Weak economic revival, global trade impacting port traffic: Our analysis of traffic at major ports, Adani Ports and Gujarat Pipavav (GPP), that cumulatively account for around 70% of India’s port volumes, suggests a slowdown in port traffic growth in 1H CY15, as weaker-than-expected domestic revival has impacted nonoil-non-gold imports while weak global growth continues to impact exports growth. The sector witnessed a tepid 3.9% y-o-y growth in 1H CY15.
Expect container traffic growth to be subdued near-term
After registering a robust 11% y-o-y (year on year) growth during 9MFY15, container traffic has slowed down to just 3% y-o-y in 1H CY15 owing to the weak EXIM trade. Our economics team has recently cut its growth estimates for non-oil-non-gold imports as well as for exports (ex-services). Besides, we believe that with containerisation already >50%, the scope for its rapid expansion going forward is limited. Consequently, we cut our estimates for container traffic growth for the sector from 9.5% CAGR (compound annual growth rate) in FY15-19 to 7.1% now.
Coal imports growth robust; but see risks going forward
Despite India’s muted power demand growth at 0.5% in 1HCY15 vs robust 8.5% domestic coal production growth, growth in coal traffic has remained strong at 20% driven by a robust 24% y-o-y growth in thermal coal. However, our bottom-up power and coal demand-supply analysis suggests that coal imports growth would turn flat in FY17 before starting to decline from FY18, as we expect Coal India to ramp-up its production at 11% CAGR in FY15-19. Thus, we cut our estimates for coal traffic growth for the sector from a 3.3% CAGR in FY15-19 to 1% now.
Expect only 4.5% CAGR in port traffic in FY15-19
Port traffic growth has a strong correlation with GDP. However, despite an improving economy, based on our bottom-up cargo-wise analysis, we expect port traffic to register a CAGR of only 4.5% in FY15-19 vs 4.7% recorded in FY10-15. We attribute our estimates to: (i) muted refinery capacity adds, which could hurt crude/POL (petroleum oil and lubricants) traffic (37% share in FY14), (ii) ramp up in domestic coal supply, impacting coal import traffic (24% share), and (iii) weak growth for containers (17%).
Market share gains by private sector ports would continue
Weak port traffic growth for the sector would also impact private sector operators. Consequently, we have cut our port traffic growth estimate for Adani Ports to 14% CAGR in FY15-19 (vs 18% earlier) and for Gujarat Pipavav to 9%
CAGR in FY15-19 (12%). However, these ports would continue to gain market share from the inefficient & congested major ports operated by the government and given their strategic location on India’s west coast.
Upgrade GPP to Neutral; prefer Adani Ports
We continue to prefer Adani Ports as we expect market share gains to 19% by FY19e (vs 14% now), strong EPS (earnings per share) CAGR of 18% and >21% RoE (return on equity) in FY15E-17e (estimates). Additionally, we upgrade Gujarat Pipavav to Neutral (from U/P) post 29% correction in the share price since April 2015.
Price objective basis & risk
Adani Ports & SEZ Ltd
We value ADSEZ using SoTP (sum-of-the-parts) methodology to arrive at a PO (purchase order) of R394/share. We value each of its port assets based on the (FCFE) free cash to equity-based DCF (discounted cash flow) using cost of equity ranging from 12.8% to 15.5% and assuming it gets an extension in its concession agreements wherever applicable . We value its stake in Adani Logistics at 3x FY17e book value and its stake in other businesses at 3x the invested equity as of March 2017. Downside risks for ADSEZ are:
(i) Potential diversion of ADSEZ’s cash flows towards cash gap for Adani’s group companies (mainly Adani Power),
(ii) continuation of loans to related parties, (iii) $800m of contingent liability towards Abbot Point and (iv) issues in extending Mundra port’s concession agreement once it expires in 2031.
GPP (XJGUF, B-2-7, R171.85)
We value GPP’s core business based on a free cash flow-to-equity-based DCF valuation. We use an 11.9% cost of equity to value GPP, which is lower than our estimates for ADSEZ (cost of equity of 12.8% to 15.5% for ADSEZ), led by GPP’s superior balance sheet and strong parentage. We value its 38.8% stake in PRCL at 17x FY17 earnings, adjusted for the dividends received by GPP for its 18% earnings CAGR expected in FY15-17. Based on this, we arrive at a SoTP-based valuation of R187. Upside risks for GPP are (i) Faster-than-expected ramp-up of new capacities, (ii) Potential of higher-than-20% dividend payouts assumed in our estimates now. Downside risk for GPP is its potentialinability to grow container traffic until it expands its capacity in Mar 2016.
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