Macquarie Research: JSW Energy: Sell target 105

JSW Energy Ltd.
Hungry for imported coal
A high cost operator
We initiate coverage on JSW Energy with an Underperform rating and a Rs105
price target. In our view, the stock offers investors highly leveraged earnings
exposure to merchant power prices over the next few years. As a high marginal
cost producer, this is a risky strategy, especially as recent power trader feedback
indicates weakness in merchant power prices. Beyond FY11, there appears to
be higher volume growth among peers. We prefer higher medium-term volume
growth exposure to companies with a cost-competitive strategy – be it fuel (Tata,
Jindal Steel and Power, Adani Power) or capex (Lanco).
Higher capacity growth elsewhere in the market
We expect FY11 to be a year of high capacity growth for JSW Energy, as we
expect it to add another 1140MW (Ratnagiri: 600MW, RajWest: 540MW)
throughout the year to its 1295MW of plant currently in operation. However,
confidence in these projects appears to be fully priced into the stock, and, in
FY12, other power developers appear to offer greater growth rates. On our
forecasts, between FY12 and FY15, there is a void of capacity growth as the
company awaits growth projects not yet under construction.
High leverage = higher risk, could become a trading stock
In our view, a power generator must have a competitive advantage to sustain
medium- to long-term outperformance. Operationally, JSW Energy has a highcost
base relative to its peers, due to its dependence on spot-imported coal;
thus, those with cheaper fuel sources may be able to compete for power
despatch more effectively than JSW Energy in an environment of increasingly
competitive bidding. With high merchant power price exposure, the stock could
start to trade more in line with short-term merchant power price expectations. We
expect a softening in merchant prices from 1Q FY11 to 2 Q FY11 and, therefore,
would not enter the stock at current levels. We note, however, that the stock
could trade higher leading into periods of bullish power prices such as the
summer months (1Q) or during periods of election (leading into 1Q FY12 for
Tamil Nadu/West Bengal State elections).
Key risks: stronger merchant prices, short-term execution
The equity market loves a good execution, and stocks perform well after units
announce their commercial operations date. We expect JSW Energy to execute
at Ratnagiri during FY11 but think this is already in the price. Higher-thanforecast
merchant power prices, a fall in thermal coal prices or securing a lowcost
coal supply would be beneficial for JSW Energy.
Price target: Rs105
JSW Energy is trading at an 18x FY11E NPAT and a 10x FY12E NPAT. Beyond
FY12, our PER rises to 15x FY13E NPAT and cash ROE falls to 9% as
merchant price forecasts decline. If we are wrong and merchant power prices
remain strong (Rs4.50/kWh), returns could rise to 13%; however, we still see
better value elsewhere in the sector and would switch into Lanco Infratech,
Adani Power or Tata Power.