Adani Enterprises' inclusion in Nifty50 index divides D-Street

Index inclusion comes after the 'best has played out for the stock' is an overarching concern

Adani Enterprises’ (AEL’s) inclusion in the Nifty50 Index has left the Street divided. Some fear a Nifty inclusion will force exchange-traded funds (ETFs) and index funds — on which rides a lot of pension money — to buy the stock that trades at a price-to-earnings multiple of more than 400x. Also, they worry the index inclusion comes after the best has played out for the stock.

Those in favour of the decision feel the Nifty inclusion will give them a chance to own the stock that has been on a tear in recent years. Many took to social media to express their views.

On Thursday, the index-providing arm of the National Stock Exchange announced that the Adani group flagship company would replace Kolkata-based Shree Cement in the Nifty50 Index that is tracked by ETFs with assets over Rs 2 trillion.

The addition and deletion of a stock from the Nifty indices are based on preset eligibility criteria. The indices undergo periodic rebalancing - stocks get added/removed, based on changes to stock price, liquidity, impact costs, and other parameters during the period under review.

AEL has become the second unit of the ports-to-power conglomerate to be included in one of India’s key equity gauges as the group expands.

Adani’s aggressive expansion has raised concerns, with some analysts pointing to pressure on the conglomerate’s credit metrics and cash flow.

AEL’s inclusion comes on the back of a near-100 per cent jump in its stock price this year. The surge in its stock price saw the company go past others in the race for a Nifty insertion.

The benchmark Nifty50 Index is the most-tracked by passive funds. For this reason, an entry into the index is coveted.

For AEL, the Nifty inclusion will bring in passive flows of over Rs 3,070 crore. On an isolated basis, the number seems minuscule for a company with a market capitalisation of Rs 3.83 trillion. However, analysts say this is significant, given the stock’s average daily volume (ADV).

“Passive trackers will need to buy nearly five days of ADV on AEL and sell over 13 days of ADV on Shree Cement. The impact balloons even further where passive will need to buy 28 days of delivery volume on AEL and sell over 36 days of delivery volume on Shree Cement. The average delivery volume to traded volume on AEL averages 20 per cent over the past three months,” says analyst Brian Freitas of Periscope Analytics.

In simple terms, the quantity of AEL shares required to be bought by ETFs is much higher than the delivery volumes the stock clocks on a daily basis.

This is partly because most public shareholders of AEL are long-term investors who don’t flip their holdings.

Freitas says AEL’s ‘real float’ – that which is actively traded in the market - is small.

“The shareholding pattern as of June shows the public shareholding in AEL as 27.72 per cent. However, there are shareholders who are unlikely to sell or will sell closer to the date of implementation. There are a few funds that hold stock in a lot of Adani Group companies and have been holders for quite a few years.

Life Insurance Corporation of India has also been a holder for some time and may not sell. Green Enterprises Investment, an arm of Abu Dhabi-based International Holding Company, invested around $1 billion in AEL in May and will not be a seller. The Financial Times Stock Exchange and the Morgan Stanley Capital International passive trackers will not sell since that will lead to tracking error in their portfolios. So that brings the real float of AEL to just over 11 per cent. Passive Nifty index trackers will need to buy over 7 per cent of the real float on the stock,” observes Freitas.

Given this scarcity, shares of AEL are expected to trend higher, ahead of its Nifty inclusion, which becomes effective on September 30.

Shares of AEL on Friday rose 3.8 per cent to close at Rs 3,357, while Shree Cement fell 2.4 per cent to finish at Rs 21,084.