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India Power Utilities
B anking on policy action in the sector
We met with various Indian power sector participants last week
We met with several power sector participants over the past week (14 September in
Mumbai, 15 Sep in Lucknow and 16 Sep in Delhi). We met officials at power
distribution companies, State Electricity Boards (SEBs), the regulator (Central
Electricity Regulatory Commission or CERC), the Planning Commission,
independent consultants in the sector, and power generation companies.
We wanted an update on the tariff hikes, SEB losses and coal supply
The key objective behind these meetings was to get the most up-to-date sector
views of industry participants. We wanted to understand the impact of the recent
tariff hikes across states and its implications for the financial health of the SEBs.
We also wanted to understand the outlook on coal availability for the power
generation sector.
Policy action from central government likely; states to raise tariffs
Our findings are: 1) the central government would focus on reducing SEB losses
and improving domestic coal availability; 2) states would continue to raise tariffs
and would rationalise electricity tariffs so that cost of supply and revenue are better
aligned; and 3) the power sector would continue to grow at a minimum of 5-6%
p.a.
UBS view and action: Power Grid and Lanco are our top picks
We think there are attractive buying opportunities in the sector. We like companies
with low risk (Power Grid and NTPC) or those with compelling valuations (Lanco
and Reliance Infrastructure). We also have Buy ratings on NTPC, Tata Power, and
Reliance Infra. We recently upgraded Reliance Power from a Sell to Buy rating.
Meetings with sector participants
Over the past week, we met with various sector participants to get their views on
the sector. We met with:
— State Electricity Boards (Maharashtra distribution company or MSEDCL
and Uttar Pradesh Power Corporation Ltd)
— CERC (central regulator)
— NTPC (the largest power generation utility in India)
— Planning Commission (central planning and coordination body)
— AF-Mercados India (independent sector consultant)
Our meetings were on 14 September in Mumbai, 15 September in Lucknow, and
on 16 September in Delhi.
Key objectives for the meetings
YTD, the Indian power sector has performed poorly in our coverage universe
and the stocks have corrected significantly. Given concerns about the outlook
for the sector, we decided to meet with the key participants in the sector to get
their views on several issues. Our key objective behind these meetings was to
get the most recent views of participants on the sector. Specifically, we wanted
to understand:
The sustainability of tariff hikes across states
The importance of power as an input for GDP growth and hence, the
implications for the power generation sector if India has to grow at 7-8%
Implications of the poor financial health of SEBs for the power generating
sector
The current coal supply scenario in India and its medium-term outlook
Outlook for merchant power capacities vs. long-term PPA-based capacity
and views on potential sector profitability and returns on investment.
Key takeaways from meetings
On the basis of our meetings, we think most participants think there are two key
issues for the sector: 1) the poor financial health of SEBs; and 2) availability of
coal supply.
We observed that in most of the meetings, SEB losses were highlighted as a
significant issue for power generation companies. However, the general view of
the people met was that: 1) tariff hikes would continue to happen across states;
2) the central government may not support states in bailing out SEBs; and 3)
progress in distribution reforms is good in many states such as Gujarat and
Maharashtra, but some other states such as Bihar, Uttar Pradesh and Madhya
Pradesh have lagged behind and this could impact the power generation sector.
On the issue of coal availability, the view was: 1) this is a structural problem
that would require a coordinated response from various ministries and
departments of the central government; 2) imports would continue to grow faster
than domestic coal supply; and 3) the logistics associated with factors such as
wagon availability from Indian Railways need to be sorted out to improve
domestic coal availability and transportation.
The following are the key messages from these meetings on various issues:
(1) Tariff hikes: As indicated in the past 6-9 months, the power tariff hikes
would continue across various states. However, it is not certain if tariffs
can be adequately raised to cover entire costs and bring down the losses to
either nil or insignificant levels.
(2) Agriculture supply: It may be politically unacceptable to link prices of
power supply to agriculture with costs. However, better metering (it will
improve the billing) and rationalisation of supply to farmers would help.
Another very important factor is that if the end market for farm produce is not
tightly controlled by the government and becomes deregulated (with measures
such as lifting of export ban on onions and sugar), the probability of rational
pricing for inputs (such as power) also increases.
