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Tata Power (TPWR)
Utilities
Revisiting the coal equation. Tata Power (TPWR) has corrected by 20% over the past
month on concerns of losses of the Mundra power plant—based on rising prices of
imported coal and revisions in Indonesian laws that annul the benefit of low price
contracts. We reiterate that TPWR remains a net beneficiary of rising prices of imported
coal, though we stress test our analysis for varied scenarios of coal prices, capacity
ramp-up and interest rates that could potentially impact fair value estimates. We
upgrade TPWR to BUY (from ADD) with revised price target of Rs1,350/share (Rs1,490
previously).
Mundra UMPP’s representation raises fresh questions on the viability of the project
The representation by Coastal Gujarat Power Ltd (Mundra UMPP) to the Ministry of Power has
raised fresh concerns on the viability of the Mundra UMPP given rising prices of imported coal, and
changes in Indonesian laws that annul the benefits of low-price coal contracts. We note that at the
current prices of coal –Mundra UMPP could potentially incur cash losses yielding a negative value
of Rs49 bn (-Rs200/share), and losses of Rs8.5 bn (PBT in FY2014E). In our view, Mundra will
operate at low PLFs (75%-80%), thereby minimizing losses on fuel costs while recovering full
capacity charge –availability below 75% will attract penalties leading to non-recoverability of
capacity charge.
Ownership in coal mines offsets losses at Mundra, benefit from rising prices of coal
TPWR ownership in coal mines in Indonesia—offset the losses of rising coal prices at Mundra,
while allowing TPWR to benefit from rising prices of coal. We note that taxes and royalties at the
coal mines (45% +10%) imply that TPWR is just about hedged to meet the rising impact at
Mundra at current production of ~60 mtpa, however, a ramp-up in coal production at the coal
mines allows TPWR to be a net beneficiary of rising coal prices. We assume long-term coal
realizations at US$80/ton and sustainable production of 80 mtpa implying a value of Rs400/share
for Mundra and Bumi combined, which increases by Rs158/share for US$10/ton increase in
sustainable coal realizations.
Upgrade to BUY with a revised target price of Rs1,350/share
We upgrade our rating on TPWR to BUY (from ADD) with a revised target price of Rs1,350
(Rs1,490 previously) as we adjust for higher coal cost incidence at Mundra UMPP. As highlighted
above, despite the potential losses at Mundra, TPWR will remain a net beneficiary of rising prices
of coal which could be further magnified by a more aggressive production ramp-up at Bumi. We
continue to like TPWR’s core distribution business which earns a stable return and is insulated from
risks of deteriorating financial health of SEBs. We have revised our EPS estimate to Rs76 (previously
Rs90) in FY2012E and Rs88 (previously Rs111) in FY2013E to account for losses at Mundra.
Our SOTP valuation comprises the following components—(1) value of operating power
assets at Rs410/share, (2) valuation of investments and cash in books equivalent to
Rs447/share, (3) Maithon project valued at Rs97/share, and (4) valuation of stake in coal
mines in Indonesia valued at Rs607/share. We ascribe a negative value of Rs207/share to
Mundra project to account for the losses likely to be incurred at Mundra.
Mundra’s first year tariff @ Rs2.2/kwh; sustainable losses @ Rs0.34/kwh
Mundra UMPP will likely incur a loss of Rs8.5 bn in its first full year of operations (FY2014E)
realizing a tariff of Rs2.24/kwh-- Rs0.98/kwh of capacity charge and Rs1.25/khw of energy
charge. At a landed cost of US$97/ton, actual fuel cost will be Rs1.73/kwh with capital cost
of Rs0.85/kwh. In our view, Mundra UMPP will likely operate at a PLF of 75% (PAF @80%),
thereby minimizing the operational losses, while maximizing the recovery of capacity charge.
We note that our fuel cost assumptions are linked to our FOB realization assumption for the
coal mines in Indonesia—without factoring the benefit of any sales at lower contracted
prices of coal.
For its first year of operation (FY2012E), tariff of Rs2.2/kwh would comprise of Rs1.26/kwh
of energy charge and Rs0.92/kwh of capacity charge yielding a fuel cost loss of ~Rs0.6/kwh.
Lower PLF at Mundra and higher production at coal mines remains the key
TPWR will be able to maximize the benefits of rising prices of coal by (1) minimizing losses at
Mundra—through low yet optimal utilization (PLF) of the Mundra capacity and (2) aggressive
ramp of production at the Indonesian mines.
As highlighted previously, operating at 75%, PLF minimizes losses on fuel cost while
maximizing recovery of capacity charge. Correspondingly, production ramp-up at Indonesia
will allow TPWR as a consolidated entity to (1) offset the losses at Mundra (which it does at
current level of production), and (2) benefit from excess production (over and above the
hedge requirement) of coal.
