Underfollowed Azure Power Global Offers Investors Exposure To Dual Powerful Macro Drivers Of India's Development And Increased ESG Investing

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I wanted to take a different approach with this article and write about a company that I have owned for quite a while that does not seem to get much coverage/exposure either here on Seeking Alpha or in the financial media universe at large. Seeking Alpha is usually one of my go-to resources for getting some color on companies and understanding their stories, but there has not been a new Seeking Alpha article on Azure Power Global Limited (AZRE) in almost five years, before the company became publicly traded, so I decided I would take it upon myself to put pen to paper and give readers a starting point on the company.

Image Source: Company Website

For full disclosure, I first bought Azure in February 2019 at around $11 a share and have held ever since. Trading at a current price at the time of writing of about $15.40, I am up close to 40% on the position. It would have been nice if I recommended it back then, but since I was recently weighing the option of adding to my position, my thought is that it would be as good a time as any to conduct some research and write an article about it. With the strong performance as described above, and the fact that shares have held up relatively well during the COVID-19-related market downturn, it seems that the company is deserving of more attention.

Company Background

Founded in 2008, domiciled in Mauritius, listed on the NYSE and based in India, Azure Power Global is “a holding company which engages in the development, production, and sale of solar energy.” Azure provides its services to both government utilities and “independent industrial and commercial customers.”

Azure states that “We developed India’s first private utility scale solar project in 2009. Since then, Azure Power has grown rapidly to become the leader in developing and operating solar power plants in India.” The company has a portfolio of over 7 GW across 24 Indian states, including 40 operational utility scale projects and several commercial rooftop projects. It seems that the company has projects in all Indian states/provinces save for the three northernmost states and the far eastern states, which is not a bad thing as that region of the country has a less accommodating climate for solar power.

India Macro Driver

Looking at things from a top-down perspective, the investment case for Azure is fairly clear. India is widely seen as a nation that will experience significant economic growth in the coming decades. Accompanying this rapid economic growth will be an increase in power and energy demand as businesses ramp up operations and citizens move into the middle class (and also migrate from rural to more urban areas). India’s lack of infrastructure is listed as an obstacle to future economic growth by the World Economic Forum, which would obviously be a challenge to many countries, but should be a tailwind for Azure since they are part of the solution for building out this infrastructure.

In its prospectus before going public in 2016, Azure stated that,

“India’s economic growth is intrinsically linked to the increasing consumption of energy and natural resources. Energy demand has outpaced capacity additions in recent years, which has resulted in persistent peak power deficits in the country. Solar is an attractive option to help address this energy gap driven by regional fundamentals and regulatory support by the Indian government. The Indian government increased its 2022 target for solar capacity from 20GW to 100GW. The following trends have made solar a large, rapidly growing market opportunity”

Image Source: Azure Power Global JPM Energy and Renewable Conference Presentation

According to its presentation at the JPM Energy & Renewables Conference from June 16th, 2020, India’s electricity usage per capita is 0.9 MWh. This is about one-fifth of China’s per capita electricity usage of 4.3 MWh. Furthermore, the United States dwarfs both of these countries with a per capita usage of 12.8 MWh, about 14X that of India. Broadly speaking, the U.S. is much more developed than India as a whole, but if we extrapolate that India will begin to catch up to the levels of the development curve that China is currently on, that would imply a 500% increase in electricity usage for India. This seems to support the fact that the Indian government increased its 2022 target for solar capacity by 5X. Additionally, the company states that there are approximately 100 million Indian citizens without a direct power source. As you can see, this provides Azure with a huge growth runway ahead.

Source: Azure Power Global JPM Energy and Renewable Conference Presentation

Indian Climate

An additional advantage that Azure Power Global (and really any other solar power company operating in India) enjoys is India’s sunny climate, which is unsurprisingly conducive to solar energy. In reviewing the company’s prospectus, I found that,

“India ranks among the highest irradiation-receiving countries in the world with more than 300 days of sunshine per year in much of the country. Solar power generation is viable across most of India, unlike wind and hydro resources which are concentrated in specific regions.”

India’s peak season for energy demand is the summer season which is also the peak season for solar energy generation. Unlike the U.S. or Canada, most of India does not have a harsh ‘winter’ season, which is obviously less conducive to solar energy. (Remember that most of the company’s projects are in the southern and central portion of the country and exclude the colder/less hospitable northern provinces like Kashmir).

Additional Advantages

The aforementioned irradiation, combined with the government’s favorable attitude towards solar and willingness to subsidize projects, has allowed solar to become the lowest-cost source of energy in India, at 3.5 cents per kWh. It’s important to note that without this government support, solar would be more expensive than conventional sources of energy (see risks section below), but for the time being, it seems like the Indian government is strongly committed to accelerating the country’s solar capacity (i.e. increasing capacity to 100 GW by 2022 from a current 38 GW), and Azure should continue to benefit greatly.

