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UBS Investment Research
India Power Utilities
Is coal a constraint for India power story?
�� Coal availability/pricing will not impact power companies’ earnings
Coal availability and pricing has become the most talked-about issue for power
companies. Based on our proprietary work, we think: 1) in our coverage universe,
there is very little risk for companies’ earnings as they have captive coal and/or
fuel cost pass-through; 2) power shortages imply any additional fuel cost can be
passed on; and 3) the biggest risk is for companies with non-captive imported coal
with merchant capacity.
�� Threat of non-availability of coal has been blown out of proportion
We think power companies have made significant progress on the development of
their captive blocks. We expect India to add ~45,000MW (coal-based) over FY10-
15 i.e. coal demand to grow at a CAGR of 8%. Since we expect Coal India (CIL)
to be able to grow production only at 5% p.a., the shortfall would be met by
captive mines in India and abroad (100MT of captive supply in FY15 for our
coverage universe).
�� +ve on utilities with fuel pass-through/captive coal; CIL on coal shortage
We believe CIL is the best play on domestic coal shortage in India. We like Jai
Balaji and Monnet Ispat for their access to huge coal resources. We think the
companies with fuel cost pass-through (NTPC, Reliance Infra) or access to
domestic captive fuel (Reliance Power) are best placed, and companies with
imported captive fuel (Lanco, Tata Power, Adani Power) are the next best options.
�� Top pick: Lanco (UBS Key Call)
Among the companies we cover, we think Adani Power and Reliance Power are
likely to be adversely impacted in the near term if coal prices increase. Our top
pick is Lanco as its current valuations do not factor in upside from capacity
addition/project pipeline.
Executive summary
Given concerns about the coal availability for power generation, in this report
we analyse the implications of lower coal availability from Coal India (CIL) for
the country. We also analyse the relevance of key issues and their impact on the
power generation utilities. In addition, we identify the potential winners from
the coal-as-a-fuel-for-generation-utilities perspective.
CIL production not sufficient to meet power
sector demand
CIL is the world’s largest pure-play coal company in terms of production
(431MT in FY10) and accounts for 81% of both India’s total production and
reserves (extractable reserves of 21.8Bt, according to Indian Standard
Guidelines, as at 1 April 2010). In FY10, CIL produced 395MT of non-coking
coal (91.6% of its total FY10 output) and 36MT of coking coal (8.4%). Please
refer to our 16 December 2010 initiation report on CIL, ‘Powering the tiger’.
Over the next five years, we believe India may face a shortage of domestic
linkage-based coal (supplied by CIL) as significant coal-based power capacity
addition is likely. We expect India to add ~45,000MW of coal-based capacity
and coal demand to increase at a CAGR of 8%.
However, we believe that CIL will be able to increase its production at a CAGR
of 5.2%. There is likely to be a gap between availability of domestic linkagebased
coal and demand for thermal coal from power generation utilities.
Strong captive reserves with power companies
We believe the shortfall in coal supply would be met by production from captive
mines of utilities (from India and abroad). Over the years, the Government of
India has allocated more than 120 mines to power generation utilities and we
expect some of these mines to start production over the next five years.
Domestic captive mines
NTPC
The mining plan for Pakri-Barwadih has been approved by the Ministry of Coal
and NTPC is close to appointing the Mine Developer cum Operator (MDO) for
this mine. Bids were opened on 25 August 2010 for the appointment of MDO
for the Chatti Bariatu block. The mining plan for Dulanga has also been
approved.
Reliance Power
Reliance Power has one of the largest resource bases for domestic coal in the
private sector in India. Recent developments are: 1) Mine plan approval for 40
MTPA for Tilaiya coal mines; and 2) Sanctions of US$917m from US Exim
Bank obtained to finance import of coal mining equipment from the US.
Tata Power
The mining plan has been approved by Ministry of Coal for the Mandakini Coal
Block. 6 (i) notifications for land acquisition for this coal block has been issued.
Tubed Block’s mining plan has been approved and land acquisition has begun.
Captive production should meet the shortfall
We believe the shortfall would be met by captive mines. ~100MT of captive
coal could become available in FY15 from companies under our coverage.
We think companies with fuel cost pass-through (NTPC) or with domestic
captive fuel (Reliance Power) would be best placed. We think companies with
imported captive fuel (Adani Power, Lanco, Tata Power) are the next best
options.
The key takeaway for the power sector
In our view, the key messages for the power sector are: 1) In our coverage
universe, there is very little risk for power companies’ earnings as they have
captive coal and fuel cost pass-through; 2) Due to huge demand-supply
mismatch for power, the additional fuel cost can be passed on through tariff
increases; 3) The big risk is for companies with non-captive imported coal and
merchant capacity.
From a coal standpoint, our preference order is as follows: Coal India > Jai
Balaji > Monnet Ispat > NTPC > Reliance Infra > Reliance Power > Lanco
> Tata Power > Adani Power.
Industry experts’ view
We spoke with many sector participants (generation utilities, experts from the
ministry, the central regulator, new entrants in the generation space, electricity
trading companies, and power sector consultants). The participants believe it is
unlikely that net generation in the country will be impacted by non-availability
of coal. However, there could be some impact on cost of generation.
What does the current market price imply?
We see a clear mismatch in terms of the perceived risk on coal (as indicated by
current stock price) and the exposure in reality. We think the winners are:
1) Lanco—with no significant exposure and captive coal, we have a Buy
rating.
2) Jai Balaji—it has access to 700m MT coal resources, which it plans to
monetise through sponge iron/steel/power routes, to be executed in a
modular way so that existing cash flows from the 0.9m MTPA steel
plant can finance the expansion. We rate it a Buy.
3) Monnet Ispat—Buy rated with minable coal reserves of 257 mio tonnes;
capacity expansion and backward integration will drive 50%+ EPS
CAGR over FY11-FY15, in our view.
UBS Utilities/Coal coverage: preference order
We prefer the companies under our coverage in the following order. This is
based on the sum total of all the factors combined, and not just coal availability.
Table 6: UBS India utilities—our preferences in order
Stock Comments
1 Lanco Infratech Key pick in India Utilities coverage universe; good execution and good upside from merchant power.
2 Power Grid Very low risk, strong competitive positioning in transmission space, good long-term stock.
3 Reliance Infra Attractive valuation, good combination of risk-free core business and upside from infrastructure and Reliance Power projects.
4 Tata Power Good defensive stock with diversification; low-risk approach makes it ideal for risk-averse investor seeking exposure to India power sector.
5 Adani Power Very strong execution capability and significant upside from merchant power; upside capped with positives largely priced in.
6 NTPC Good defensive stock; however, we do not think there is significant upside from current levels.
7 Reliance Power Fuel security is a key feature, but execution risks are not fully factored in.
Source: UBS estimates
Table 7: UBS India coal coverage
Stock Comments
1 Coal India Ltd We believe Coal India is the best play on the structural coal shortage in India
2 Jai Balaji Jai Balaji has access to 700m MT coal resource, which it plans to monetise through sponge iron / steel / power routes
3 Monnet Ispat Monnet is an integrated steel and power company with coal reserve of 257 MT; capacity expansion and backward integration are the drivers
Source: UBS estimates
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