To illustrate the point above, see Exhibit 2 below which charts the sensitivity of our fair value
estimate to different PLF and volumes assumptions for Mundra and Bumi, respectively, at
varying sustainable realizations for coal. As seen in the Exhibit, optimal PLF for Mundra will
be a function of coal cost incidence (and corresponding Bumi’s realization).
Taxes and royalties increase the burden at Bumi, no offset available at Mundra
Every US$10/ton increase in prices of coal yields a contribution of US$5/ton as taxes (@45%)
and royalties (10-15%) are paid to local Indonesian authorities. However, as Mundra UMPP
is a loss making entity—there is no offset in the form of lower taxes for higher cost
incidence. Therefore, assuming no energy charge escalation, TPWR needs to hedge its losses
at Mundra UMPP with nearly twice the attributable coal production at the Indonesian mines.
It may be beneficial for TPWR to merge Mundra UMPP with a profitable entity to get the tax
benefit of losses incurred at Mundra UMPP (fuel as well as interest cost).
Mumbai distribution business – recent MERC orders could stem the inflow of
customers
Recent MERC order which allows (1) Reliance Infrastructure (RELI) to recover its regulatory
assets of Rs23 bn from all those consumers who have migrated to Tata Power supply but still
on RELI’s wires (~97% of total migrated consumers) and (2) levying of a cross subsidy
surcharge on consumers migrating to Tata Power network could potentially bridge the gap
between end-use tariffs of RELI and TPWR, which in turn would stem the mass switchover of
consumers from RELI to TPWR supply. We note that although this dos not affect the nearterm
profitability of TPWR, it could potentially impact the prospective capex (and hence
growth) in Mumbai distribution business.
On a separate note, we highlight that cash generation from Mumbai distribution remains
healthy (unlike NDPL as discussed below) with debtors from unbilled revenues decreasing to
Rs974 mn from Rs1.2 bn while tariff adjustment account increasing marginally to Rs6.4 bn
from Rs5.6 bn.
Other key businesses, extant and future portfolio
In this section, we discuss other key businesses of TPWR and the future portfolio of TPWR
along with pipeline generation projects.
NDPL - NDPL had an accrued regulatory asset of Rs24 bn as of March 2011 akin to other
distribution licensees in New Delhi (Reliance Infra through BYPL and BRPL). We note that
the regulatory asset stood at Rs10.2 bn as of March 2010 and Rs3.2 bn as of March 2009.
The increase in regulatory asset was primarily on account of shortfall in collection by
Rs11.5 bn in FY2011 and had raised concerns about the cash flows of the company. We
note that tariff order for FY2011 was not released by DERC due to a stay order by Delhi
High Court which meant that NDPL billed its consumer at power purchase cost of
Rs2.63/kwh as against actual cost of Rs4.21/kwh in FY2011 thus leading to swelling up in
regulatory assets. However, the stay order has now been lifted and NDPL has filed its
tariff petition with DERC for FY2012.
Industrial Energy Limited (IEL) – IEL is a 74% owned subsidiary of TPWR which
operated two power plants – IEL Phase 6 (120 MW) and Unit 5 Jojobera (120 MW), both
of which sell power to Tata Steel. Jojobera Unit 5 was commissioned in March 2011.
Maithon Power Limited (MPL) - Maithon project (1050 MW) is 96% complete and Unit
I has been synchronized. TPWR has invested Rs11.6 bn equity as of March 2011 into the
project. For Unit 1, TPWR has already signed an FSA with BCCL for supply of 1.66 mtpa.
TPWR also has a Letter of Assurance (LoA) from CCL for supply of 2 mtpa. In order to
supplement coal supplied from CIL, TPWR has also entered into a supply agreement with
Tata Steel for supply of ~1 mtpa.
Powerlinks transmission (PTL) – PTL is a 51% owned JV of TPWR and transmits power
from Tala Hydroelectric project from Bhutan. PTL reported revenues of Rs2.9 bn (-4% yoy)
and PAT of Rs1.1 bn (-2% yoy).
Tata Power Trading (TPTL) – TPTL transacted 4,354 MU in FY2011 at an average rate of
Rs4.43/kwh yielding revenue of Rs19.3 bn. TPTL PAT was Rs91.5 mn (11% yoy) in
FY2011.