The company also touts its in-house EPC (engineering, procurement, and construction) capabilities and says that this in-house expertise helps it to offer low-cost power solutions to customers.

While beyond the scope of this article, India is perceived to be a potential beneficiary of the U.S./China trade war as more large global companies may move their operations to India. Furthermore, disruptions to supply chains based on the COVID-19 outbreak, as well as increasing concerns over intellectual property issues in China, could cause more companies to reconsider having a large part of their operations/supply chain in China. This would obviously lead to even more growth and power demand in India, but overall would be more of just an added bonus on top of the overall economic/demographic trajectory of the country.

Valuation

It is difficult to value Azure versus peers for several reasons. First, as far as I can tell, it is the only publicly-traded solar company focusing on the Indian market, so there aren’t any direct competitors to easily compare it to. Secondly, it is difficult to value it against some of the primary U.S. solar players because they have a wide range of different business models – it doesn’t really make sense to compare Azure to large U.S. utilities like NextEra Energy (NYSE:NEE) that engage in solar because they are not a pure play on solar and generate the bulk of their power from traditional means. Similarly, many other renewable energy companies in the U.S. and globally have moved towards more of a ‘yieldco’ model, incorporating a dividend and attracting more income-oriented investors in the manner of a traditional utility, whereas Azure is not a dividend payer and does not look like it will be any time soon. Lastly, Azure is both a manufacturer and installer of solar products, whereas many other companies in the space are solely manufacturers or solely installers. For a total wildcard, the always controversial Tesla (NASDAQ:TSLA) has a solar segment, but obviously is a totally different business altogether than the rest of these companies.

Using Seeking Alpha’s sector median and looking at what I believe to be the relevant valuation metrics, Azure seems to trade at somewhat of premium to the rest of the sector (based on looking at Seeking Alpha’s sector median). In terms of forward EV/EBIDTA, Azure trades at 10.9x vs the sector median of 10.6x. Azure is not currently profitable, so it doesn’t make sense to value it on a P/E basis. In terms of forward price to sales, Azure trades at 3.67x sales compared to the sector median of 2.21x. Overall this seems like a negligible difference and Azure deserves more of a premium in my view since it is a higher-growth company in a faster-growing market.

This higher valuation seems warranted when comparing the company’s growth metrics to the same peers. For example, according to Seeking Alpha’s metrics, Azure is growing revenue over 30% year over year compared to a sector median of a paltry -1.12%. Azure is also growing EBITDA 20.9% year over year compared to a sector median of 5.6%. In the graphic below, you can see this growth illustrated, as the company has grown EBITDA by 313% since its IPO.

Source: Azure Global Power JPM Energy and Renewable Conference Presentation

ESG Angle

As a renewable energy company, I also foresee Azure benefiting from increased interest from large institutional shareholders as ESG investing continues to gain prominence. The shift towards ESG investing has been monumental and will continue to gain momentum. For example, some analysts expect inflows to ESG funds to rival the size of today’s S&P 500 over the coming decades. Furthermore, BlackRock CEO Larry Fink talked about how we are “at the edge of a fundamental reshaping of finance” away from fossil fuel companies and towards sustainable investments, and BlackRock put action to words by announcing that it would divest from fossil fuel companies, while doubling the number of sustainable funds it offers. (For more information on the momentum of ESG inflows, see my blog post here.)

Image Source: Morningstar

At the very least, Azure seems to be aware of this trend, recently publishing its first ‘sustainability report’ and launching a sustainability website. While its business as a solar power generator in a developing country would theoretically be of interest to ESG investors in and of itself, the company is also undertaking dedicated measures to make itself more sustainable as well, such as cutting water consumption by 50% last year per unit of electricity generated and striving to be water neutral in the near future.

For the ‘Social’ part of ESG, the company has undertaken admirable efforts such as building clean water plants that give over 70,000 people access to clean drinking water, and built a number of smart classrooms and sustainable homes in the communities in which it operates in. They have also created thousands of jobs and offered skills training in the impoverished rural areas that they operate in. In terms of the ‘G’ part of ESG, corporate governance, the company complies with NYSE, SEC and SGX corporate governance standards, has increased the gender diversity on its board, and underwent 287 internal audits and 4 external audits in FY 2020 with no reported significant non-compliance.

Of course, none of these factors are reasons to invest in a company in and of themselves, but you always want to skate to where the puck is going and in today’s investing environment it is important to see where momentum and activity is heading and ESG investing is clearly one such area.

