Will Adani Group be able to survive after witnessing a Debt to Equity ratio of 2021%

On one humid Sunday morning, you sit on the balcony of your house, only to read a newspaper thinking what a lovely day it is! Oh! suddenly a news headline catches your attention –  “Gautam Adani Now World’s 3rd Richest, First Asian In Top 3”.

Now I am sure as an Indian, it would be a matter of utmost pride for you but a conscious part of your brain will also provoke you to wonder how on Earth can a person become so richer than the government when you are still struggling with your EMIs. 

Interestingly, after watching TV shows like Scam 1992 and Shark Tank, I am sure every Indian has discovered this hidden entrepreneur inside them and now they very well know that the rich folks don’t hold their money in their bank accounts, rather they own a part of the business and this is what makes them rich. And since we are in the middle of a bull run, the valuations of the company are over inflated at this point and Adani is no outsider in this case. Today we are gonna unveil one such company of the Adani group that is trading at a P/E ratio of more than 750 and holds a debt to equity ratio of 2021%

Many of you might have guessed it right but let me draw the curtains for you. It’s none other than – Adani Green !

The company is one of the seven listed entities of Gautam Adani’s empire. From ports to renewable energy, this company has witnessed its debt to equity inflate to second highest in Asia triggering an alarm on whether the billionaire’s aggressive expansion plans have over-leveraged his businesses. 

But before moving forward, let us understand What is Debt to Equity ratio?

A debt to equity ratio indicates the financial leverage that the company uses in its operations and is calculated by dividing the company’s debt by shareholders equity. In simple terms, it tells us the amount of financial leverage a company has, in terms of having funds to cover all the debt the company owes. 

A high debt to equity ratio is an alarming situation. Generally, across industries, analysts see 2 as the ideal D/E ratio. This means that there is one equity instrument for every 2 debt units, which is considered healthy. Meanwhile for asset heavy industries like steel or even banks this ratio can go as high as 8 to 10. 

But what would happen if the same debt to equity is 2021% ? Now, that would be a very alarming situation for the company. Isn’t it? So, this Adani’s company has a debt to equity ratio of 2021% and is only behind China’s Datang Huayin Electric Power Co., which has a ratio of 2,452%, among 892 listed companies in Asia, according to data compiled by Bloomberg. 

Not only this but this company is the most leveraged of the companies in the tycoon’s empire as it always relies on debt to fund the conglomerate’s $70 billion pivot toward renewable energy.

So what’s the problem here?

You see Adani is not like any other platform companies – Zomato, Ola or OYO where they have zero assets and so much bloating or in other words over inflated valuation.

Adani group has assets – they have ports, infrastructure, power leases, power distribution licenses and what not. Now an important question arises that If they have so many assets, then what is the problem?

Well, the problem is their business model – it is less about growth and development and more about value bloating. Let me explain:

Rather than to invest in a port, make it profitable then invest in another port and make it also profitable and repeat the same process until you hold a large number of ports and other infrastructure. They invest in nothing; rather they borrow a large chunk of money from the bank and invest that money in the port. Further they use that port as collateral to get a loan for establishing another port and so they are heavily encumbered. They gamble on the fact that the value of port land will increase and as long as their port value increases, their stakes in the port will increase and subsequently their collateral will become more valuable. By this way they will be able to renew their loans.

But this is not a bad deal for the bank and lenders, afterall all the loans extended by the banks are still less than the value of collateral used. So for example if you want a loan of 10 lacs then the bank will only give you 70-80% which in this case would be 7-8 lacs. 

However the “Adani group has overshot”. As we know, the group is heavily based on the port model but things turned ugly as they began to raise heavy debt on the Power distribution companies. Sadly this is not an appreciating asset and the collateral against this is not fixed assets like ports but rather Adani group’s own shareholdings. Likewise they have borrowed more and more money for Green Energy farms or edible oils etc. 

THIS IS A MASSIVE BLACK HOLE !!

As we know the Adani group has a huge debt over their head. But this debt against port and infrastructure is always safe and secured because the land value always appreciates. Interestingly, no one knows how much they have borrowed against ports and infrastructure but the good news is that the collateral is always valuable.  

The debt against power companies, green energy companies and edible oil is not very secure. Though they are secured by the personal guarantees and shareholding just like that of Vijay Mallya. Until now, we have quite understood that if this debt grows then the value of collateral must also increase in order to raise more debt and sustain operations. The only way to do this is by:

1. Dubious accounting
2. Manipulating share prices and keeping them rising.  

Now we might not be sure about the first part but we can be certain about the second part as the Adani Green’s share price rose more than 8000% over the period of last 5 years.

So, the Adani group is massively overextended. Their power lines, green energy are all crippled by debt and a lot of this debt is based on shareholdings and valuations & accountancy rather than the hard core assets’ (Not for Ports and Infra business though). Also Fitch recently published a report titled – “Adani Group: Deeply Overleveraged” that stated the aggressive expansion plan led by Adani group that has pressured its credit metrics and cash flows.  

“In a worst-case scenario, overly ambitious debt-funded growth plans could eventually spiral into a massive debt trap, and possibly culminate into a distressed situation or default of one or more group companies. In the Adani group’s favor, we take comfort in its solid banking relationships with both domestic and international banks, which have been willing to lend the group large amounts for both its existing businesses and new ventures”, the report said.

The only way for the group to survive is that their ports become ultra valuable and their security is enough to cover the massive borrowings of their other businesses. Or their revenue shoots to a peak all of a sudden but even then the shareholders will take a toll as their Earnings per share would decrease. 

Who takes a massive hit due to debt?

Of course it is the shareholders who would take a toll due to this surmounting debt. You see, the shareholders get the money only after all the expenses are taken care of and interest is one such column. With more debt on books, the value of interest to be paid will also increase which in return would decrease the cash left with the company. This would result in no or negligible dividends and a falling Earnings per Share. The rising interest rates are also serving as a cherry on the cake in this situation. On August 5, 2022, the Reserve Bank of India (RBI) announced a third repo rate hike to 5.40%, up 50 basis points with immediate effect. Amid heightened risk of recession, the RBI maintained its inflation projection at 6.7% in 2022-23 and real GDP growth projection at 7.2%. Now, with rising interest rates, the interest available will be of higher cost which again would cripple the shareholders.  

But when will this happen?

It is only possible if India signs an RCEP (Regional Comprehensive Economic Partnership) with China because China is only capable of so much volume on their port. If this happens then Adani group’s port business will boom which would give him enough revenues to survive and settle the debt. 

The conglomerate has shrugged off concerns thus far, and has continued apace with its acquisition agenda: On Tuesday it launched a hostile bid for New Delhi Television Ltd. as part of a plan to expand its footprint into media and broadcasting. 

“The group’s aggressive growth is mainly debt-funded, though it has a track record of obtaining third-party investments, such as TotalEnergies’ $2.5 billion investment in Adani Green Energy,” wrote Bloomberg Intelligence analyst Sharon Chen.