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Tata Power Co
Upside from Indonesian Coal Asset; Retain EW
What's Changed
Price Target Rs1,087.00 to Rs1,231.00
F2011 EPS From Rs33.68 to Rs37.81
F2012 EPS From Rs31.10 to Rs33.65
Investment conclusion: We maintain an Equal-weight
rating on Tata Power with a revised target price of
Rs1,231 largely due to higher upside from investments
in Indonesian coal assets. In our view, the company has
strong execution capabilities, and there is high visibility
on the implementation of power projects. However, the
stock is trading at 2.2x P/B and 9.8x EV/EBITDA on our
F2012 consolidated estimates, which we believe is
expensive relative to peers.
Capacity addition on track: Tata Power has
completed 65% of the work on the Mundra UMPP with
ordering for major packages now finalized. The first unit
is expected to be commissioned in September 2011,
with each of the units four months later. On the Maithon
project, 90% of the work is completed. The first unit is
expected to be commissioned by F4Q11, with the
second unit by F1Q12.
F1H11 results lackluster: Tata Power reported F1H11
consolidated revenue of Rs97.8bn (up 6% YoY),
EBITDA of Rs21.5bn (up 21% YoY), and adjusted profit
of Rs7.5bn (up 41.5% YoY). Our F2011 consolidated net
profit estimate is Rs16.6bn. We have increased our
consolidated EPS for F2011e and F2012e by 2% and
14%, respectively, primarily due to higher coal
realizations.
Key triggers: Monetization of group company
investments and commencement of construction work
on pipeline projects will be positive for the stock, in our
view. Also, any improvement in coal outlook could help
earnings.
Investment Thesis
• One of the largest private integrated
electric utilities in India with
experience in generation,
transmission, and distribution
businesses.
• Strong execution skills as exhibited in
the Mundra UMPP and the Maithon
projects.
• Upside from investment in Indonesian
coal assets largely due to increases in
coal prices.
Key Value Drivers
• Regulatory regime improving in India
and Indonesia.
• Push from government to increase
private participation in utility sector.
• Higher production and better
realizations for Indonesian coal
assets.
Potential Catalysts
• Liquidation of investments to finance
the capex program.
• Upside to the investment in other Tata
group companies.
Key Risks
• Continued ambiguity on monetization
of investments.
• Delays in execution of power projects.
• Downside risk to Indonesian coal
assets due to lower production, lower
coal prices or ongoing tax dispute.
• High leverage and increasing interest
cost burden.
Investment Case
We maintain an Equal-weight rating on Tata Power with a
revised price target of Rs1,231. We now peg our price target to
our base-case fair value vs. our previous method of probability
weighting of 80% to our base case and 20% to our bull case.
Our base-case fair value has risen primarily due to an increase
in the value of the company’s investment in Indonesian coal
assets (since the market price of Bumi Resources, which we
use as a proxy, has risen).
Our key reasons for being Equal-weight on the stock are:
1. Capacity addition program is on track with the Maithon and
Mundra projects progressing well. However, in our view,
the company is not being aggressive on working on some
of the development projects that have captive coal block
allocations (such as Naraj Marthapur and Tiruldin).
2. Increase in international coal prices will help earnings and
valuations, although we believe it is already in the price.
3. F1H11 adjusted consolidated earnings have grown 42%
YoY, but have not surprised us on the upside.
4. Valuation: The stock trades at 2.2x P/B and 9.8x
EV/EBITDA on our F2012 consolidated estimates, which
we believe leaves limited upside.
Valuation
Our change in price target from Rs1,087 to Rs1,231/share is
primarily due to the following:
• We have increased the value of its investment in
Indonesian coal assets due to a higher implied value of the
coal assets. We have also reduced the hedge adjustment
from 25% to 10% and taken away the holding company
discount of 20%.
• We have increased our cost of equity for Tata Power from
13.68% to 13.82% due to an increase in the risk-free rate.
• We have reduced the terminal growth rate for the Mumbai
License Area from 4% to 3%.
We also now peg our price target to our base-case value vs.
our previous probability weighted basis.
We have also increased our F2011 standalone EPS forecast
by 12% and our F2012 estimate by 8% primarily due to higher
other income and a lower tax rate.
Current generation business (including Mumbai License
Area): We use a discounted cash flow (DCF) model to value
the current generation business, which consists largely of the
Mumbai License Area. We expect business in this area to
continue to grow because of expansion in the consumer base
and the increase in consumption. The company earns
regulated returns on its generation, transmission and
distribution businesses, which we expect will continue. The
merchant capacity is limited to 200 MW from Trombay Unit 8
and Haldia. We have also built in additional distribution
revenue emanating from the Mumbai License Area as the
company commenced retail distribution operations in April
2010.