(3) Power as an input for growth: GDP growth (especially industrial growth) is
not possible without sufficient availability of quality power at competitive
prices. If India has to grow at 7-8%, then power demand would also grow a
minimum of 5-6%.
(4) Central government’s role: The central government has become
increasingly aware of the importance of and issues in the sector. In the next
six months, it is highly likely that the government will take significant
measures to address key issues such as coal availability, environment
clearance for projects, etc.
(5) Capacity addition: 45,000-50,000MW is likely to be added in the XI Five-
Year Plan (FY08-12) and fuel and land will likely be the key issues in the
XII Five-Year Plan. Fuel is the most critical issue.
(6) Coal supply: This requires a coordinated response from various ministries
and departments of the central government; logistics is one of the key
challenges. Still, imports would continue to grow faster than domestic coal
supply.
(7) SEB losses: the poor financial health and losses of SEBs is the biggest
concern as progress in distribution reform remains slow. This could impact
the power generating sector.
UBS view
Please refer to our sector report ‘India Power Utilities: Not all doom and gloom’
dated 25 August 2011.
While investor sentiment has been negative, we think understanding the
importance of electricity as a political issue and a key input of India’s GDP
growth is vital in forming a view on India’s power sector. A prolonged
electricity shortage could have serious consequences for the political class and
might lead to a backlash during the elections. The infrastructure development
agenda is a central one and recent elections indicate that electricity, roads, and
water have become the main issues for election campaigns. We think the state
governments have started to address the SEBs’ losses (as the central government
is unlikely to bail them out).
As it is politically unacceptable for power to be cut off for extended periods of time,
we believe power tariffs have to increase so that the SEBs can afford to buy more
power from independent power producers (IPP). SEBs have also been trying to
lower their losses and control their purchases (by only buying in quantities that
strike a balance between power cuts and their financial health). Once the tariff
increases, we believe the SEBs will be more willing to purchase greater
amounts. As we expect plant load factors (PLFs) at the merchant plants and
tariffs for them to remain under pressure, there appear to be no quick fixes.
However, if the net cost of power generation is reasonable, we do not think the
fuel cost pass-through is at serious risk of not being honored. PLFs for long-term
power purchase agreements (PPAs) are not under threat (80% or 85% on a caseby-
case basis).
We think tariffs can be adequately raised to cover costs and lower losses as this
is more a question of political will from the state governments. We also believe
that the electorate understands that tariff hikes are a reality. For instance, over
the past ten years, prices of all the other basic and essential commodities such as
salt, wheat, rice, pulses and kerosene have increased more rapidly than
electricity. The states are also taking measures that are less direct such as the use
of distribution franchises (where only the distribution part is privatised for a
specific duration such as 10-15 years). This has been a success in some
distribution circles such as Bhiwandi, where aggregate technical and commercial
(AT&C) losses have fallen from around 60% in 2008 to around 18% currently.
During the tariff hikes over the past six to 12 months, resistance from the
opposition political parties has been manageable for the local governments.
Another key factor supporting tariff hikes is that among the state governments,
there was hope that the central government would help the SEBs if things do not
improve. The Power Ministry and the Planning Commission have informed the
states in clear terms that this is now highly unlikely.
Overall, the single biggest problem for the Indian power sector today is the
losses of distribution companies. Most of these distribution companies are under
their respective state governments' control and the power supply for agriculture
is free (in some states) or significantly below cost (in almost all states). The
heavily under-priced supply of power to farmers is one of the most important
reasons behind the distribution companies' losses. We think the issue of why the
governments subsidise the inputs required for agriculture is clearly linked with
the fact that there is no free market for produce as well. Most states have started
to revise tariffs and this would be positive for the power sector in India.
Although it is politically challenging to bring power supply for agriculture under
commercial principles, any positive development in this direction would be a
huge positive.
While we think it is unlikely, there is a political risk that tariff hikes may not
occur. In this case, the utilities’ new projects will be affected. In the following
table, we try to quantify the risk and examine how the worst-case scenario
would impact the utilities under our coverage. We think the risk is highest for
Lanco and Tata Power, followed by Reliance Power. We do not expect any
impact on Power Grid and NTPC. In this case, we would prefer Power Grid,
NTPC, Reliance Infrastructure, Reliance Power, Lanco and Tata Power, in that
order
Over the next twelve months, we think a few factors could improve for the
sector: 1) more tariff hikes at the state level; 2) more positive policy action from
the government; and 3) investors may start to appreciate the fact that it is not
easy to build a generation capacity base in India.
