Adani Ports & SEZ rating ‘neutral’: KPCL deal in likely to be value-accretive

We view the deal to be value-accretive, based on management estimates, as our TP of Rs 430 for ADSEZ implies an EV/Ebitda multiple of 10.3x on FY21F numbers.

ADSEZ announced on January 3, 2020 that management has entered into an agreement with the promoters of KPCL to acquire a 75% stake in the company for an enterprise value of Rs 135.72 bn. Management estimates the acquisition at 10.2x FY19 Ebitda and 8.6x on FY21F Ebitda estimates. We view the deal to be value-accretive, based on management estimates, as our TP of Rs 430 for ADSEZ implies an EV/Ebitda multiple of 10.3x on FY21F numbers.

KPCL’s EV consists of Rs 62.12 bn of debt in 1HFY20 and equity at Rs 73.6 bn; thus ADSEZ requires Rs 55.2 bn as cash to consummate the deal and this will be funded by internal accruals. While near-term leverage metrics may deteriorate, in our view, management estimates that by FY21 net debt to Ebitda will stabilise at 3.2x, which is largely similar to FY19 levels. Further, with limited capex of Rs 7.5 bn over FY20-25, management expects to increase capacity from 65mnt at present to 100mnt largely through de-bottlenecking investments.
We do not expect significant challenges in completing the acquisition

The acquisition of KPCL significantly increases ADSEZ’s footprint on the East Coast and should increase access to the southern hinterland around Andhra Pradesh. Further, we assess that the likely change in industry concentration by this deal will not be significant to face possible regulatory intervention. Thus, we expect the deal to close by end-FY20F.

Significant scope for cost reductions
We have benchmarked KPCL’s realisation and cost profiles against Dhamra (dry bulk port) and with Kattupalli (container port) to estimate if the potential cost optimisation, as highlighted by management, is feasible. We estimate that while a reduction in the cost of operations to Rs 130/T (ex of royalty) may seem challenging, it can be feasible based on mgmt’s cost saving assumptions. It expects Ebitda margins to improve from 54-55% levels historically to 65%+ from FY21 onwards. Based on our estimates, Ebitda margin improvement to at least 60%+ looks a definite possibility.

Mgmt guides for strong volume growth
At present, port capacity is 65mnt and management expects to take it up to 100mnt by FY25 through de-bottlenecking and the present evacuation infrastructure is adequate for 100 mnt. Thus, there is enough scope for cargo volume growth, in our view. Overall, management forecasts cargo to increase from 54mnt in FY19 to 84mnt in FY25 (9.1% CAGR) and reach 100 mnt in another two years. The cost savings should lead to Ebitda doubling in 4 years, according to management estimates.

Maintain Neutral with a TP of Rs 430
We value ADSEZ on DCF, based on a 12.5% cost of equity to arrive at a TP of Rs 430, with Neutral rating. Weaker volumes and rising debt are downside risks, while strong OCF generation is an upside risk.