The Delhi distribution business includes NDPL (North Delhi
Power Limited), in which Tata Power holds 51%. NDPL earns a
16% ROE on the regulatory capital base and also an incentive
if it reduces AT&C losses below the Delhi government’s
stipulated level.
We use an RI model to value the stake in NDPL at Rs30/share.
We use a cost of equity of 14% (risk-free rate of 8% and
expected risk premium of 6%) and a terminal growth rate of 4%.
We value NDPL at Rs58/share and Tata Power’s 51% stake in
NDPL accordingly is Rs30/share, based on our residual
income (RI) model.
Powerlinks Transmission: Tata Power, together with PGCIL,
set up the 1,200 km Tala transmission line for extracting power
from Bhutan and supplying it to the northern parts of India. The
company is to earn a post-tax ROE of 16% + incentives (post
the CERC regulations effective April 2009 to March 2014) on
the Powerlinks Transmission project, and its total investment is
Rs2.5 billion. We value the investment in Powerlinks
Transmission at Rs14/share based on our RI model
Maithon Thermal Power Project: This 1,050 MW thermal
plant is being implemented through a 74:26 joint venture of
Tata Power and Damodar Valley Corporation. We use an RI
model to value the project at Rs50/share.
Mundra UMPP: Tata Power was the lowest bidder for the
Mundra UMPP with a 25-year levelized tariff of Rs2.26/kWh.
The company expects the first unit to be commissioned in
September 2011, and each of the next units four months later.
We value the project at Rs105/share using a FCFe model. We
use a cost of equity of 14.8%, which is 100bp in excess of cost
of equity for the company.
India Energy Limited: Tata Power has set up two plants of
120 MW each in a joint venture with Tata Steel (26% equity
owner). We believe these plants will earn an ROE of 16% and
hence on a residual income model we value these plants at
Rs12/share. Our assumption for cost of equity is 13.8% (risk-
free rate of 8% and expected risk premium of 6%).
Investment in Indonesian coal assets: We value the
investments in coal assets using the current stock price of Bumi
Resources (the 70%-equity owner of the coal assets) as a
proxy. Since Bumi’s value represents its 70% stake in the KPC
and Arutmin coal assets, we have grossed it up to achieve the
implied market capitalization of the coal assets as US$7bn.
The implied value for TPWR’s 30% stake in the coal assets
after backing out the net debt of US$79mn aggregates to
US$2.9bn or Rs565/share. However, we now apply a 10%
discount (25% earlier) to this value as we believe the 30%
stake in the coal assets partially acts as a hedge for 3.24 mtpa
of coal requirements for the Mundra UMPP since it comes at a
fixed price for the first five years of the project, thus reducing
the exposure to higher coal prices.
Accordingly, the fair value of the 30% stake in the Indonesian
coal assets is Rs509/share for Tata Power (Exhibit 13). We
have removed the holding company discount of 20% that we
were applying earlier.
Investments in companies: Tata Power has investments
primarily in group companies such as VSNL, Tata Teleservices
and Tata Sons. These investments carried a face value of
about Rs20 billion on the balance sheet as at March 31, 2010.
In Exhibit 14, we present a list of these investments and their
estimated fair values. We have assumed a 30% discount to
determine the net realizable value.
Risks to Our Target Price
We use a sum-of-the-parts methodology to determine the
target price of Tata Power. The key upside risks to our target
price are:
• Significant increase in generation capacity.
• Additional projects in the transmission or distribution
segment.
• Upside to investment in Indonesian coal assets and other
investments in group companies.
• Upside to returns from the generation projects.
• Monetization of investments for investment in the core
business.
The key downside risks to our target price are:
• Significant changes in regulations that could impair the
business in Mumbai and Delhi.
• Continued ambiguity about the company’s intentions
concerning the monetization of investments in group
companies.
• Significant increase in capex.
• Significant downside to earnings for the Indonesian coal
assets due to production delays or decline in coal pricing.
• Political intervention in India and Indonesia
Company Description
Tata Power is one of India's largest private sector electric utility
companies. It has installed generation capacity of 2,999 MW
and distribution businesses in Mumbai and Delhi. It acquired a
30% equity stake in the KPC and Arutmin coal mines in
Indonesia in June 2007. Tata Group is the majority shareholder,
holding 31.8% of Tata Power's equity.
