Adani Group: Overvalued?

Adani HQ, Ahmedabad, India

Overview

Adani Group, the combination of all listed companies, has a cumulative ~$200B market cap. It is composed of 8 entities, all centered around infrastructure (except Adani Wilmar which is in the food processing business).

Adani’s rise has been staggering, being almost unknown just 15 years ago. Growth has come from constant acquisitions (generally done by the flagship incubator, Adani Enterprises, until the acquisition is mature enough to spin off). The most recent has been Ambuja Cement which in turn bought Penna Cements; this is a bet on growing Indian infrastructure demand in rural zones. Adani Group, based in Gujarat, India, can also attribute its rise to Gujarat’s former chief minister and close partner rising to become the nation’s prime minister.

Samosa Capital finds Adani Group to be overvalued but likely to see continued long-term growth in its stock price given India’s unusual market dynamics (read here for our piece on why Indian equities as a whole continue to rise without strong fundamentals to back it) and regulator intervention. Investors should closely monitor BJP's prospects in the 2029 national election when determining how long to hold Adani Group stock.

Disclaimer: This is not financial advice or recommendation for any investment. The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

Earnings Misinterpretation

After finding each spin-off’s P/E ratio and weighting all 8 entities’ ratios by market cap, Adani can be assigned a P/E of 155.54. This is astoundingly high considering the conglomerate is in the industrial space with low-profit margins (this past quarter was 6% even off of a huge year). Operating margins have also been decreasing with the flagship Adani Enterprises having one of just 3.6% from 2021 to 2023.

Now an argument for the high valuation is recent earnings. So far throughout 2024, Adani Group has had 65% earnings growth YoY. This would imply a P/E ratio of 140 based on a value investing framework.

Samosa Capital finds this valuation to be unsustainable:

• Airports propelled revenue up by 30% due to reversals from travel lockdowns, a one-time gain

• Revenue and growth have been increasing due to BJP policies that are being rolled back

  • BJP's reliance on coalitions has reduced spending bills benefitting ports, power, and construction

• Earnings growth isn’t taking into account capital expenditures: even if earnings growth, Adani is spending large amounts of available cash on acquisitions and projects which reduces cash flow attributable to investors

  • Gross debt climbed by 13% for Adani Enterprises ($7B) at a time with a higher expected natural rate of interest which will increase the cost of capital

  • On top of bank and bond financing at 7% plus a risk premium, Adani Group is looking for a share sale this month or next which further adds financing costs

  • Even when projects like a new Mumbai airport, a copper mine, and increased cement production manifest themselves, they will remain low-margin ventures

  • As CapEx continues to grow, depreciation and amortization will continue rising further reducing earnings growth

It should be said, however, that even a high debt load is not a huge burden for Adani considering the immense and diversified scale of their holdings. Investors should note that such a scale still does not justify Tesla-esque multiples.

Squeezed Share Supply

An important factor to look at is the supply/demand driver for Adani shares. A recent SEBI report indicates that around 70-75% of the total conglomerate is family-owned. Another 15% is foreign institutions and the rest is domestic. Now if the price action was driven by foreign funds betting on Indian long-term growth, there could be a bullish argument.

The more likely explanation is that the bullish bias that SEBI and the Indian government place (see short selling regulation) has resulted in retail traders playing a ‘greater fools’ game with Adani. SEBI protecting retail traders from the downside is what has led to the overall high NIFTY valuations and exodus of foreign dollars which find the Indian market overvalued in the current state. A P/E ratio of 150 would necessitate 70% earnings growth YoY in perpetuity which for an infrastructure business simply makes no sense.

Family ownership also comes with pitfalls. There will of course be future drama, bad management, and egotistical decisions. Beyond those relationships, the rapid rise of Adani coincides with the rise of another group: PM Modi and the BJP. Receding power reduces the favoritism and protection that Adani has gotten from banks, regulators, and all levels of government.

Political Risk

At this point, it is cliche to point out Adani Group’s cozy relationship with the Modi administration. Still, specific instances of corporate favoritism must be pointed out to show the company’s reliance on a BJP government to maintain strong values.

For example, Modi’s government removed the condition that a single company could win contracts to build more than two airports domestically, allowing them to hand all six of the airport building contracts in 2019 to Adani Group. In a similar vein, Adani Group has been a beneficiary to food subsidy and coal mining contracts. The Economist reports Adani Group “now runs some of India’s biggest ports, stores a third of its grain, operates a fifth of its power-transmission lines and makes a fifth of its cement.” The closeness of Adani and Modi is so well recognized that upon the election of Modi to Prime Minister, a subsidiary of Adani Group’s stock immediately jumped by 23%. Adani Group’s stock swings violently on news of BJP election prospects: when June exit polls predicted a strong BJP finish in the national Lok Sabha elections, Adani Group gained $20 billion in market cap in a single day. When it was revealed that BJP would not hold on to a single-party majority, the gain was completely wiped overnight.

Closing Thoughts

While Adani’s fundamentals are far better than they were when the Hindenburg Report came out, it is still far too overvalued to consider. The entire company came just a handful of Lok Sabha seats away from seeing a 50% devaluation in June. The Hindenburg findings have tarnished the reputation of the company and resulted in much higher scrutiny from foreign investors.

While this would normally mean selling short, that recommendation also seems hard to justify, however. First, SEBI’s regulations make this task in itself difficult. Secondly, similar to Tesla, the market can stay irrational far longer than an investor (especially one who is short) can stay solvent.