Goldman Sachs: Utilities: NT concerns appear to be priced in; Buy Lanco (on CL), Tata Power

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India: Utilities
Equity Research
NT concerns appear to be priced in; Buy Lanco (on CL), Tata Power 
Near-term headwinds more visible; cut TPs and EPS estimates
We lower our 12-month target prices by 13% on average and revise our
FY11E/FY12E/FY13E EPS by 8%/-5%/-7% on average as we now believe that
there is more visibility on near-term headwinds to the sector. These are: (1)
risks to utilization levels on account of deteriorating finances of state
distribution companies and intrastate transmission constraints; (2) higher fuel
costs due to production cut by Coal India Limited for FY12E; and (3) increase
in interest costs on account of higher inflationary expectations.
Capacity additions to magnify risk to utilization levels
Overall PLFs for 10MFY11 were 73.7% vs. 76.7% in 10MFY10 and
generation was lower by 16% due to low demand schedules from state
discoms. Our discussions with regulators and industry sources indicate
that states are now reluctant to buy power even at normal PPA rates due to
deteriorating finances and high distribution losses. With capacity addition
gaining momentum coupled with intra-state transmission constraints, we
believe the PLFs of generators are at risk and accordingly reduce our
average utilization levels to 80% (vs. 85%-90% previously) for FY12E/13E.
Stocks down by 5%-45%, but consensus estimates still high
While stocks have corrected by an average 25% over the past three
months, reflecting some of these concerns, we believe consensus
estimates remain high (we are 14%/21% below consensus on FY12E/13E)
and think the sector will continue its underperformance.
Maintain Rs4/kwh for FY12E with elections for 6 states in 2012
Given the elections in Tamil Nadu in May 2011 and impending polls for 6
states in 2012, we maintain our short-term rate forecast of Rs4/kwh in
FY12E (Rs4.50/kwh in 1HFY12; Rs3.50/kwh in 2HFY12).
Upgrade Lanco to Buy (add to CL), TPWR to Buy; downgrade RELI
to Neutral; remove Adani from CL
We continue to prefer companies that score well in execution and that are
integrated backwards in fuel supplies. We upgrade Lanco Infratech and
Tata Power (TPWR) to Buy from Neutral as we believe their valuations
reflect near-term headwinds; we also add Lanco to the Conviction List (CL).
We reiterate our Buy on Adani Power but remove it from CL. We
downgrade Reliance Infrastructure to Neutral due to a balanced risk/reward.


Near-term risks more visible; some concerns priced in
The stocks under our coverage have corrected by 25% (on average) since we reiterated our
cautious stance on the sector on Oct 26, 2010 and market cap erosion is stark in companies
having high merchant exposure. While sector underperformance is in line with our view,
the pace of stock correction – particularly over the last month – has surprised us. We
believe the correction is mainly on account of greater visibility on near-term risks, such as:
 News flow on the deteriorating finances of state boards that is posing a risk to the
utilization levels of the generators;
 production cut guidance by Coal India Limited to about 2% for FY12E from 6% earlier,
leading to an increase in concerns on fuel costs; and
 likely increase in interest expenses due to expectations of high inflation.
Although our estimates reflect some of the above concerns (in Oct 2010, we were
11%/16%/20% below Bloomberg consensus on FY11E/FY12E/FY13E earnings), we further
reduce our target prices by 13% on average and FY12E/FY13E EPS by 5%/7% on account of
the following main reasons:
 Utilization levels cut to 80%: Our conversations with various state regulators and
industry sources indicate that some states are reluctant to buy power even at normal
PPA rates due to their deteriorating finances and high transmission and distribution

losses. With capacity addition gaining momentum (11GW so far and 18GW for FY12E)
and gaps emerging in intra state transmission systems, we believe the utilization levels
of generators are at risk. We cut our utilization level assumption to 80% from our
earlier estimate of 85%-90% for FY12E/13E.
 Higher fuel and interest costs: We have reflected a higher imported fuel component
for plants that depend on imported coal and increased interest expense by about 100
bp on account of likely increase in interest rates in line with the views of our economist.
On taking a deep dive into the valuations post-correction, we believe some of these
concerns are in the price. We believe the magnitude of stock correction for Lanco Infratech
and Tata Power is unwarranted and upgrade the stocks to Buy from Neutral. We add Lanco
Infratech to our Conviction List, and remove Adani Power from the Conviction List due to
its outperformance versus peers (see Exhibit 10). We downgrade Reliance Infrastructure to
Neutral due to a better risk/reward ratio for other stocks in our coverage universe.