Stock ideas: top picks (Power Grid and Lanco)
We like companies with low risk (Power Grid and NTPC) or those at
compelling valuations (Lanco and Reliance Infrastructure). We have recently
upgraded Reliance Power to a Buy given its strong advantage in captive coal.
Our coverage universe and UBS summary view is as follows:
Power Grid (Buy, DCF-based PT of Rs135)
Power Grid is a strong defensive in a natural monopoly sector and we think
Power Grid will be a key beneficiary of growth in the transmission sector; it has
over 50% market share which we expect to increase. We believe Power Grid has
significant advantages: 1) the low-risk nature of its business with ROE of 15.5%
plus incentives based on transmission network availability totalling 17-18%; and
2) as the central transmission utility, it has been assigned the role of co-ordinator
in the sector.
Power Grid has a capex target of Rs550bn in the 11th Five Year Plan (FY08-
FY12). To achieve that, the company will have to incur Rs177bn of capex in
FY12. We believe that even in the worst-case scenario, 90-95% of the target can
be achieved. We think this is a strong positive, as the company’s business model
is strongly linked to the capex incurred and the commissioning of its projects.
We believe there are strong share price catalysts over the next 12 months: 1)
FY12 is the last year of the 11th Five-Year Plan and ordering activity is likely to
remain strong towards the end of the financial year (Q4 FY12); 2) strong
capitalisation of Capital Works in Progress; 3) higher capex as Power Grid has a
target of Rs550bn by March 2012; and 4) we believe valuations are attractive.
Lanco (Buy, SOTP-based PT of Rs30)
Lanco has been one of the worst performers in the sector. The share price has
corrected significantly and we think this reflects the difficult environment for
the generation sector and company-specific issues. However, we believe that the
market is ignoring the strong generation capacity base (3,300MW), which is not
easy to replicate. We also believe that the share price fully factors in a decline in
merchant tariffs and the likely impact on PLF due to non-availability of fuel.
However, there are challenges as well. In the near term, we believe the risks are
as follows: 1) a court case related to Griffin Coal in Australia; 2) transmission
issues at the Udupi 1,200 MW plant; 3) lack of clarity on the PPA of 300MW;
and 4) fuel issues at operational plants. However, we think that most are shortterm
issues and are priced in.
NTPC (Buy, DCF-based PT of Rs215)
NTPC provides a low-risk exposure to the India Power Generation Sector.
NTPC’s share price has corrected 16% YTD and marginally underperformed the
BSE Sensex. In our view, this is unwarranted for a company with relatively low
risk, i.e. a fixed return on investment-based model. We believe NTPC’s core
fundamentals are intact: 1) a high demand-supply gap in India; 2) the largest
capacity base; 3) competitive generation cost; and 4) we think fuel cost passthrough
is not at risk.
NTPC has a strong payment security mechanism. In case of non-payment of
receivables from SEBs, NTPC can directly recover the outstanding amount from
central government grants to respective states. This was evident in FY11: NTPC
realised 100% payment of bills from customers for the eighth successive year.
We also think that as NTPC is Coal India’s biggest customer and a government
company, it may get preference in coal allocation.
Reliance Infrastructure (Buy, SOTP-based PT of Rs700)
With a strong infrastructure portfolio, Reliance Infrastructure (RELI) is a longterm
asset play. We are positive on RELI’s strong infrastructure portfolio (11
road projects, five airports, five transmission projects, and three metro lines).
We also like the diversified nature of the business, as the company has no
particular preference for sub-sectors. In our view, RELI is a good long-term
asset play on India’s infrastructure growth story. As more projects become
operational, the company could monetise some of the assets.
In India, infrastructure projects face significant execution challenges that include
land acquisition, approvals and clearances, financial closure and availability of
skilled manpower. RELI is trying to meet these challenges with its: 1) captive
EPC division; b) strong in-house capabilities in different segments such as
metro, roads and transmission; 3) strong balance sheet; and 4) synergies with
group companies.
