Stock Call. Why Adani Ports and SEZ is well-placed to ride the revival in trade

India is the world’s 19th-largest exporter and 10th-largest importer of merchandise goods and services, according to the World Trade Organization (WTO). Aside from being a preferred trading partner globally, India is set to benefit further from the de-bottlenecking strategies of many countries — given its locational advantage and infrastructure.

This expected uptick in trade is likely to benefit the shipping industry the most, with ports constituting about 95 per cent of India’s trade by volume and 70 per cent by value. Within the sector, minor ports are likely to have an edge, given their increasing market share and favourable cost dynamics.

Against this backdrop, investors with a long-term horizon, can consider accumulating the stock of Adani Ports and SEZ.

The company is the clear market leader in India’s port sector, with its 10 ports encompassing 410 million tonnes (mt) of installed capacity. The company surpassed the industry volume growth rate of 4.9 per cent (CAGR) and recorded a growth of 9.7 per cent, over FY17-20.

Over the same period, Adani SEZ’s consolidated revenue and EBITDA grew 12.1 and 9.9 per cent to ₹11,873 crore and ₹7,565 crore, respectively. This is thanks to its diversified business streams (Special Economic Zone and logistics business) and operational efficiencies.

That said, near-term risks around trade volumes due to Covid-induced disruptions remain, which could limit the upside for the stock in the near term. The stock is currently trading at 15.6 times its FY21 earnings (estimated), which is at a 16 per cent discount to its three-year average PE of 18.66 times.

Volumes protected

Amid the growing uncertainties, the management of Adani SEZ refrained from giving out any guidance numbers in the March quarter. But the company appears better-placed to tide over near-term pain and contain the volume drop in FY21.

One, long-term contracts (with a term of five years or above) constituted about 60 per cent of the total volumes in FY20.

This suggests good revenue visibility over the medium term when activity resumes.

Two, the company’s ongoing strategy of further diversifying the geographical and the product mix can aid volumes.

In FY20, its west-east cargo ratio improved to 80:20 from 85:15 in FY19.

Also, in FY15, the company was dependent on coal in a large way — constituting about 47 per cent of cargo volumes. In FY20, the share of coal dropped to 33 per cent and that of container and crude (and other cargo) inched up to 41 per cent and 26 per cent, respectively. The cargo portfolio is set to diversify further with the addition of LPG and LNG from January 2020 onwards.

That apart, about 20 per cent of the company’s consolidated revenues comes from its SEZ, logistics and other businesses. With Adani Logistics’ recent acquisition of Innovative B2B Logistics Solutions, the revenue from logistics business spiked by 65 per cent (y-o-y) in FY20. While the revenues of other businesses increased by 10 per cent (y-o-y) in FY20, SEZ revenues dropped by 5 per cent (y-o-y) in FY20.

Three, the planned acquisitions of Krishnapatnam (will also aid in bringing down the west-east ratio to 65:35) and Dighi ports are expected to be completed by the third quarter of FY21. In the first quarter of FY21, major ports witnessed a 20 per cent y-o-y drop in cargo volume.

On the basis of this, ICRA estimates a 5-8 per cent contraction in cargo volumes in FY21, hinting at a revival in cargo throughput in the subsequent quarters.

Adani Ports appears well-placed to ride this recovery.

Debt and cash flows

Due to the acquisitions, the company’s debt inched up by ₹2,275 crore to ₹29,463 crore in FY20.

However, the debt to equity ratio is still at 1.1 times.

In FY20, the company also refinanced its expensive debt (to the tune of ₹5,500 crore) with cheaper debt, and elongated its maturity profile from three to six years.

While the firm generated healthy free cash flows to the tune of ₹6,600 crore in FY20, it seeks to conserve cash in FY21. Hence, the capex plans for FY21 have been curtailed to ₹2,000 crorefrom its earlier guidance of ₹4,000 crore (compared with ₹3,600 crore spent in FY20).

A key risk for the stock was the high portion of pledged promoter shares — 58.25 per cent in March. This, however, came down to 28.7 per cent in June 2020. The management, in its March quarter earnings call, had indicated that the promoter family is looking for a phased exit from this pledge route of financing over the next 12-18 months.