Adani Enterprises' fair value at ₹945, says valuation guru Aswath Damodaran – a detailed assessment of stock by him

Valuation guru Aswath Damodaran believes even without factoring in the Hindenburg effect, the valuation of Adani Enterprises stock deserves a price of ₹945 per share.

Shares of Adani Enterprises collapsed nearly 54 percent to ₹1,586.80 on NSE on February 3, since the release of the Hindenburg report on January 24.

Despite a colossal 54 percent fall, shares are still highly-priced, Damodaran believes.

He teaches corporate finance and valuation at the Stern School of Business at New York University.

In his blog on February 4, 2023, Damodaran dissected the fundamentals of Adani Group's flagship company Adani Enterprises.

(Meanwhile, if you want to read the basics of stock valuation, you can read this: What does stock valuation mean and what are the key matrices to determine it?)

It is important to note that a company's past and current financial performance, ownership, management and business model are some of the important factors to determine the true value of its share price.

So, Damodaran has considered several aspects, including the nature of the business, historical performance, and the ownership structure, to support his assessment of the stock price.

Let's try to understand what he said.

What is Adani Group's main business?

Damodaran pointed out that barring Adani Wilmar, which is a food processing business, the Adani Group is primarily involved in the infrastructure businesses, requiring large up-front investments and having long gestation periods, with regulatory and government oversight.

"An increasing proportion of the company's investments are related to energy, (in green energy and gas transmission/distribution), but the company's most significant investments are in logistics, especially in airports and ports. While each of these businesses is operated by a stand-alone Adani company, the businesses flow through a holding company, Adani Enterprises," Damodaran added.

What has been the growth trajectory of the group?

Damodaran underscored the Adani Group was not among the top 10 groups of the country - in terms of revenues or market capitalisation or enterprise value - as recently as ten years ago.

However, at the start of 2023, four Adani companies were in the top twenty Indian companies, in terms of market capitalisation. 

“The collective value of the seven publicly traded Adani companies was $220 billion ( ₹17,600 billion), greater than the market capitalisation of Reliance, the Ambani family flagship, and India's largest company,” said Damodaran.

"The surprise is that this dramatic boost in market capitalisation happened at a family group built around infrastructure businesses, where investors have to wait for decades for payoffs, and are often not driven to sudden changes in value assessment," said Damodaran.

What have been the operating margins?

In order to understand Adani Group's market prominence, Damodaran dissected the 20-year history of Adani Enterprises' revenues and operating income.

He broke the 20-year history into three sub-periods-

(1) The 2002-2015 time period, where the company grew its revenues steadily and reported solid, albeit low, profitability.

(2) The 2016-2021 time period after a major restructuring in 2015 that spun off Adani Ports Adani Power and Adani Transmission, as separate companies.

(3) The most recent year and a half (from March 2021 to September 2022), where the company reported a quantum leap in revenues.

"While the revenue part of the 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," Damodaran observed.

"While some of the declines can be attributed to the revving up of reinvestment in new businesses, it is also worth emphasising that even when these investments start paying off, they will remain low-margin businesses," he said.

A steady decline in return on invested capital

Damodaran said Adani Enterprises' return on invested capital has steadily declined, even as it has scaled up, hovering just over 3 percent in 2021-2022.

Damodaran finds Adani Group's rapid growth surprising

Damodaran said it is rare to see infrastructure companies grow as quickly as Adani has, and the reason is that growth in this business requires large investments in capacity.

"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.

Heavy debt burden

Damodaran said the company funded almost all of its growth with debt in the last 20 years. He added that the company continued to pay a 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.

"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," Damodaran said.

"The debt-to-book capital ratio stayed high through the period, but the rise in market capitalisation in 2021 and 2022 lowered the debt-to-market capital ratio," he added.

A "family" business

It is normal for the family group companies to be controlled and run by the families, but Damodarna highlighted that the degree of family ownership in the Adani Group is high, even by the standards of Indian family group companies.

"Consolidating across the Adani companies, it looks like the family owns about 73 percent of the outstanding equity in these companies," said Damodaran.

"While a family controlling a significant portion of the equity in a family group may not surprise you, the fact that this ownership stake has hardly budged over a decade where the company has increased in scale more than ten-fold, with dependence on external capital for that growth, is striking," said Damodaran.

How has the market perception of Adani Enterprises been over time?

In the last two years, the surge in the stock price of Adani Enterprises has been striking on every pricing metric. Damodaran highlighted that the PE ratio (price-to-earnings ratio) for the stock has gone from a modest 15 times earnings in the 2016-21 time period to 214 times earnings in the most recent two years.

"The enterprise value has jumped from about 12 times EBITDA during 2016-21 to 53 times EBITDA in the most recent two years. In the price to book, 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," Damodaran added.

What is Damodaran's assessment of Adani Enterprises' stock?

Damodaran said even though Adani Group did not manipulate its stock price directly, it used the surge in its market capitalisation to its advantage, especially when raising fresh capital.

"Adani, notwithstanding all of its flaws, is a competent player in a business (infrastructure), which, especially in India, is filled with frauds and incompetents. A more nuanced version of the Adani story is that the family group has exploited the seams and weakest links in the India story, to its advantage, and that there are lessons for the nation as a whole, as it looks towards what it hopes will be its decade of growth," said Damodaran.

Damodaran said the market was over-stretched when it valued the Adani companies collectively at $220 billion ( ₹17,600 billion) and Adani Enterprises at $53 billion ( ₹4,243 billion).

"A valuation of Adani Enterprises with upbeat assumptions on revenue growth and operating margins, and without factoring any of the Hindenburg accusations of fraud and malfeasance, yields a value of just about ₹ 945 per share, well below the stock price of ₹ 3,858 per share," said Damodaran.

"Even with the share price at ₹1,531 per share, I still think the company is priced too high, given its fundamentals (cash flows, growth and risk) and before factoring the damage that might have done to the company's reputation and long term value, by this short selling episode," said Damodaran.

Disclaimer: This article is based on Aswath Damodaran's blog. The views and recommendations given in this article are those of the analyst. These do not represent the views of MintGenie.