India Utilities
Industry View: In-Line
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Power Co
Upside from Indonesian Coal Asset; Retain EW
What's Changed
Price Target Rs1,087.00 to Rs1,231.00
F2011 EPS From Rs33.68 to Rs37.81
F2012 EPS From Rs31.10 to Rs33.65
Investment conclusion: We maintain an Equal-weight
rating on Tata Power with a revised target price of
Rs1,231 largely due to higher upside from investments
in Indonesian coal assets. In our view, the company has
strong execution capabilities, and there is high visibility
on the implementation of power projects. However, the
stock is trading at 2.2x P/B and 9.8x EV/EBITDA on our
F2012 consolidated estimates, which we believe is
expensive relative to peers.
Capacity addition on track: Tata Power has
completed 65% of the work on the Mundra UMPP with
ordering for major packages now finalized. The first unit
is expected to be commissioned in September 2011,
with each of the units four months later. On the Maithon
project, 90% of the work is completed. The first unit is
expected to be commissioned by F4Q11, with the
second unit by F1Q12.
F1H11 results lackluster: Tata Power reported F1H11
consolidated revenue of Rs97.8bn (up 6% YoY),
EBITDA of Rs21.5bn (up 21% YoY), and adjusted profit
of Rs7.5bn (up 41.5% YoY). Our F2011 consolidated net
profit estimate is Rs16.6bn. We have increased our
consolidated EPS for F2011e and F2012e by 2% and
14%, respectively, primarily due to higher coal
realizations.
Key triggers: Monetization of group company
investments and commencement of construction work
on pipeline projects will be positive for the stock, in our
view. Also, any improvement in coal outlook could help
earnings.
Investment Thesis
electric utilities in India with
experience in generation,
transmission, and distribution
businesses.
• Strong execution skills as exhibited in
the Mundra UMPP and the Maithon
projects.
• Upside from investment in Indonesian
coal assets largely due to increases in
coal prices.
Key Value Drivers
• Regulatory regime improving in India
and Indonesia.
• Push from government to increase
private participation in utility sector.
• Higher production and better
realizations for Indonesian coal
assets.
Potential Catalysts
• Liquidation of investments to finance
the capex program.
• Upside to the investment in other Tata
group companies.
Key Risks
• Continued ambiguity on monetization
of investments.
• Delays in execution of power projects.
• Downside risk to Indonesian coal
assets due to lower production, lower
coal prices or ongoing tax dispute.
• High leverage and increasing interest
cost burden.
Investment Case
We maintain an Equal-weight rating on Tata Power with a
revised price target of Rs1,231. We now peg our price target to
our base-case fair value vs. our previous method of probability
weighting of 80% to our base case and 20% to our bull case.
Our base-case fair value has risen primarily due to an increase
in the value of the company’s investment in Indonesian coal
assets (since the market price of Bumi Resources, which we
use as a proxy, has risen).
Our key reasons for being Equal-weight on the stock are:
1. Capacity addition program is on track with the Maithon and
Mundra projects progressing well. However, in our view,
the company is not being aggressive on working on some
of the development projects that have captive coal block
allocations (such as Naraj Marthapur and Tiruldin).
2. Increase in international coal prices will help earnings and
valuations, although we believe it is already in the price.
3. F1H11 adjusted consolidated earnings have grown 42%
YoY, but have not surprised us on the upside.
4. Valuation: The stock trades at 2.2x P/B and 9.8x
EV/EBITDA on our F2012 consolidated estimates, which
we believe leaves limited upside.
Valuation
Our change in price target from Rs1,087 to Rs1,231/share is
primarily due to the following:
• We have increased the value of its investment in
Indonesian coal assets due to a higher implied value of the
coal assets. We have also reduced the hedge adjustment
from 25% to 10% and taken away the holding company
discount of 20%.
• We have increased our cost of equity for Tata Power from
13.68% to 13.82% due to an increase in the risk-free rate.
• We have reduced the terminal growth rate for the Mumbai
License Area from 4% to 3%.
We also now peg our price target to our base-case value vs.
our previous probability weighted basis.
We have also increased our F2011 standalone EPS forecast
by 12% and our F2012 estimate by 8% primarily due to higher
other income and a lower tax rate.
Current generation business (including Mumbai License
Area): We use a discounted cash flow (DCF) model to value
the current generation business, which consists largely of the
Mumbai License Area. We expect business in this area to
continue to grow because of expansion in the consumer base
and the increase in consumption. The company earns
regulated returns on its generation, transmission and
distribution businesses, which we expect will continue. The
merchant capacity is limited to 200 MW from Trombay Unit 8
and Haldia. We have also built in additional distribution
revenue emanating from the Mumbai License Area as the
company commenced retail distribution operations in April
2010.
