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UBS Investment Research
India Power Utilities
Coal—concern but no impending disaster
In 9M FY11, Coal India’s production increased only 1% YoY
In the first nine months of FY11, Coal India (CIL) has been able to increase
production to 299.5MT vs. 295.5MT in 9M FY10 (just 1% growth YoY). If the
trend continues, our current estimate of a 4.4% CAGR over FY10-15E for
domestic coal supply for the power sector could be at risk. This could put pressure
on imports and we believe the combined next two years’ (FY12 and FY13) thermal
coal imports for the power sector could also increase beyond 110MT (vs. 20MT
actual in FY10).
Captive coal production to see significant increase in medium term
We think power companies have made significant progress on the development of
their captive blocks. We expect a part of the fuel shortfall to be met by captive
mines of power companies (100MT captive coal in FY15 for our coverage
universe). This is an encouraging sign for fuel security of Indian power companies.
We prefer utilities with fuel pass-through/captive coal
We like power generation companies with fuel cost pass-through (NTPC, R Infra).
We also believe utilities with 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 option. We also do not really think that fuel cost passthrough
is at serious risk, if the net cost of generation is reasonable.
Top pick: Lanco, Power Grid and NTPC
Among the companies we cover, we think Adani Power and Reliance Power could
be more adversely impacted in the near term. Our top pick is Lanco as we think the
current valuations do not factor in upside from capacity addition/project pipeline.
Key issues related to coal imports
Coal India’s ability to increase production
1) Currently India has ~85,000MW operating on coal and we think that another
~40,000-45,000MW will be added over the next five years. This means close to
an 8-9% CAGR in coal-based operating capacity till FY15.
2) For the next five years, it looks more or less certain that even a 4.5% CAGR
for production increase will not be easy for CIL. A more realistic estimate could
be a ~3-4% CAGR.
How will the shortfall be met?
1) In FY10, 13% of the requirement for coal (for the power sector) was met by
either imported or captive domestic coal. If CIL production (and other
domestic supply) increases at a 3% CAGR, 31% of the coal requirement in
FY15 would have to be met with captive domestic production and imports.
2) In FY10, 55mt of coal for the power sector came from imports or captive
domestic mines. If CIL production (and other domestic production) increases at
a 3% CAGR, this number would be 186mt.
Can domestic captive production increase that fast?
1) If we look at some of the large power generation companies, they have been
working on developing captive domestic mines; but of course, the progress has
been slow due to various reasons.
2) 50mt of new captive coal production is likely in FY15. We only include
NTPC, Reliance Power, Tata Power and some other small domestic mines.
Would there be pressure on imports?
1) It is very much likely in the near term and considering the fact that many of
the Indian power generation utilities own mines abroad e.g. Australia, Indonesia
and other geographies, the companies are already preparing for that.
2) There are no major power generation companies in India, including stateowned
NTPC, that are not considering coal mine acquisition abroad.
Can availability of gas change the equation?
1) Expectations of a significant improvement in the gas availability scenario
have increased, especially after the BP-Reliance Industries deal. Therefore, if
there is an increase in gas production and provided the costs are reasonable, we
think this would be a positive for fuel supply availability for the power
generation sector in India.
2) We believe higher gas availability for power projects could reduce the
overdependence on coal. This may reduce the concerns among investors on fuel
supply, to some extent. However, this is not very likely in the near term.
Is associated infrastructure good enough?
1) The current issue is related with the Indian Railways' inability to transport all
the coal from mines to the power stations. In fact, our channel checks suggest
that the availability of rail and wagons is a major problem for coal transportation.
2) We believe the support infrastructure required to transport coal from mines to
power plants is a key challenge and a significant upgrade is required very
urgently.
Is this a big worry for power companies?
1) Most of the companies operate on the fuel cost pass-through model and more
than 90% of power in India is sold under that. Hence, the impact may seem
insignificant, provided the proportion of imported coal is not very high.
2) The risk is that any hike which is more than 10% in end-tariffs would put
severe stress on state electricity boards (SEBs) and this effectively means that
even if the imported fuel (at spot rates) becomes 15% of total coal used, fuel
cost pass-through may not hold in practical terms. Either the SEBs will not
allow pass-through i.e. delay the payments, or they may buy from alternate
sources if available.
Which power companies should we like?
1) Our order of preference is as follows: a) companies with domestic captive
coal; b) companies taking measures to buy mines abroad; and c) companies with
a lower proportion of open/merchant capacity and a higher mix of fuel cost passthrough
capacity.
