KSK: Power business ramping up - IIFL

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KSK Energy Ventures: Power business ramping up

KSK’s 2QFY11 net profit increased 47% YoY, thanks to ramp up in the core power generation business
that offset drop in project development fees. The aggregate generation increased 156% YoY through a
combination of new capacity and higher PLFs of older units. KSK expects to add 313MW capacity in
2HFY11, as against 270MW added in 1HFY11. We adjust our FY11-13ii earnings by 20% to factor in
higher coal costs and slower-than-expected ramp up in newly installed capacity. Timely
commissioning of projects is key for the stock to end its underperformance to the broader markets.




Power business drives growth: Unlike in 2QFY10, where profits were driven by the project development
segment, 2QFY11 PAT growth was led by the core power business. Power business EBIT was up 514% YoY thanks
to: 1) higher generation (up 156% YoY); and 2) improved realisations (up 31% YoY). Power business EBIT
accounted for 98% of consolidated EBIT as against 25% a year ago. Power business EBIT growth could have been
higher had KSK not shutdown its units to conduct reliability run and performance guarantee tests. As per the
management, in 3QFY11, the newly commissioned capacity is expected to operate at full load.


Coal costs critical for earnings: KSK has been operating VS Lignite on captive lignite, which is reflected in the
flat QoQ fuel costs/unit. However, due to delays in supplies from Coal India, its Wardha Warora unit has been
compelled to purchase coal through e-auctions (average price: Rs2800-3000/tonne), which has resulted in 40%
increase in fuel costs QoQ. Since KSK has already contracted power from this unit for the next four years at fixed
rates (MSEDCL + RELI), volatility in coal costs would affect its profits.
Timely completion of capacity, key for outperformance: KSK has experienced delays in capacity additions by 6-8
months on an average, which has affected its FY11 cash flows. We adjust our FY11-13ii EPS forecasts downwards by
18-20% to reflect delay in capacity additions and higher coal prices. If KSK continues to experience delays in capacity
additions (2HFY11: 313MW guided), our FY12 EPS forecasts could see further downgrades. Positive surprises in
execution and news flow on the 3.6GW project at Chhattisgarh are the key triggers for stock’s outperformance hereon.


Conference call highlights:
KSK expects to add 313MW in 2HFY11: Over the last 12 months,
KSK has commissioned 405MW (3x135MW) of power projects and its
aggregate capacity stands at 549MW. Over the next six months, KSK
guided to add 313MW capacity and achieve its target to be a ~900MW
genco. Since these capacities are now approaching commissioning,
KSK’s project development income is set to decline, and hereon the
earnings would be driven by the power generation business.
Newly commissioned capacity to ramp up PLFs in 2HFY11: To
conduct the reliability run and performance guarantee test by the EPC
contactor, KSK had shut down the newly commissioned units (270MW)
in 2QFY11. This affected its PLFs - VS Lignite operated at 56%, while
Wardha Warora PLF was 65%. With these two quality checks through,
KSK expects these two units to operate at peak load in 2HFY11.
Coal costs expected to reduce hereon: KSK’s Wardha Warora unit
was to receive coal from CIL’s marginal coal blocks. However, so far it
has not been receiving adequate coal, due to administrative issues. As a
result, KSK purchased almost 85% of coal for this unit from the eauction
route, where it paid almost Rs2,800-3,000 per m tonnes as
against Rs1,800 per m tonnes from coal linkages. However, going
ahead, KSK guided that coal supplies from CIL would commence and
reduce its fuel costs, which would bring down e-auction purchases to
15-20% only.
Taxation benefits to sustain in FY11: KSK's tax rate during the
quarter was down to 2%, as compared to 18% YoY, as the company
availed tax benefits accruing from purchase of wind assets and higher
generation from Wardha Warora plant, which being in an SEZ, is not
liable to pay tax. Currently, KSK operates 52MW of wind assets and
plans to add another 19MW by the end of December 2010. The
company plans to install wind assets at its existing thermal operating
plant sites, which would enable it to supply a combination of thermal
and renewable energy to its industrial customers.
Possible upside from debt refinancing: KSK is in negotiation to
refinance its debt for VS Lignite and Wardha Warora to bring down the
debt servicing cost by 100bps from the present 11.25-11.50%.
Chhattisgarh project to be fully commissioned by FY14: KSK
highlighted that the construction work on 3600MW project has started
and expects the first unit to be commissioned by June 2012.
Subsequent units are expected to commission at an interval of every
four months thereon and the entire project is expected to be
commercial by FY14. So far, KSK has invested Rs45bn into the project
and drawn a debt of Rs24bn. An advance of Rs27bn has been paid to
Shangdong Electric Power Construction Corporation (SEPCO) for the
supply of equipments and EPC contracts. Of the two coal mines allotted
for this project—Morga II and Gare Pelma—KSK expects Gare Pelma to
be operational in the next 6-8 months; however, Morga II is yet to get
the necessary clearances.