GVK Power :: Growth plans entail more risk: Downgrade to UW ::JPMorgan

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GVK Power & Infrastructure
▼ Underweight
Previous: Neutral
GVKP.BO, GVKP IN
Growth plans entail more risk: Downgrade to UW


GVK’s quest for long-term growth and fuel security, though legitimate from
the company’s perspective, raises risk for equity investors substantially over
the medium term. We downgrade to UW.
 GVK may take a stake in Kevin and Alpha coal mines, owned by
Hancock, in Queensland, Australia. As per news reports (Livemint), the
mine is valued at A$2.4B. The % stake to be taken and how this would be
shared between GVK and its promoters is not known. But even in a
conservative scenario, we believe GVK would have to dilute at least 11% of
equity and might have to bear at least Rs3B of additional interest burden (4x
of FY13E profit). We believe any adverse movement in interest rates, coal
prices, Australia's mineral taxes, or delay in production ramp-up or creation
of rail/port infrastructure could expose GVK equity holders to huge risk.
 GVK continues to have more growth aspirations, ranging from airports
in Indonesia (likely US$1.6B) to India (likely US$2B) to more power
projects in India (est. US$1.7B). In the context of GVK’s current market
cap, we think the balance sheet cannot support all this growth, and might
necessitate more risk / dilution going ahead.
 Playing the devil’s advocate – at 0.9x P/B, and given the sharp value
erosion over 1-yr, is all bad news in the price? The foll. datapoints
suggest that risk is worsening and stock may have to correct further before
offering meaningful risk-adjusted returns to the equity holder: 1) RoE at
4.7%, inching up to barely 8.4% by FY14, 2) FY13E NDER rises to 2.6x,
while EBITDA to interest ratio drops to 1.6x, even without any additional
debt for these acquisitions
 We would use any relief rally, emanating from a potential solution to
the Mumbai airport real estate issue, to exit the stock. The government
has proposed a relaxation to eligibility norms for slum dwellers’ rehab,
which might potentially pave the way for RE lease-outs: this is already in
our PT. Our new PT of Rs17 factors in higher discounting rate for key
assets considering higher risk. Any measures by management to limit its
equity and debt exposures to new acquisitions would constitute upside risk
to our PT.