Tata Power (Buy, SOTP-based PT of Rs1,350)
Mundra remains an overhang for the stock. The Indonesian government has
decided to link the price of exported coal with a benchmark based on
international prices. Indonesia is the source of coal for the Mundra project and if
the spot price is above US$65-70/tonne, the project may not be profitable, in our
view. Currently, we do not include the Mundra project in our valuation and
believe that this issue will continue to remain an overhang for the stock.
Tata Power is developing a 4,000MW imported coal-based project and the key
points on this Ultra Mega Power Project (UMPP) are: 1) Unit I (800MW) is
likely to be commissioned in March 12 or Q1 FY13; 2) the Indonesian
government is unlikely to provide any relief in terms of relaxation from new
regulation; 3) Tata Power would explore options to use lower-grade coal if it
leads to economic benefit; 4) beneficiary states would like to involve the central
government in any discussion related to tariff revisions.
Overall, Tata Power has a target of reaching 25,000MW generation capacity by
2017 from current operating capacity of 3,176MW; 2) the development at
captive coal blocks of Mandakini and Tubed is on track; 3) the company's
strategy on merchant capacity is cautious and merchant power is unlikely to be
>10% in generation mix.
Reliance Power (Buy, DCF-based PT of Rs105)
Reliance Power has one of the largest coal reserves in the private sector (nongovernment)
in India. The company has been allotted coal mines with 2bn
tonnes of reserves (versus 730m tonnes required for the life cycle of the
8,000MW Sasan and Tilaiya UMPPs), a critical advantage. We believe the
market is ignoring the fuel security available to the company. We also think
there is no risk of coal blocks being de-allocated as mine development is on
track.
The key positives in the past 12 months were: 1) approval for 40mtpa at the
Tilaiya mine; 2) a Rs450bn contract with Shanghai Electric for main plant
equipment for 30,000MW of coal-based projects; 3) a Rs34bn contract with GE
for a 2,400MW gas project; and 4) MOUs with Chinese banks and Ex-Im Bank
for Rs750bn in financing. We think Reliance Power could emerge as a cost
leader due to its captive coal, less expensive Chinese equipment, and external
debt financing.
Adani Power (Sell, DCF-based PT of Rs80)
We are negative on Adani Power as the risks do not seem to be priced in. We
like the company for its strong execution, but think the share price does not
factor in risks such as: 1) a decline in merchant tariffs; and 2) no fuel price
escalation clauses in long-term PPAs. We believe the share price risk is to the
downside.
According to media reports, the Indonesian government has decided to link the
price of coal exported from the country with a benchmark based on international
coal prices. However, we expect the impact on Adani Power to be limited
(Adani Enterprises Limited has captive mines and it was subsidising supply to
Adani Power). We assume a price of US$36/tonne for imported coal to Adani
Power.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Power Utilities
B anking on policy action in the sector
We met with various Indian power sector participants last week
We met with several power sector participants over the past week (14 September in
Mumbai, 15 Sep in Lucknow and 16 Sep in Delhi). We met officials at power
distribution companies, State Electricity Boards (SEBs), the regulator (Central
Electricity Regulatory Commission or CERC), the Planning Commission,
independent consultants in the sector, and power generation companies.
We wanted an update on the tariff hikes, SEB losses and coal supply
The key objective behind these meetings was to get the most up-to-date sector
views of industry participants. We wanted to understand the impact of the recent
tariff hikes across states and its implications for the financial health of the SEBs.
We also wanted to understand the outlook on coal availability for the power
generation sector.
Policy action from central government likely; states to raise tariffs
Our findings are: 1) the central government would focus on reducing SEB losses
and improving domestic coal availability; 2) states would continue to raise tariffs
and would rationalise electricity tariffs so that cost of supply and revenue are better
aligned; and 3) the power sector would continue to grow at a minimum of 5-6%
p.a.
UBS view and action: Power Grid and Lanco are our top picks
We think there are attractive buying opportunities in the sector. We like companies
with low risk (Power Grid and NTPC) or those with compelling valuations (Lanco
and Reliance Infrastructure). We also have Buy ratings on NTPC, Tata Power, and
Reliance Infra. We recently upgraded Reliance Power from a Sell to Buy rating.
