»Profit Hunter by Equitymaster

On This Day - 23 NOVEMBER 2020
Is this Sector the Best Contrarian Bet Right Now?

Rahul Shah, Editor, Profit Hunter

To be honest, around a year back I hadn't even heard of this stock and now, Adani Green is one of the most valued companies in India.

Its market cap now exceeds more storied names like Nestle and L&T.

State Bank of India is the only PSU bigger than Adani Green.

And its 10-bagger rise in the last one year has been nothing less than meteoric.

However, when I looked under the hood and tried to understand its fundamentals, I was in for a rude shock.

The company has made losses in four of the last five years. Its balance sheet is loaded with debt and it trades at a stratospheric price to earnings multiple of almost 1200!

Yes, you read that right. No extra zeroes. The PE of the company is indeed well over a 1,000.

Put differently, at current level of earnings, it will take the company 1,000 years to earn the price one is willing to pay for it.

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Let that sink in. One thousand years.

Well, there are companies that value investors don't like to touch even with a 10-foot pole.

Adani Green is certainly one of the top contenders for this rare honour.

Don't get me wrong. I totally understand why investors love this company. They see it as one of the prime beneficiaries of the disruptive shift in the energy landscape.

A shift where traditional hydrocarbon-based energy will be replaced by green energy like solar and wind.

However, this investor exuberance seems to be overdone in my view.

Even if the company logs in very high growth in earnings over the next few years, valuations have run very far ahead of its fundamentals.

So far ahead that there's only a slim chance an investor would make money in the stock.

In fact, I am strongly of the view that this irrational exuberance for green energy stocks has opened up a huge contrarian opportunity in the traditional energy space.

I am talking about stocks like ONGC and Oil India.

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Sample this...

ONGC has never traded this low in more than 15-years. Ditto for Oil India.

Both the companies have stellar profit history with equally attractive dividend payouts. In fact, at current valuations, ONGC trades at a dividend yield of 7% and Oil India an incredibly attractive 12%.

Last but not the least, the debt on their balance sheets is much lower than equity even during these troubled times.

And despite this, both the stocks trade at a massive discount to their latest book values.

This puts the risk-reward equation strongly in favour of the latter.

I know the future of both these companies may not be like its past but is it going to be as bad as the current valuations indicate? Are they always going to trade at a big discount to their book values from here on?

To be honest, no one knows the right answer to this question.

What we do know is that when investors fall head over heels in love with a sector or a stock, they end up taking its price much higher than its true intrinsic value.

And when any sector or a stock falls deeply out of favour, they end up taking its price much lower than its true intrinsic value.

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Right now, traditional energy companies like ONGC and Oil India are deeply out of favour.

And therefore, there's a strong chance their true value is significantly higher than their current price.

This presents a good opportunity for alert value investors looking to exploit this gap.

What do you think?

By the way, do check out this video on why I believe these stocks - with an attractive risk-reward ratio - are better investments than blue chips like Nestle or HUL right now.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

PS: In India's defence space there is a potential 10X profit opportunity. Tanushree will tell you all about it at the Explosive Profits Summit on 1st December. Book your free seat.

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