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Coal, burns a hole
Our commodity team has increased JFY12 coal price estimate by 15% to
US$125/t. We are cutting our FY11-12 earnings for KEPCO by 36-96%.
We see potential for 21-45% earnings cut for FY12-14 earnings (already
20-30% below consensus) for JSW Energy and Adani Power in India.
There is further downside risk to China IPP earnings after recent 8-20%
earnings cut. Tenaga is luckier to get away with 7-14% earnings cut due
to strengthening Ringgit. Utilities with coal cost pass through should
outperform those without. We prefer Tata Power, Banpu (net long on
coal) and NTPC, CLP, EGCO and Ratch which have coal cost pass through.
Coal prices raised to $125/t for JFY12 and $115/t JFY13
Our commodities team has increased JFY12 coal price estimates by 15% to
US$125/t on the back of recent supply disruptions in Australia and elsewhere
and supportive liquidity macro environment. In 2007-08 when coal prices
went up sharply, utilities without a coal price pass through massively
underperformed those with a cost pass through. This time around the
divergence in performance has just started and can continue for a while.
Earnings cuts for KEPCO, Tenaga, China IPPs…
We are cutting our earnings for KEPCO by 96% for 2011 and 36% for 2012.
Unfortunately for KEPCO the new tariff reform at mid-year will lock in the
benchmark fuel cost from 2Q11 thus lowering its locked in RoE as well.
Recent CRR survey suggests that coal contract price hike for China IPPs could
be higher than 2% estimated by us implying further earnings risk. Earning cut
for Tenaga at 7-14% is moderate due to Ringgit appreciation and earlier
conservative coal price forecasts.
… collateral damage for Indian private utilities
With shortfall in Coal India’s production, a number of utilities depending on
coal linkages will have to import coal. We see potential 28-45% earnings cut
for JSW Energy which has plants dependent on imported coal and 21-36%
earnings cut for Adani Power which has 6GW capacity with no pass through.
Stick with utilities with fuel cost pass through
Tata Power and Banpu are net long on coal and are our top picks. NTPC,
CLP, EGCO and RATCH have coal cost pass through and low/ reasonable net
gearing and valuations. We also like TEPCo, CHEPco and Osaka Gas.
KEPCO – 96% earnings cut for 2011, 36% for 2012
• New “benchmark” price for thermal coal is $118.25 in 2011 and $117.5 in
2012, from US$104.8 and $110 respectively.
• Every US$1 in coal cost change = roughly US$80m in additional cost to
Kepco, due to the roughly 80m tonnes of coal used
• Thus the impact of the changes is roughly US$1.08 bn in 2011 and
US$600m in 2012 (1.19 trn won and 660 bn won)
• CLSA believes that with Kepco having many different “rolling contracts”
that expire throughout the year, the actual realised average price in 2011
is likely lower than the $118.25 forecast, perhaps by $10, but it will
eventually fully hit by 2012 since contracts are 1 year in nature, and 90%
of coal procured is contract, 10% spot; almost all contract coal is from
Australia and Indonesia, although there have been efforts to diversify
more to Russia / Canada in recent years. China’s percentage to Korea
has come down dramatically over the years.
What about the mid-year tariff reform process ??
• The very unfortunate thing about the mid year tariff reform, is that its
based off the 2Q average fuel costs. And so while there will be a lag
effect on coal costs to Kepco into 2H, in all likelihood the reference
benchmark cost will still be high by historical standards ---
In theory the mid year tariff reform is meant to LOCK in Kepco at the
RoE level they are earning at that time, so that it can’t get worse,
NOR can it get better – in other words, if raw material costs come
DOWN in 3Q, in theory the consumers get a tariff CUT
• The ANNUAL tariff hikes are meant to be the way to get Kepco up to
their fair rate of return. So the amount of annual tariff hike needed to
do so will effectively rise if the reference fuel cost in 2Q is high.
• This does NOT mean Kepco won’t eventually earn their fair rate of
return if the new plan is stuck to, but it does mean it could take
longer
Comments from Kepco
• Details of tariff freeze policy will be disclosed in few days.
• Government policy about utility tariff freeze will be disclosed in detail
this week, so we will be able to know whether electricity is included or
not.
• If electricity is not included, non-issue for Kepco and in fact a good
sign.
• However, if electricity is included, tariff will freeze only for the time
being that the government is targeting (probably during 1Q, but not
sure yet)
• Tariff will hike will definitely occur in any case per Kepco, It’s only
about timing.
• KEPCO expects tariff will hike in 2Q or before July 1st even in the worst
scenario. 1Q seems not probable.
Tenaga – 14% earnings cut for 2011, 7% for 2012
Following the coal and Ringgit assumptions change, we have reduced core net
profit by 7-14% for FY11-12. Although Tenaga continues to face earnings and
share price weakness arising from the recent coal price spike, we believe in
the 2H2011 it should be able to re-rate following a consistent tariff review
from the government subsidy reduction program. We maintain Buy with new
RM7.90/share target price (with an implied PBV of 1.4x).
21-45% earnings cut potential for Adani Power, JSW Energy
The shortfall in Coal India’s production is likely to force Adani Power to
import coal 2.5-3.5mt of coal at market rates (assuming Indonesian mine
production is as per the targets).
Since a substantial capacity of Adani Power does not have coal cost pass
through, higher coal prices will hit its earnings. We expect 21-36% cut in
earnings on the back of higher coal imports. If the production from
Indonesian mines owned by Adani Enterprises is lower than the targeted
7.9mt in FY12 and 11.7mt in FY13-14 there could be a further hit on
earnings. Our earnings estimates for Adani Power are already c.20% below
street estimates.
JSW Energy needs to import 4mt of coal per annum to meet its fuel
requirements. While some of the capacity has fuel cost pass through, other is
merchant power capacity without any fuel cost pass through. Thus we expect
potential for a sharp 28-45% reduction in earnings. The saving grace could be
a potential deal to supply power to JSW Steel at a cost plus basis.
China IPPs – 8-20% earnings cut
We recently cut our earnings for China IPPs by 8-20% (except for Huadian
which went from profits to losses). Our earnings estimates factor in a 2%
increase in contract coal prices. A recent survey done by our CRR team
suggests that utilities expect a higher effective contract price because the
expect low fulfilment ratio of those contracts. If the contract coal price turns
out be 5% instead of 2%, we could see another sharp 20-60% reduction in
earnings for China IPPs. We expect a 5% tariff hike in 2H 2011. We remain
U-WT on China IPPs. CRP is the only stock we would consider holding
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