Why Adani Transmission Is The Best Performer In Power Index

A not-so-widely tracked stock is the biggest gainer on the power index as its improved revenue outlook, lower repayment obligations and acquisition of new projects, among others, offset the concerns over a fall in electricity demand triggered by the coronavirus pandemic.

Shares of Adani Transmission Ltd.—India's biggest private power transmission company with a 25% market share as of March 2020—surged almost 47% in the last one month. That compares with a 3.4% rise in state-owned Power Grid Corp., its only direct peer, and a 3.1% gain in the BSE India Power Index.

Demand for power crashed as all economic activities barring essential businesses came to a standstill during the world's biggest lockdown to contain the Covid-19 pandemic. And even as the nation gradually lifts the stay-at-home curbs, the plunge in electricity demand will drag on. A tariff cut by Maharashtra, too, hurt the Adani Group flagship.

Still, IDFC Securities estimates the private power distributor's operating profit and earnings to grow at an annualised rate of 19% and 40%, respectively, over financial years 2020-22. That will be driven by commissioning of new assets and refinancing-led interest cost savings. The brokerage, which has a target price of Rs 185 apiece on Adani Transmission, also sees new project wins worth Rs 4,000-5,000 crore every year and assumes an attractive returns on capital employed.

Here's what aided the rally of Adani Transmission:

Tariff Framework

The cumulative revenue from the company's four key operating transmission assets is based on a cost-plus tariff framework. These assets, according to Fitch Ratings, are expected to contribute 73% of the overall earnings before interest, tax, depreciation and amortisation in the fiscal ending March 2021. The contribution, however, may fall below 60% thereafter as all new transmission assets in India are awarded on bidding mechanism.

Cost-plus tariff framework allows pass through higher costs, protecting returns, and tariffs are not locked in long-term pacts like in case of competitive bidding.

Margins are higher in the cost-plus tariff framework than competitive bidding, which according to the rating agency offers less protection than the cost-plus tariff model. And as competitive bidding rises, margin of transmission projects may decline.

Revenue Outlook

A low operating risk profile of transmission assets and improved operating performance allow for steady revenue growth. The company's nine transmission assets, including the Mumbai transmission business, have consistently outperformed the government's regulatory return on equity benchmark of 15% over the last three years.

Transmission Capacity

The company expanded its transmission capacity, including under-construction assets, by about 2.8 times to 14,740 circuit kilo-metres over the last four years, according to exchange filings.

Anil Sardana, managing director and chief executive officer, in the company's latest annual report, said maintaining the 25% market share in the private transmission market by growing through organic and inorganic routes is a top priority.

Fitch Ratings expects Adani Transmission to maintain its record of prudently bidding for or acquiring new projects to achieve a robust return on its investments and ensure that its financial profile is maintained. This is reflected in the growth numbers for the company over the last five years as well.

The company's sales and Ebitda grew at a compounded annual rate of 39% and 18.1%, respectively, in the last five years.

Balance Sheet Refinancing

Adani Transmission had refinanced most of its rupee-term debt/bonds with dollar bonds in the financial year ended March 2020. That will reduce its repayment obligations in the next two financial years.

Over the last five years, the average cost of debt reduced by 160 basis points to 9.3% in March 2020, according to the company's annual report. Almost all its debt is now forex loans, which according to the company, is cheaper than domestic loans.

Valuations

Adani Transmission trades at 2.7 times the estimated 12-month forward book value. That compares with Power Grid's 1.32 times. Both stocks are trading below their five-year average, according to Bloomberg data and IDFC Securities.

Valuations have factored in a lot of positive news on growth prospects for the stock. The impact of any sale of assets by the company on valuations will be something to watch out for in the future, according to Parthiv Shah, director at Tracom Stock Brokers. Re-rating of valuations, Shah told BloombergQuint over the phone, will be based on the expected inorganic growth for the Adani Group as a whole.

Key Concerns

Bharat Parekh, analyst at CLSA, said the balance sheet of Adani Transmission, an investment grade company, is worrying, with net debt-to-equity rising to 4 times on account of its recent acquisition of Reliance Infrastructure Ltd.'s assets, and the forex losses due to dollarisation of debt. The brokerage has a price target of Rs 146 apiece, implying a downside of 45% from the current market price.

The company's consolidated debt, according to an exchange filing, has tripled over the last five years to Rs 23,526 crore. Debt repayments for the fiscal ending March 2021 stand at $24 million ($12 million in September 2020 and $12 million in February 2021).

Also, as of March 2020, Adani Transmission's promoters held 74.92% stake in the company, of which 53.63% is offered as collateral by controlling shareholders.

BloombergQuint's emailed queries to Adani Transmission remained unanswered.

Capex Plan

The company pegged its capital expenditure for the ongoing fiscal at Rs 3,000 crore, including that of Adani Electricity Mumbai's Rs 1,500 crore, and has no plans to curtail it, according to its annual report. The company has commenced work from June as the lockdown restrictions eased.

Besides, Adani Electricity Mumbai has received an approval from the Maharashtra Electricity Regulatory Commission for a high-voltage direct current line and construction work is expected to start by September, according to annual report. The total project cost is Rs 6,000 crore and is expected to be completed in 36 months. Last month, Adani Transmission, according to an exchange filing, acquired Kharghar Vikhroli Transmission for a period of 35 years.