RNWWW - Azure: Don't Fall For The Medium Term Rally It Will Likely Lead To Long Term Underperformance

2023-05-08 03:30:55 ET

Summary

• Azure is an Indian renewables firm that has recently come under fire, facing severe public scandal.
• Nonetheless, Azure has demonstrated consistent revenue growth, and a rally may be in store once investors get over the scandal surrounding the company.
• However, Azure's revenue growth is incommensurate with that of its industry as demonstrated by one of its peers, indicating long-term underperformance.

Introduction

Azure Power Global Limited ( AZRE ), one of India’s premier renewable energy firms, came under fire in mid- to late 2022 for a marked increase in management turnover that saw it lose four CEOs and a few other executives in the span of about a year ( two CEOs between April and September 2022, and two more between September 2022 and May 2023). Also problematic for the company was the revelation of whistleblower allegations of mismanagement and data manipulation within the company, as well as Azure’s confirmation of the whistleblower’s claims .

These issues have damaged the company’s reputation and prompted investors to sell off the stock, driving it down from over $10 per share in late August 2022, before these incidents, to ~$2 per share at time of writing. In this article, I will briefly explain why I think that even if the resolution of these scandals prompts a rally in the medium term, Azure stock still may not be a good long term pick for investors.

Financials

Financial data on Azure is somewhat sparse after 2021, so I will recap the last 5 full years of data, with fiscal years ending in March.

Total revenues were $65 million, $118 million, $143 million, $172 million, and $208 million in the 2017-2021 period. This is to say that revenue increased at a mostly linear clip of about $30 million per year for the past 5 years, excluding a near-doubling of revenue between 2017 and 2018. Cash flow from operations for the 2017-2021 period was -$400 thousand, $29 million, $31 million, $49 million, and $68 million. Finally, net incomes for this period were -$22 million, -$12 million, $1.1 million, -$30 million, and -$57 million.

To sum up, the core business of Azure has been cash flow positive, but Azure overall has not yet become consistently profitable, and may be declining in profitability over time as of 2021 based on the increasingly negative net income. Not the most encouraging financials, but I have certainly seen worse.

Valuation

Valuation data for AZRE is even sparser than financial data, but there at least is some data of note. AZRE’s forward Price to Book ratio is 0.46, compared to nearly 1.8 for the utilities sector; AZRE’s forward Price to Cash flow ratio is about 1.9 compared to the sector ratio of ~8. Both of these indicate significant undervaluation for AZRE compared to the average stock in its sector, but for the reasons I will explain in the next section, I don’t see long term undervaluation or deep value here.

To clarify, I do see some undervaluation in the short to medium term, as AZRE seems oversold on account of investors’ overreaction to the company's scandals, but in time, underperformance from Azure the company will lead to fair undervaluation of its stock. AZRE is thus something of a long term value trap.

Short term and medium term value investors may net worthwhile returns by going long on AZRE shares and selling after a while, but as I will explain, long term value investors may want to look elsewhere.

My Viewpoint on Azure

Bright Medium Term Prospects

Despite the seriousness of the public scandals weighing on Azure, I think the negative consequences will be relatively short-lived. As a renewable energy firm in a country that is rapidly expanding its renewable energy production and investments , and whose government is adopting aggressive green energy targets , Azure has multiple tailwinds propelling its business and its stock price toward the achievement of decent performance in the medium term. Once investors get over the bad publicity and realize Azure is still a firm that is growing its revenues in an expanding industry with a bright future, they are likely to snap up AZRE shares, contributing to a short to medium term rally for the company.

Still, even assuming that the company does put these 2022 scandals fully behind it, Azure appears poised for long term underperformance compared to peers like ReNew Energy Global Plc ( RNW ).

Dim Long Term Prospects

The major issue I have with Azure as a long-term investment stems from its inexplicably low growth. While the market for solar power in India grew exponentially by 24 times between 2014 and 2022, Azure’s revenues have mostly grown linearly over the past 5 years. As mentioned in the financials section, this mainly consisted of steady ~$30 million increases from ~$120 million to ~$210 million over the past 4 years.

By contrast, ReNew’s revenues from 2017-2022 (fiscal year ending in March) were $200 million, $378 million, $621 million, $642 million, $658 million, and $781 million. ReNew has also banked almost $700 million in revenue from Q1-Q3 2023, indicating that the company has a good chance of making ~$850 million for FY2023.

Aside from the difference in scale of the revenues for each company, what sticks out to me is the difference in revenue growth. Like Azure, ReNew started the late 2010s with an exponential increase in revenues; unlike Azure, however, Renew continued its exponential revenue trajectory in the following years, excluding a slump from 2019-2021.

Not only is ReNew’s revenue base larger, but its exponential growth is more consistent, which should be the case for a successful firm in a nascent and growing industry. Azure’s chronic inability to grow exponentially in tandem with its market is thus a red flag that signals a moderate to high likelihood of long term underperformance.

Risks to Thesis

Questions abound as to what Azure’s current financial numbers might look like. Azure’s 2022 and 2023 data, once made available, could reveal that exponential revenue growth has been renewed at the firm, pun intended. This revelation would be the main risk for the thesis of this article, since Azure’s low, linear growth is primarily what gives me pause.

However, it could also be the case that the reputational fallout from current scandals is set to doom the company, ushering in the beginning of the end for Azure. Investors may sell off the stock further, and Azure’s business partners may soon cut ties with the firm, both due to Azure’s current controversies, culminating in bankruptcy proceedings for the firm. This would erase any chance of Azure having a rally coming its way in the medium term, thus breaking that part of the thesis.

Conclusion

Due to its inexplicably low growth, I cannot recommend Azure Power Global Limited as a long term investment. It seems likely to underperform other companies like ReNew Energy Global Plc in the long term, regardless of the medium term rally that will likely arise once its 2022 issues are settled. However, because of secular tailwinds that will likely propel the company forward, I cannot recommend that long term investors sell Azure either, since its long term prospects, while poorer than its peers in my opinion, are not irredeemably poor.

Therefore, for long term investors interested in riding the wave of Indian renewable energy investments, I rate AZRE a hold.

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