POWER SECTOR Too many ends to tie : Emkay

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POWER SECTOR

Too many ends to tie

Our analysis of all the factors having a bearing on power tariffs - (1) demand, (2) supply and (3) health of state distribution companies (discoms) - point towards low merchant power prices. Even our most optimistic assumptions for power generators indicate unfavorable risk reward for investors. While demand supply dynamics (surplus situation by end FY13E) are bound to significantly bring down power prices, discoms’ financials otherwise would be a potential trigger. Our detailed scrutiny of discoms’ financials for the past 5 years reveals that higher power prices were responsible for almost 2/3rd of its increased losses (Rs342bn) during FY08-FY10. Should the discoms continue to buy upcoming merchant power at Rs4.5/unit (current bilateral merchant tariffs) or Rs3.6/unit (implied tariffs accounting for current stock valuations), its annual losses would rise to Rs1,143bn (1.4% of nominal GDP) or Rs1,006bn by FY13E respectively. Moreover, states are likely to feel the real pinch of losses going forward as large part of increased losses would be actual cash outflows (till now, 85% merchant volumes by state utilities, hence forth by private utilities).

No wonder, power stocks have already underperformed the Nifty by 24% in the last one year. We believe that the underperformance is likely to continue as our assessment where tariffs will stabilize is Rs2.7/unit, maximum leeway being till FY13E. In this context, our valuation matrix to choose stocks is largely driven by the nearness to this long term tariff (Rs2.7/unit) besides other factors like (1) fuel security at competitive rates, (2) off take tie ups at attractive IRRs, (3) early mover advantage and (4) relatively lower EVM (enterprise value per adjusted mw). We initiate coverage on Independent Power Producers (IPPs) with an ‘Underperform’ rating and within the IPPs, we prefer Lanco Infratech. Our stock specific rating is as follows:-

Buy - Lanco Infratech (Lanco) (lowest implied merchant rate of Rs2.9/unit).

Accumulate - Reliance Power (RPL) (implied tariff of Rs3.4/unit, however most sustainable business model), Nava Bharat Ventures Ltd (NBVL) (natural hedge, early mover advantage, relatively lower implied tariff of Rs3.3/unit).

Hold -  Adani Power (APL) (balanced but valuations price in all the upsides and implied tariff of Rs3.9/unit), Jaiprakash Power Ventures (JPVL) (back ended capacity additions and implied tariff of Rs3.6/unit) and KSK Energy (attractive MOUs/contracts but materialization risk, implied tariff of Rs3.6/unit).

Reduce - JSW Energy (fuel and off-take both open - a risky strategy, highest implied tariff of Rs4.0/unit)