Future projects – Apart from near-term capacity addition of 5 GW (Mundra and
Maithon), TWPR also has another 4.4 GW under advanced stages of planning and
development. We note that our valuation for TPWR does not include the pipeline projects
as we these projects are yet to tie in the necessary inputs though we highlight that
traction on these projects could be a key upside to our estimates. Exhibit 4 details the
execution status of pipeline projects.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Power (TPWR)
Utilities
Revisiting the coal equation. Tata Power (TPWR) has corrected by 20% over the past
month on concerns of losses of the Mundra power plant—based on rising prices of
imported coal and revisions in Indonesian laws that annul the benefit of low price
contracts. We reiterate that TPWR remains a net beneficiary of rising prices of imported
coal, though we stress test our analysis for varied scenarios of coal prices, capacity
ramp-up and interest rates that could potentially impact fair value estimates. We
upgrade TPWR to BUY (from ADD) with revised price target of Rs1,350/share (Rs1,490
previously).
Mundra UMPP’s representation raises fresh questions on the viability of the project
The representation by Coastal Gujarat Power Ltd (Mundra UMPP) to the Ministry of Power has
raised fresh concerns on the viability of the Mundra UMPP given rising prices of imported coal, and
changes in Indonesian laws that annul the benefits of low-price coal contracts. We note that at the
current prices of coal –Mundra UMPP could potentially incur cash losses yielding a negative value
of Rs49 bn (-Rs200/share), and losses of Rs8.5 bn (PBT in FY2014E). In our view, Mundra will
operate at low PLFs (75%-80%), thereby minimizing losses on fuel costs while recovering full
capacity charge –availability below 75% will attract penalties leading to non-recoverability of
capacity charge.
Ownership in coal mines offsets losses at Mundra, benefit from rising prices of coal
TPWR ownership in coal mines in Indonesia—offset the losses of rising coal prices at Mundra,
while allowing TPWR to benefit from rising prices of coal. We note that taxes and royalties at the
coal mines (45% +10%) imply that TPWR is just about hedged to meet the rising impact at
Mundra at current production of ~60 mtpa, however, a ramp-up in coal production at the coal
mines allows TPWR to be a net beneficiary of rising coal prices. We assume long-term coal
realizations at US$80/ton and sustainable production of 80 mtpa implying a value of Rs400/share
for Mundra and Bumi combined, which increases by Rs158/share for US$10/ton increase in
sustainable coal realizations.
Upgrade to BUY with a revised target price of Rs1,350/share
We upgrade our rating on TPWR to BUY (from ADD) with a revised target price of Rs1,350
(Rs1,490 previously) as we adjust for higher coal cost incidence at Mundra UMPP. As highlighted
above, despite the potential losses at Mundra, TPWR will remain a net beneficiary of rising prices
of coal which could be further magnified by a more aggressive production ramp-up at Bumi. We
continue to like TPWR’s core distribution business which earns a stable return and is insulated from
risks of deteriorating financial health of SEBs. We have revised our EPS estimate to Rs76 (previously
Rs90) in FY2012E and Rs88 (previously Rs111) in FY2013E to account for losses at Mundra.
Our SOTP valuation comprises the following components—(1) value of operating power
assets at Rs410/share, (2) valuation of investments and cash in books equivalent to
Rs447/share, (3) Maithon project valued at Rs97/share, and (4) valuation of stake in coal
mines in Indonesia valued at Rs607/share. We ascribe a negative value of Rs207/share to
Mundra project to account for the losses likely to be incurred at Mundra.
Mundra’s first year tariff @ Rs2.2/kwh; sustainable losses @ Rs0.34/kwh
Mundra UMPP will likely incur a loss of Rs8.5 bn in its first full year of operations (FY2014E)
realizing a tariff of Rs2.24/kwh-- Rs0.98/kwh of capacity charge and Rs1.25/khw of energy
charge. At a landed cost of US$97/ton, actual fuel cost will be Rs1.73/kwh with capital cost
of Rs0.85/kwh. In our view, Mundra UMPP will likely operate at a PLF of 75% (PAF @80%),
thereby minimizing the operational losses, while maximizing the recovery of capacity charge.
We note that our fuel cost assumptions are linked to our FOB realization assumption for the
coal mines in Indonesia—without factoring the benefit of any sales at lower contracted
prices of coal.
For its first year of operation (FY2012E), tariff of Rs2.2/kwh would comprise of Rs1.26/kwh
of energy charge and Rs0.92/kwh of capacity charge yielding a fuel cost loss of ~Rs0.6/kwh.
Lower PLF at Mundra and higher production at coal mines remains the key
TPWR will be able to maximize the benefits of rising prices of coal by (1) minimizing losses at
Mundra—through low yet optimal utilization (PLF) of the Mundra capacity and (2) aggressive
ramp of production at the Indonesian mines.
As highlighted previously, operating at 75%, PLF minimizes losses on fuel cost while
maximizing recovery of capacity charge. Correspondingly, production ramp-up at Indonesia
will allow TPWR as a consolidated entity to (1) offset the losses at Mundra (which it does at
current level of production), and (2) benefit from excess production (over and above the
hedge requirement) of coal.