Meetings with sector participants
Over the past week, we met with various sector participants to get their views on
the sector. We met with:
— State Electricity Boards (Maharashtra distribution company or MSEDCL
and Uttar Pradesh Power Corporation Ltd)
— CERC (central regulator)
— NTPC (the largest power generation utility in India)
— Planning Commission (central planning and coordination body)
— AF-Mercados India (independent sector consultant)
Our meetings were on 14 September in Mumbai, 15 September in Lucknow, and
on 16 September in Delhi.
Key objectives for the meetings
YTD, the Indian power sector has performed poorly in our coverage universe
and the stocks have corrected significantly. Given concerns about the outlook
for the sector, we decided to meet with the key participants in the sector to get
their views on several issues. Our key objective behind these meetings was to
get the most recent views of participants on the sector. Specifically, we wanted
to understand:
The sustainability of tariff hikes across states
The importance of power as an input for GDP growth and hence, the
implications for the power generation sector if India has to grow at 7-8%
Implications of the poor financial health of SEBs for the power generating
sector
The current coal supply scenario in India and its medium-term outlook
Outlook for merchant power capacities vs. long-term PPA-based capacity
and views on potential sector profitability and returns on investment.
Key takeaways from meetings
On the basis of our meetings, we think most participants think there are two key
issues for the sector: 1) the poor financial health of SEBs; and 2) availability of
coal supply.
We observed that in most of the meetings, SEB losses were highlighted as a
significant issue for power generation companies. However, the general view of
the people met was that: 1) tariff hikes would continue to happen across states;
2) the central government may not support states in bailing out SEBs; and 3)
progress in distribution reforms is good in many states such as Gujarat and
Maharashtra, but some other states such as Bihar, Uttar Pradesh and Madhya
Pradesh have lagged behind and this could impact the power generation sector.
On the issue of coal availability, the view was: 1) this is a structural problem
that would require a coordinated response from various ministries and
departments of the central government; 2) imports would continue to grow faster
than domestic coal supply; and 3) the logistics associated with factors such as
wagon availability from Indian Railways need to be sorted out to improve
domestic coal availability and transportation.
The following are the key messages from these meetings on various issues:
(1) Tariff hikes: As indicated in the past 6-9 months, the power tariff hikes
would continue across various states. However, it is not certain if tariffs
can be adequately raised to cover entire costs and bring down the losses to
either nil or insignificant levels.
(2) Agriculture supply: It may be politically unacceptable to link prices of
power supply to agriculture with costs. However, better metering (it will
improve the billing) and rationalisation of supply to farmers would help.
Another very important factor is that if the end market for farm produce is not
tightly controlled by the government and becomes deregulated (with measures
such as lifting of export ban on onions and sugar), the probability of rational
pricing for inputs (such as power) also increases.
(3) Power as an input for growth: GDP growth (especially industrial growth) is
not possible without sufficient availability of quality power at competitive
prices. If India has to grow at 7-8%, then power demand would also grow a
minimum of 5-6%.
(4) Central government’s role: The central government has become
increasingly aware of the importance of and issues in the sector. In the next
six months, it is highly likely that the government will take significant
measures to address key issues such as coal availability, environment
clearance for projects, etc.
(5) Capacity addition: 45,000-50,000MW is likely to be added in the XI Five-
Year Plan (FY08-12) and fuel and land will likely be the key issues in the
XII Five-Year Plan. Fuel is the most critical issue.
(6) Coal supply: This requires a coordinated response from various ministries
and departments of the central government; logistics is one of the key
challenges. Still, imports would continue to grow faster than domestic coal
supply.
(7) SEB losses: the poor financial health and losses of SEBs is the biggest
concern as progress in distribution reform remains slow. This could impact
the power generating sector.
UBS view
Please refer to our sector report ‘India Power Utilities: Not all doom and gloom’
dated 25 August 2011.
While investor sentiment has been negative, we think understanding the
importance of electricity as a political issue and a key input of India’s GDP
growth is vital in forming a view on India’s power sector. A prolonged
electricity shortage could have serious consequences for the political class and
might lead to a backlash during the elections. The infrastructure development
agenda is a central one and recent elections indicate that electricity, roads, and
water have become the main issues for election campaigns. We think the state
governments have started to address the SEBs’ losses (as the central government
is unlikely to bail them out).
