Valuation guru Aswath Damodaran finds fair value of Adani Enterprises at Rs 945. In his latest blog on Musing on Markets, Damodaran said even at Rs 1,531, the 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, 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.
Three periods of growth
Damodaran noted 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. The first is the 2022-2015 time period, where the company grew its revenues steadily and reported solid, albeit low, profitability. He referred to 2016-2021 as the second period following the major restructuring in 2015 that spun off Adani Ports Adani Power and Adani Transmission as separate companies. The third period is the most recent year and a half -- from March 2021 to September 2022, where the company's acquisitions of Holcim's cement business holdings Ambuja Cements and ACC in India, led to a quantum leap in revenues.
Damodaran noted that while the revenue part of the Adani Enterprises story is one of almost unstoppable growth, it is worth noting that through 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 per cent 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.
Debt-funded growth
Damodaran said it is incontestable that the Adani Enterprises funded almost all of its growth with debt through this period. In fact, the company continued to pay dividend 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.
Valuations
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 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.
Who drove the stock price higher?
By itself, 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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