Adani Enterprises

Shareholders of Adani Enterprises (Adani), a business conglomerate with interest across industries, can consider subscribing to the rights issue made by the company. At Rs 475, the offer price is not at a significant discount to the market price of Rs 479. Besides, at a ratio of one share for every 16 held, the offer is unlikely to add significant exposure to investors' current holdings.

However, given the good long-term prospects that the company's assets provide, investors can consider subscribing to the rights. The stock can also be accumulated on dips in the open market.

Adani is set to hold a potent portfolio of 9,240 MW of power-generating assets (by 2013), a private port facility which can be expected to handle over 40 million tonnes of cargo annually, besides 70 million tonnes of coal mining operations.

In short, Adani Enterprises is in the process of undergoing a complete transformation of identity — from a low-margin trading house to a conglomerate that would hold a lucrative portfolio of annuity-yielding assets. Investors, though, may have to wait for at least two-to-three years, to reap benefits from the same. At the offer price, the stock trades at 15 times it per share earnings expected for FY-11. We have factored in an expansion of about 15 per cent in equity as a result of the proposed qualified institutional placement(QIP) of about Rs 4,000 crore, after the current rights offer. This valuation is based on current streams of revenue.

Once through with all its approvals, Adani would hold an 81 per cent stake in Mundra Port, a listed port player with a market capitalisation of over Rs 30,000 crore. It already holds a 70 per cent stake in Adani Power. The per share value derived from the listed entities on a post-QIP equity base would be Rs 204 per share from Adani Power and Rs 283 per share from Mundra Port.

The calculation assumes that the promoters would be issued that many equity shares (for the Mundra deal) which would result in keeping their stake in Adani Enterprises unchanged at 75 per cent.

Power assets

From a business that generated over 90 per cent of its revenue from trading of coal, power, metals and minerals and agricultural products, Adani has moved to owning assets such as power utilities, operating coal mines, gas distribution, and refining and processing of agro products.

Of these, we view three segments as being key drivers of revenue for Adani — coal mining, power and port.

The subsidiary, Adani Power, has 330 MW in operation, with another 330 MW to go onstream anytime now. With the company already tying up funds for over 9,000 MW, execution would be the key event to watch out, for earnings accretion.

A 70:30 ratio of power purchase agreements and merchant power is expected to provide a healthy combination of steady revenues and some market-driven pricing. Fuel linkages at competitive rates from its parent and tax exemptions arising from being located in a SEZ are the key advantages for Adani Power.

Robust port operations

Mundra Port, the first port to be listed in the country, handled close to 36 million tonnes of cargo in FY-09; almost double that of FY-07. Mundra's unique combination of steady revenues from long-term contracts with auto makers, oil refineries and power companies in the region, coupled with volume growth from the diversified cargo mix it handles leave less room for volatility in earnings arising from slowdown in foreign trade.

Mundra's sales and net profits for the nine months ended December 2009, stood at Rs 9,257 crore and Rs 5,087 crore respectively.

Adani is stated to be the largest importer of coal to India with a 49 per cent market share in imports supplied to top players such as NTPC. While the company has its own coal mine in Indonesia, it has entered into joint ventures for coal mining in three locations in the country for mining and processing of coal for power stations.

Though coal mining now contributes less than 1 per cent to its revenues (Indian mining operations yet to commence), the segment could provide superior access to the supply-end of the coal trading business and also insulate the company from international coal prices.

The operating margins too would be superior to mere trading of coal, given the exploration mining and processing activities involved. The company's power trading business accounts for 8 per cent of its total revenues and is set to increase from Adani's power's merchant trading.

Overall, apart from the port business (which is also a crucial link for transport of coal), the power business of Adani is fully integrated from fuel to power trading.

Risks

Adani's subsidiaries, though, hold risks that could pose a threat to earnings. Changes in mining policies in Indonesia could increase coal costs; two, Adani Power is involved in litigation for one of its power purchase agreements in Gujarat; three, the company is yet to prove its strength in coal mining operations in India.

Adani is also highly geared with a debt-equity ratio in excess of 2.5:1. While much of the proceeds from this Rs 1500 crore offer would go towards repaying debt,a QIP placement could be the only way to ensure that leverage does not once again reach alarming proportions. However, such high leverage is not uncommon in nascent asset-intensive businesses.

For the nine months ending December, Adani's revenues stood at Rs 18,064 crore and net profit was Rs 580 crore.

Current net margins at about 3 per cent are set to increase as revenue from the power subsidiary expands and interest cost reduces. The offer closes on April 15.