2) We believe that the most important issue is how aware and proactive the
company is on this issue.
3) We think companies with fuel cost pass-through (NTPC) or with domestic
captive fuel (Reliance Power) would be best-placed. We regard companies with
imported captive fuel (Lanco, Tata Power, Adani Power) as the next best option.
Overall, we prefer companies under our coverage in the following order, based
on the sum total of all the factors combined, and not just coal availability.
Table 7: 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 Low risk, strong competitive positioning in transmission space, ideal long-term stock.
3 NTPC Good defensive stock. Current valuations are attractive.
4 Reliance Infra Attractive valuation, good combination of risk-free core business and upside from infrastructure and Reliance Power projects.
5 Tata Power Good stock with diversification, low-risk approach makes it ideal for risk-averse investor seeking exposure to India power sector.
6 Reliance Power Fuel security is a key feature, but execution risks are not fully factored in.
7 Adani Power Very strong execution capability and significant upside potential from merchant power, upside capped with positives largely priced in.
Source: UBS estimates
Coal availability: a big challenge
Coal-based power generation capacity increased from 69GW in FY06 to 84GW
in FY10—a CAGR of 5.3%, and coal consumption in power plants from 308Mt
in FY06 to 411Mt in FY10—a CAGR of 7.4%. Based on current power projects
under construction and approved power projects, we estimate coal-based
capacity will increase to 129GW by FY15 at a CAGR of 9% (although the initial
years would see better capacity addition). Consequently, the coal requirement of
the power sector should increase to 598Mt at a CAGR of 7.8%. Coal demand
growth is lower than the capacity growth due to the increase in imported coal,
which has gross calorific value (GCV) higher than domestic coal, and because
newer power plants are likely to be more efficient than existing plants.
The slower pace of reforms and project execution delays and overruns,
especially in the power sector, resulted in coal consumption growing at a slower
pace than GDP in the FY00-10 period. On the basis of our interaction with
investors and sector participants, we believe the coal availability for power
companies has become a huge concern for investors. Given thoughts about the
coal availability for power generation, in this report, we analyse the implications
of lower coal availability from CIL in the country. We also analyse the
relevance of key issues and their impact on the wider power market and
generation utilities. In addition, we try to identify the winners from the coal-asa-
fuel-for-generation-utilities perspective.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Power Utilities
Coal—concern but no impending disaster
In 9M FY11, Coal India’s production increased only 1% YoY
In the first nine months of FY11, Coal India (CIL) has been able to increase
production to 299.5MT vs. 295.5MT in 9M FY10 (just 1% growth YoY). If the
trend continues, our current estimate of a 4.4% CAGR over FY10-15E for
domestic coal supply for the power sector could be at risk. This could put pressure
on imports and we believe the combined next two years’ (FY12 and FY13) thermal
coal imports for the power sector could also increase beyond 110MT (vs. 20MT
actual in FY10).
Captive coal production to see significant increase in medium term
We think power companies have made significant progress on the development of
their captive blocks. We expect a part of the fuel shortfall to be met by captive
mines of power companies (100MT captive coal in FY15 for our coverage
universe). This is an encouraging sign for fuel security of Indian power companies.
We prefer utilities with fuel pass-through/captive coal
We like power generation companies with fuel cost pass-through (NTPC, R Infra).
We also believe utilities with 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 option. We also do not really think that fuel cost passthrough
is at serious risk, if the net cost of generation is reasonable.
Top pick: Lanco, Power Grid and NTPC
Among the companies we cover, we think Adani Power and Reliance Power could
be more adversely impacted in the near term. Our top pick is Lanco as we think the
current valuations do not factor in upside from capacity addition/project pipeline.
Key issues related to coal imports
Coal India’s ability to increase production
1) Currently India has ~85,000MW operating on coal and we think that another
~40,000-45,000MW will be added over the next five years. This means close to
an 8-9% CAGR in coal-based operating capacity till FY15.
2) For the next five years, it looks more or less certain that even a 4.5% CAGR
for production increase will not be easy for CIL. A more realistic estimate could
be a ~3-4% CAGR.
How will the shortfall be met?
1) In FY10, 13% of the requirement for coal (for the power sector) was met by
either imported or captive domestic coal. If CIL production (and other
domestic supply) increases at a 3% CAGR, 31% of the coal requirement in
FY15 would have to be met with captive domestic production and imports.
2) In FY10, 55mt of coal for the power sector came from imports or captive
domestic mines. If CIL production (and other domestic production) increases at
a 3% CAGR, this number would be 186mt.