As it is politically unacceptable for power to be cut off for extended periods of time,
we believe power tariffs have to increase so that the SEBs can afford to buy more
power from independent power producers (IPP). SEBs have also been trying to
lower their losses and control their purchases (by only buying in quantities that
strike a balance between power cuts and their financial health). Once the tariff
increases, we believe the SEBs will be more willing to purchase greater
amounts. As we expect plant load factors (PLFs) at the merchant plants and
tariffs for them to remain under pressure, there appear to be no quick fixes.
However, if the net cost of power generation is reasonable, we do not think the
fuel cost pass-through is at serious risk of not being honored. PLFs for long-term
power purchase agreements (PPAs) are not under threat (80% or 85% on a caseby-
case basis).
We think tariffs can be adequately raised to cover costs and lower losses as this
is more a question of political will from the state governments. We also believe
that the electorate understands that tariff hikes are a reality. For instance, over
the past ten years, prices of all the other basic and essential commodities such as
salt, wheat, rice, pulses and kerosene have increased more rapidly than
electricity. The states are also taking measures that are less direct such as the use
of distribution franchises (where only the distribution part is privatised for a
specific duration such as 10-15 years). This has been a success in some
distribution circles such as Bhiwandi, where aggregate technical and commercial
(AT&C) losses have fallen from around 60% in 2008 to around 18% currently.
During the tariff hikes over the past six to 12 months, resistance from the
opposition political parties has been manageable for the local governments.
Another key factor supporting tariff hikes is that among the state governments,
there was hope that the central government would help the SEBs if things do not
improve. The Power Ministry and the Planning Commission have informed the
states in clear terms that this is now highly unlikely.
Overall, the single biggest problem for the Indian power sector today is the
losses of distribution companies. Most of these distribution companies are under
their respective state governments' control and the power supply for agriculture
is free (in some states) or significantly below cost (in almost all states). The
heavily under-priced supply of power to farmers is one of the most important
reasons behind the distribution companies' losses. We think the issue of why the
governments subsidise the inputs required for agriculture is clearly linked with
the fact that there is no free market for produce as well. Most states have started
to revise tariffs and this would be positive for the power sector in India.
Although it is politically challenging to bring power supply for agriculture under
commercial principles, any positive development in this direction would be a
huge positive.
While we think it is unlikely, there is a political risk that tariff hikes may not
occur. In this case, the utilities’ new projects will be affected. In the following
table, we try to quantify the risk and examine how the worst-case scenario
would impact the utilities under our coverage. We think the risk is highest for
Lanco and Tata Power, followed by Reliance Power. We do not expect any
impact on Power Grid and NTPC. In this case, we would prefer Power Grid,
NTPC, Reliance Infrastructure, Reliance Power, Lanco and Tata Power, in that
order
Over the next twelve months, we think a few factors could improve for the
sector: 1) more tariff hikes at the state level; 2) more positive policy action from
the government; and 3) investors may start to appreciate the fact that it is not
easy to build a generation capacity base in India.
Stock ideas: top picks (Power Grid and Lanco)
We like companies with low risk (Power Grid and NTPC) or those at
compelling valuations (Lanco and Reliance Infrastructure). We have recently
upgraded Reliance Power to a Buy given its strong advantage in captive coal.
Our coverage universe and UBS summary view is as follows:
Power Grid (Buy, DCF-based PT of Rs135)
Power Grid is a strong defensive in a natural monopoly sector and we think
Power Grid will be a key beneficiary of growth in the transmission sector; it has
over 50% market share which we expect to increase. We believe Power Grid has
significant advantages: 1) the low-risk nature of its business with ROE of 15.5%
plus incentives based on transmission network availability totalling 17-18%; and
2) as the central transmission utility, it has been assigned the role of co-ordinator
in the sector.
Power Grid has a capex target of Rs550bn in the 11th Five Year Plan (FY08-
FY12). To achieve that, the company will have to incur Rs177bn of capex in
FY12. We believe that even in the worst-case scenario, 90-95% of the target can
be achieved. We think this is a strong positive, as the company’s business model
is strongly linked to the capex incurred and the commissioning of its projects.