Financial Position/Top Shareholders

AZRE has a market cap of approximately $733 million.

The company’s largest shareholder is Caisse de dépôt et placement du Québec (also known as CDPQ), which owns over 50% of the shares outstanding. While one institution owning over 50% of the shares raises some eyebrows, CDPQ is Canada’s second largest pension fund and a reputable institutional investor with over $340 billion in AUM, which is certainly more reassuring than a shadowy chairman or a less reputable investor holding that many shares.

While one institution owning so much of the company is certainly a bit unusual, for a small-cap, foreign-domiciled company such as Azure, it doesn’t hurt that it also gives some reassurance about the company’s credibility. This is pure speculation on my part, but I would imagine that so much of the company being held by this long term, somewhat ‘vanilla’ investor is probably part of the reason that the company is not very frequently covered/discussed in financial media as it means there is just not that much ‘action’ going on or wild volatility from day to day to discuss.

I would also speculate that this large, long-term shareholder owning such a large portion of the company is a big factor for why the company is relatively thinly traded – average volume is just 17,482 shares a day, or just over $275,000, so this small volume and dollar amount of shares trading probably make the company an unwieldy investment for many other institutional investors and hedge funds who would be looking for more liquidity and trading volume.

One positive that I take away from CDPQ’s large and increasing ownership stake is that they had initially established a $75 million position in the company at the IPO price of $18/share, and with the stock still below that IPO price despite its recent appreciation, Caisse de dépôt et placement du Québec is still increasing its position and thus seems to believe that shares are undervalued at current levels, and could also serve as a nice backstop to the share price.

Risks

As would be expected with any small-cap, thinly traded company operating in a developing country, investing in Azure is not without its risks. The company is not currently profitable, and in its S1 states that,

“We have never been profitable, and believe we will continue to incur net losses for the foreseeable future.”

This has been the case thus far, with the company reporting a loss of $0.77 per share for the 2019 fiscal year and a quarterly loss of $0.10 for its most recent quarter.

The company has a decent amount of debt for a $750 million market cap company, with approximately $46.7 million in short term debt and $1.192 in long-term debt on its balance sheet. In the S1, Azure warns that “Our substantial indebtedness could adversely affect our business, financial condition, results of operations, and cash flows.”

On the plus side, as aforementioned, Caisse de Depot is now the majority shareholder, and Azure believes this is a positive as its “long term approach and AAA credit rating” will give the company “better access to external capital further improving our future growth and return prospects,” as stated on its June earnings call. On the same call, the company stated that it would pursue additional equity, “from the lowest cost sources” and that it was possible they would issue additional shares, although this likely wouldn’t be until FY 2022 at the earliest and that “The stock price… would need to be substantially above current levels,” which seems sensible.

As mentioned above, the company and India’s solar industry as a whole enjoy strong subsidization and a favorable operating climate from the Indian government. If the government were to change course and no longer favor or subsidize solar, this would obviously have a damaging effect on Azure’s prospects. As Azure details in the prospectus,

“The reduction, modification, or elimination of central and state government subsidies and economic incentives in India may reduce the economic benefits of our existing solar projects and our opportunities to develop or acquire suitable new solar projects. Our long term growth depends in part on the Indian government’s ability to meet its announced target capacity.”

Listed in the U.S. and operating in India, Azure also obviously has exposure to currency risk and exposes investors to currency risk.

Conclusion

The share price of Azure Power Global has quietly been appreciating nicely over the past year-plus, and the company has been growing revenue and EBITDA at an impressive rate in under the radar fashion for the past several years. I believe that Caisse de dépôt et placement du Québec’s 50%+ ownership stake is part of the reason for the lack of attention the stock receives and for its low trading volumes, but I also think that their large position and the fact that they are continuing to buy shares serve as a nice backstop for the share price at current levels. This should help to limit the amount of downside going forward.

This limited downside combined with undiluted exposure to one of the world economy’s strongest macro themes, the rise of the Indian economy and the country’s continued development, and the fact that Azure is one of the key companies powering that growth, make Azure an attractive investment. As an added bonus, ever-increasing interest in ESG investing and investing in renewable energy could help bring new buyers to the stock over time. While not without risk, for these reasons discussed, I feel that Azure Power Global is an attractive stock to buy and hold over the next 5-10 years.

Disclosure: I am/we are long AZRE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Additional disclosure: Investing in equities can involve substantial risk. Potential investors should use this article as a starting point for their own research. Before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. I am not a professional/registered financial adviser; investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. This article is for general information purposes only, and should not be relied upon as a formal investment recommendation.