Can domestic captive production increase that fast?
1) If we look at some of the large power generation companies, they have been
working on developing captive domestic mines; but of course, the progress has
been slow due to various reasons.
2) 50mt of new captive coal production is likely in FY15. We only include
NTPC, Reliance Power, Tata Power and some other small domestic mines.
Would there be pressure on imports?
1) It is very much likely in the near term and considering the fact that many of
the Indian power generation utilities own mines abroad e.g. Australia, Indonesia
and other geographies, the companies are already preparing for that.
2) There are no major power generation companies in India, including stateowned
NTPC, that are not considering coal mine acquisition abroad.
Can availability of gas change the equation?
1) Expectations of a significant improvement in the gas availability scenario
have increased, especially after the BP-Reliance Industries deal. Therefore, if
there is an increase in gas production and provided the costs are reasonable, we
think this would be a positive for fuel supply availability for the power
generation sector in India.
2) We believe higher gas availability for power projects could reduce the
overdependence on coal. This may reduce the concerns among investors on fuel
supply, to some extent. However, this is not very likely in the near term.
Is associated infrastructure good enough?
1) The current issue is related with the Indian Railways' inability to transport all
the coal from mines to the power stations. In fact, our channel checks suggest
that the availability of rail and wagons is a major problem for coal transportation.
2) We believe the support infrastructure required to transport coal from mines to
power plants is a key challenge and a significant upgrade is required very
urgently.
Is this a big worry for power companies?
1) Most of the companies operate on the fuel cost pass-through model and more
than 90% of power in India is sold under that. Hence, the impact may seem
insignificant, provided the proportion of imported coal is not very high.
2) The risk is that any hike which is more than 10% in end-tariffs would put
severe stress on state electricity boards (SEBs) and this effectively means that
even if the imported fuel (at spot rates) becomes 15% of total coal used, fuel
cost pass-through may not hold in practical terms. Either the SEBs will not
allow pass-through i.e. delay the payments, or they may buy from alternate
sources if available.
Which power companies should we like?
1) Our order of preference is as follows: a) companies with domestic captive
coal; b) companies taking measures to buy mines abroad; and c) companies with
a lower proportion of open/merchant capacity and a higher mix of fuel cost passthrough
capacity.
2) We believe that the most important issue is how aware and proactive the
company is on this issue.
3) We think companies with fuel cost pass-through (NTPC) or with domestic
captive fuel (Reliance Power) would be best-placed. We regard companies with
imported captive fuel (Lanco, Tata Power, Adani Power) as the next best option.
Overall, we prefer companies under our coverage in the following order, based
on the sum total of all the factors combined, and not just coal availability.
Table 7: 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 Low risk, strong competitive positioning in transmission space, ideal long-term stock.
3 NTPC Good defensive stock. Current valuations are attractive.
4 Reliance Infra Attractive valuation, good combination of risk-free core business and upside from infrastructure and Reliance Power projects.
5 Tata Power Good stock with diversification, low-risk approach makes it ideal for risk-averse investor seeking exposure to India power sector.
6 Reliance Power Fuel security is a key feature, but execution risks are not fully factored in.
7 Adani Power Very strong execution capability and significant upside potential from merchant power, upside capped with positives largely priced in.
Source: UBS estimates
Coal availability: a big challenge
Coal-based power generation capacity increased from 69GW in FY06 to 84GW
in FY10—a CAGR of 5.3%, and coal consumption in power plants from 308Mt
in FY06 to 411Mt in FY10—a CAGR of 7.4%. Based on current power projects
under construction and approved power projects, we estimate coal-based
capacity will increase to 129GW by FY15 at a CAGR of 9% (although the initial
years would see better capacity addition). Consequently, the coal requirement of
the power sector should increase to 598Mt at a CAGR of 7.8%. Coal demand
growth is lower than the capacity growth due to the increase in imported coal,
which has gross calorific value (GCV) higher than domestic coal, and because
newer power plants are likely to be more efficient than existing plants.
The slower pace of reforms and project execution delays and overruns,
especially in the power sector, resulted in coal consumption growing at a slower
pace than GDP in the FY00-10 period. On the basis of our interaction with
investors and sector participants, we believe the coal availability for power
companies has become a huge concern for investors. Given thoughts about the
coal availability for power generation, in this report, we analyse the implications
of lower coal availability from CIL in the country. We also analyse the
relevance of key issues and their impact on the wider power market and
generation utilities. In addition, we try to identify the winners from the coal-asa-
fuel-for-generation-utilities perspective.
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