To illustrate the point above, see Exhibit 2 below which charts the sensitivity of our fair value
estimate to different PLF and volumes assumptions for Mundra and Bumi, respectively, at
varying sustainable realizations for coal. As seen in the Exhibit, optimal PLF for Mundra will
be a function of coal cost incidence (and corresponding Bumi’s realization).
Taxes and royalties increase the burden at Bumi, no offset available at Mundra
Every US$10/ton increase in prices of coal yields a contribution of US$5/ton as taxes (@45%)
and royalties (10-15%) are paid to local Indonesian authorities. However, as Mundra UMPP
is a loss making entity—there is no offset in the form of lower taxes for higher cost
incidence. Therefore, assuming no energy charge escalation, TPWR needs to hedge its losses
at Mundra UMPP with nearly twice the attributable coal production at the Indonesian mines.
It may be beneficial for TPWR to merge Mundra UMPP with a profitable entity to get the tax
benefit of losses incurred at Mundra UMPP (fuel as well as interest cost).
Mumbai distribution business – recent MERC orders could stem the inflow of
customers
Recent MERC order which allows (1) Reliance Infrastructure (RELI) to recover its regulatory
assets of Rs23 bn from all those consumers who have migrated to Tata Power supply but still
on RELI’s wires (~97% of total migrated consumers) and (2) levying of a cross subsidy
surcharge on consumers migrating to Tata Power network could potentially bridge the gap
between end-use tariffs of RELI and TPWR, which in turn would stem the mass switchover of
consumers from RELI to TPWR supply. We note that although this dos not affect the nearterm
profitability of TPWR, it could potentially impact the prospective capex (and hence
growth) in Mumbai distribution business.
On a separate note, we highlight that cash generation from Mumbai distribution remains
healthy (unlike NDPL as discussed below) with debtors from unbilled revenues decreasing to
Rs974 mn from Rs1.2 bn while tariff adjustment account increasing marginally to Rs6.4 bn
from Rs5.6 bn.
Other key businesses, extant and future portfolio
In this section, we discuss other key businesses of TPWR and the future portfolio of TPWR
along with pipeline generation projects.
NDPL - NDPL had an accrued regulatory asset of Rs24 bn as of March 2011 akin to other
distribution licensees in New Delhi (Reliance Infra through BYPL and BRPL). We note that
the regulatory asset stood at Rs10.2 bn as of March 2010 and Rs3.2 bn as of March 2009.
The increase in regulatory asset was primarily on account of shortfall in collection by
Rs11.5 bn in FY2011 and had raised concerns about the cash flows of the company. We
note that tariff order for FY2011 was not released by DERC due to a stay order by Delhi
High Court which meant that NDPL billed its consumer at power purchase cost of
Rs2.63/kwh as against actual cost of Rs4.21/kwh in FY2011 thus leading to swelling up in
regulatory assets. However, the stay order has now been lifted and NDPL has filed its
tariff petition with DERC for FY2012.
Industrial Energy Limited (IEL) – IEL is a 74% owned subsidiary of TPWR which
operated two power plants – IEL Phase 6 (120 MW) and Unit 5 Jojobera (120 MW), both
of which sell power to Tata Steel. Jojobera Unit 5 was commissioned in March 2011.
Maithon Power Limited (MPL) - Maithon project (1050 MW) is 96% complete and Unit
I has been synchronized. TPWR has invested Rs11.6 bn equity as of March 2011 into the
project. For Unit 1, TPWR has already signed an FSA with BCCL for supply of 1.66 mtpa.
TPWR also has a Letter of Assurance (LoA) from CCL for supply of 2 mtpa. In order to
supplement coal supplied from CIL, TPWR has also entered into a supply agreement with
Tata Steel for supply of ~1 mtpa.
Powerlinks transmission (PTL) – PTL is a 51% owned JV of TPWR and transmits power
from Tala Hydroelectric project from Bhutan. PTL reported revenues of Rs2.9 bn (-4% yoy)
and PAT of Rs1.1 bn (-2% yoy).
Tata Power Trading (TPTL) – TPTL transacted 4,354 MU in FY2011 at an average rate of
Rs4.43/kwh yielding revenue of Rs19.3 bn. TPTL PAT was Rs91.5 mn (11% yoy) in
FY2011.
Future projects – Apart from near-term capacity addition of 5 GW (Mundra and
Maithon), TWPR also has another 4.4 GW under advanced stages of planning and
development. We note that our valuation for TPWR does not include the pipeline projects
as we these projects are yet to tie in the necessary inputs though we highlight that
traction on these projects could be a key upside to our estimates. Exhibit 4 details the
execution status of pipeline projects.
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