Utilities and Infrastructure: Year ahead 2011: JPMorgan

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Utilities and Infrastructure- Key themes for 2011
Business/Economics:
After a round of fund raising in 2009, IPPs
commissioned some new projects, announced capacity
expansion plans and signed long-term equipment supply
contracts in 2010. However, execution was weak with
significant delays in some cases. Chasing fuel security
was a theme through 2H with IPPs investing in coal
mines abroad and lining up to sign LoAs with Coal India.
It was also a year of regulatory uncertainties and heavy
capex for infrastructure plays resulting in
underperformance.
Political
The MoEF’s strong stance on classifying coal blocks to
be in the ‘no go’ zone was a dampener for IPPs in 2010.
Further environmental restrictions would have a negative
impact on execution. The strong government support for
infrastructure development in the country, especially the
power sector will continue to be a recurring theme in
2011. We expect a further push by the agencies to meet
the reduced 11th plan target of 62GW in installed
capacity, given that only 24GW has been achieved to
date. However, further slippages are imminent, in our
view. For the infrastructure space we look forward to
clarity on airport charges, Mumbai airport monetization
and electricity distribution license for Reliance
Infrastructure.
How the business is expected to evolve through the
year
With merchant rates being below expectations in 2H
CY10, we see more IPPs having a more conservative
merchant mix in their portfolio going forward. We expect
merchant rates to be lower than in 2010; a significant
decline would be a key risk to the sector. Focus on fuel
security will continue as IPPs will require a backup to
linkage coal and secure coal for their long-term pipeline.
Lower PLFs and higher coal prices are again a key risk to
the sector. In 2011, the market will look forward to gas
allocation from RIL’s KG D6 basin for under
construction projects, which will be a positive for some
IPPs. We expect cash flow generation in some key
infrastructure projects sch as Delhi and Hyderabad
airports and look forward to news of listing of
independent verticals.
Sector view
With coal prices on the rise we prefer IPPs with
relatively good fuel security, such as Adani Power, also
due to their superior execution in light of the recent
slippages. We estimate a spike in near-term earnings due
to a ramp-up in operating capacity for Adani and Lanco.
In the infrastructure space we prefer companies with
assets nearing cash flow generation stage, like GMR and
GVK, and avoid RELI which has seen execution delays.
Stock recommendations
Our top picks are Adani Power and GVK, both strong on
execution. We see TPWR as a net beneficiary of
increased coal prices due to its Indo coal mines, but with
limited catalysts otherwise. We see NTPC continuing to
claw back, with potential safety and assured returns as
USPs. We would avoid JSW on lack of fuel security and
lack of fuel cost-pass through in tariffs as well as RPWR
given the nascent stage of its development pipeline. For
GVK, the monetization of Mumbai airport real estate
remains the key catalyst, in our view. We recommend
switching from RELI to GMRI / GVK and buying
MPSEZ on declines.