The Delhi distribution business includes NDPL (North Delhi
Power Limited), in which Tata Power holds 51%. NDPL earns a
16% ROE on the regulatory capital base and also an incentive
if it reduces AT&C losses below the Delhi government’s
stipulated level.
We use an RI model to value the stake in NDPL at Rs30/share.
We use a cost of equity of 14% (risk-free rate of 8% and
expected risk premium of 6%) and a terminal growth rate of 4%.
We value NDPL at Rs58/share and Tata Power’s 51% stake in
NDPL accordingly is Rs30/share, based on our residual
income (RI) model.
Powerlinks Transmission: Tata Power, together with PGCIL,
set up the 1,200 km Tala transmission line for extracting power
from Bhutan and supplying it to the northern parts of India. The
company is to earn a post-tax ROE of 16% + incentives (post
the CERC regulations effective April 2009 to March 2014) on
the Powerlinks Transmission project, and its total investment is
Rs2.5 billion. We value the investment in Powerlinks
Transmission at Rs14/share based on our RI model
Maithon Thermal Power Project: This 1,050 MW thermal
plant is being implemented through a 74:26 joint venture of
Tata Power and Damodar Valley Corporation. We use an RI
model to value the project at Rs50/share.
Mundra UMPP: Tata Power was the lowest bidder for the
Mundra UMPP with a 25-year levelized tariff of Rs2.26/kWh.
The company expects the first unit to be commissioned in
September 2011, and each of the next units four months later.
We value the project at Rs105/share using a FCFe model. We
use a cost of equity of 14.8%, which is 100bp in excess of cost
of equity for the company.
India Energy Limited: Tata Power has set up two plants of
120 MW each in a joint venture with Tata Steel (26% equity
owner). We believe these plants will earn an ROE of 16% and
hence on a residual income model we value these plants at
Rs12/share. Our assumption for cost of equity is 13.8% (risk-
free rate of 8% and expected risk premium of 6%).
Investment in Indonesian coal assets: We value the
investments in coal assets using the current stock price of Bumi
Resources (the 70%-equity owner of the coal assets) as a
proxy. Since Bumi’s value represents its 70% stake in the KPC
and Arutmin coal assets, we have grossed it up to achieve the
implied market capitalization of the coal assets as US$7bn.
The implied value for TPWR’s 30% stake in the coal assets
after backing out the net debt of US$79mn aggregates to
US$2.9bn or Rs565/share. However, we now apply a 10%
discount (25% earlier) to this value as we believe the 30%
stake in the coal assets partially acts as a hedge for 3.24 mtpa
of coal requirements for the Mundra UMPP since it comes at a
fixed price for the first five years of the project, thus reducing
the exposure to higher coal prices.
Accordingly, the fair value of the 30% stake in the Indonesian
coal assets is Rs509/share for Tata Power (Exhibit 13). We
have removed the holding company discount of 20% that we
were applying earlier.
Investments in companies: Tata Power has investments
primarily in group companies such as VSNL, Tata Teleservices
and Tata Sons. These investments carried a face value of
about Rs20 billion on the balance sheet as at March 31, 2010.
In Exhibit 14, we present a list of these investments and their
estimated fair values. We have assumed a 30% discount to
determine the net realizable value.
Risks to Our Target Price
We use a sum-of-the-parts methodology to determine the
target price of Tata Power. The key upside risks to our target
price are:
• Significant increase in generation capacity.
• Additional projects in the transmission or distribution
segment.
• Upside to investment in Indonesian coal assets and other
investments in group companies.
• Upside to returns from the generation projects.
• Monetization of investments for investment in the core
business.
The key downside risks to our target price are:
• Significant changes in regulations that could impair the
business in Mumbai and Delhi.
• Continued ambiguity about the company’s intentions
concerning the monetization of investments in group
companies.
• Significant increase in capex.
• Significant downside to earnings for the Indonesian coal
assets due to production delays or decline in coal pricing.
• Political intervention in India and Indonesia
Company Description
Tata Power is one of India's largest private sector electric utility
companies. It has installed generation capacity of 2,999 MW
and distribution businesses in Mumbai and Delhi. It acquired a
30% equity stake in the KPC and Arutmin coal mines in
Indonesia in June 2007. Tata Group is the majority shareholder,
holding 31.8% of Tata Power's equity.
India Utilities
Industry View: In-Line
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