributor to value
ADE is India's largest coal trader; with 28.8MMT of volumes in FY10 (CAGR of
~40% over the past four years), the company had a 42% market share of India’s
total coal imports. Management guides to 35MMT of volume (up 21% yoy) in
FY11, which is in line with our estimate. We expect EBITDA to grow at a CAGR of
19% thru FY14. Based on 12x FY12 P/E, we value the ICM business at Rs146B
(Rs133/share, 20% of total value) compared to Rs81B (14.5x FY11 P/E)
previously.
Management expects to earn sustainable margins of ~$8-9/ton driven by purchase
efficiencies, recovery of handling charges and sales strategy. Usually arrangements
with clients and suppliers are on a back-to-back basis for -6 months with ~15-20%
of volume coming through stock and sale arrangements with IPPs, thus mitigating
any price risk. We increase our sustainable EBITDA margin estimate by 150bps
to 8%, resulting in an improved value for the ICM business.
Overseas assets: very long-term value drivers but possible
drain on near-term cash flows
With the lack of complete clarity and pending financial closure of the Galilee and
Bukit Asam projects, we do not yet include them in our SOTP valuation for Adani
Enterprises. However, the ultimate use of coal from both will be used to ensure fuel
supply for Adani Power’s potential generation capacity of 20GW by 2020 in the
absence of domestic linkage coal. Also, it could alternatively be used for trading as a
part of the ICM (coal trading) business with possibly improved margins, given the
control on cost. That said, these projects run the risk of cost operating overruns,
delayed execution, and inflated capex.
What is the Galilee project going to cost Adani Enterprises? … A look at some
other projects in the Galilee Basin
The Galilee Basin in Central Queensland is expected to have coal reserves of ~100B
tones. However, currently the basin has very limited rail connectivity to the nearby
ports of Abbot Point, Hay Point and/or Dudgeon Point. COALRail is forecasting an
eventual 100-130MTPA demand from mines in this region based on the current
announced projects.
Given the capex outlay planned by other players in the region (see Table 5 below),
ADE could incur $3.0-6.8B of cpaex for Phase I of 30MTPA, in our view. This
includes its own railway line ($1.5-2.0B), proposed 30-60MPTA ($1.0-2.5B) of port
facilities at Dudgeon point and mine development capex ($2.0-2.3B for Phase I of
30MTPA). The Hancock rail network will have spare capacity for third-party users;
ADE is exploring using this as an option as opposed to setting up its own railway
line.
According to management, they are likely to incur capex to the tune of $1.5B for the
railway and mine to establish a production capacity of 14MPTA initially (by FY17 in
our est.).
Coal purchase agreement with Bukit Asam
ADE has entered into a binding agreement with the governments of South Sumatra
and PT Bukit Asam, a 65% government-owned coal mining company (PTBA IJ) to
own, construct and operate a 250km rail line capable of transporting 35MMTPA of
coal (expandable to 60MMTPA) from the mining area of Tanjung Enim to Tanjung
Carat. ADE will have the right to purchase 60% of the coal transported at a govt.
denominated price and freight revenue on the balance 40% (currently ~$11/ton) over
the 30-year concession Period. See our recent Note ‘Another Move to Secure Long
Term Fuel Requirements’ for additional details.
Improved balance sheet health
String of corporate actions to reduce leverage
As of FY10, ADE’s net debt-to-equity was relatively high at 2.4x, which we expect
to reduce to 1.7x in FY11 on account of the corporate actions listed below. Hence, in
our view, risk of excessive leverage is mitigated for ADE. Also, we do not foresee
any capital infusion in the near term. We model the company to incur capex to the
tune of ~Rs400B over the next five years and leverage to reduce further as cash
flows from the ports and power businesses accelerate.
1. Rs40B raised through the recent QIP @ Rs536/share.
2. Rs15B raised through a rights issue @ Rs475/share.
3. Conversion of Rs9.8B of FCCBs at the hold co level to result in the issuuance of
31M shares.
4. According to management, holding company debt of Rs34B outstanding as of
FY10 reduced to Rs3.5B via proceeds from a right issue and conversion of
outstanding FCCBs.
5. Amalgamation of Mundra Port to result in the issue of 465M shares in a share
swap agreement. However, MPSEZ had a much lower gearing of 0.78x
consolidated net debt-to-equity as of FY10, which has a positive impact on
ADE's balance sheet upon consolidation.
Power and Ports to be key contributors, MDO to pick up
beyond FY13
We forecast PAT CAGR of 70% through FY14, with Adani Power (174% CAGR,
41% of FY14 PAT), Mundra Port (41% CAGR FY11-FY14, 25% of FY13 PAT)
being the key growth drivers. Beyond FY13, we also see a marked pick-up in the
other two important businesses of AEL – MDO and real estate. Through FY13, we
believe these businesses would be in investment/development phase.
FCF positive in FY13
In our view, ADE will become FCF positive in FY13 as operating cash flows from
power and ports accelerate. We also see MDO and real estate businesses starting to
make modest contributions. Capex for Adani Power begins to decelerate in FY13,
while we expect steady investments in ports and power to continue.
Valuation and price target
We roll forward our SOTP-based price target to Mar-12 and increase it to Rs665 vs.
Rs640 earlier. Our PT incorporates the increased values for Adani Power (OW, PT
Rs153) and Mundra Ports (N, PT Rs161) based on our published PTs for these
covered stocks which, in turn, are based on DCF of individual assets.
Our SOTP includes 36% for power, 34% for ports, 13% for coal mining, 20% for
coal trading, the balance coming from smaller businesses. We have taken a holdco
discount of 10% vs. 5% previously.
AEL trades at 14.3x FY12 EV/EBITDA, in the middle of the pack compared to other
conglomerates like RELI at 11.5x, GMR at 14.4x, and GVK at 16.0x. Our price
target implies a 14.7x FY12 EV/EBITDA. We maintain our Neutral rating and
expect the next leg up once the MDO vertical reaches a mature stage for potential
listing. Key upside risks: Increase in merchant prices, increase in port traffic, Key
downside risks: Slower-than-expected development of MDO business and cost
overruns at Galilee/Bukit Asam.
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