We believe there are strong share price catalysts over the next 12 months: 1)
FY12 is the last year of the 11th Five-Year Plan and ordering activity is likely to
remain strong towards the end of the financial year (Q4 FY12); 2) strong
capitalisation of Capital Works in Progress; 3) higher capex as Power Grid has a
target of Rs550bn by March 2012; and 4) we believe valuations are attractive.
Lanco (Buy, SOTP-based PT of Rs30)
Lanco has been one of the worst performers in the sector. The share price has
corrected significantly and we think this reflects the difficult environment for
the generation sector and company-specific issues. However, we believe that the
market is ignoring the strong generation capacity base (3,300MW), which is not
easy to replicate. We also believe that the share price fully factors in a decline in
merchant tariffs and the likely impact on PLF due to non-availability of fuel.
However, there are challenges as well. In the near term, we believe the risks are
as follows: 1) a court case related to Griffin Coal in Australia; 2) transmission
issues at the Udupi 1,200 MW plant; 3) lack of clarity on the PPA of 300MW;
and 4) fuel issues at operational plants. However, we think that most are shortterm
issues and are priced in.
NTPC (Buy, DCF-based PT of Rs215)
NTPC provides a low-risk exposure to the India Power Generation Sector.
NTPC’s share price has corrected 16% YTD and marginally underperformed the
BSE Sensex. In our view, this is unwarranted for a company with relatively low
risk, i.e. a fixed return on investment-based model. We believe NTPC’s core
fundamentals are intact: 1) a high demand-supply gap in India; 2) the largest
capacity base; 3) competitive generation cost; and 4) we think fuel cost passthrough
is not at risk.
NTPC has a strong payment security mechanism. In case of non-payment of
receivables from SEBs, NTPC can directly recover the outstanding amount from
central government grants to respective states. This was evident in FY11: NTPC
realised 100% payment of bills from customers for the eighth successive year.
We also think that as NTPC is Coal India’s biggest customer and a government
company, it may get preference in coal allocation.
Reliance Infrastructure (Buy, SOTP-based PT of Rs700)
With a strong infrastructure portfolio, Reliance Infrastructure (RELI) is a longterm
asset play. We are positive on RELI’s strong infrastructure portfolio (11
road projects, five airports, five transmission projects, and three metro lines).
We also like the diversified nature of the business, as the company has no
particular preference for sub-sectors. In our view, RELI is a good long-term
asset play on India’s infrastructure growth story. As more projects become
operational, the company could monetise some of the assets.
In India, infrastructure projects face significant execution challenges that include
land acquisition, approvals and clearances, financial closure and availability of
skilled manpower. RELI is trying to meet these challenges with its: 1) captive
EPC division; b) strong in-house capabilities in different segments such as
metro, roads and transmission; 3) strong balance sheet; and 4) synergies with
group companies.
Tata Power (Buy, SOTP-based PT of Rs1,350)
Mundra remains an overhang for the stock. The Indonesian government has
decided to link the price of exported coal with a benchmark based on
international prices. Indonesia is the source of coal for the Mundra project and if
the spot price is above US$65-70/tonne, the project may not be profitable, in our
view. Currently, we do not include the Mundra project in our valuation and
believe that this issue will continue to remain an overhang for the stock.
Tata Power is developing a 4,000MW imported coal-based project and the key
points on this Ultra Mega Power Project (UMPP) are: 1) Unit I (800MW) is
likely to be commissioned in March 12 or Q1 FY13; 2) the Indonesian
government is unlikely to provide any relief in terms of relaxation from new
regulation; 3) Tata Power would explore options to use lower-grade coal if it
leads to economic benefit; 4) beneficiary states would like to involve the central
government in any discussion related to tariff revisions.
Overall, Tata Power has a target of reaching 25,000MW generation capacity by
2017 from current operating capacity of 3,176MW; 2) the development at
captive coal blocks of Mandakini and Tubed is on track; 3) the company's
strategy on merchant capacity is cautious and merchant power is unlikely to be
>10% in generation mix.
Reliance Power (Buy, DCF-based PT of Rs105)
Reliance Power has one of the largest coal reserves in the private sector (nongovernment)
in India. The company has been allotted coal mines with 2bn
tonnes of reserves (versus 730m tonnes required for the life cycle of the
8,000MW Sasan and Tilaiya UMPPs), a critical advantage. We believe the
market is ignoring the fuel security available to the company. We also think
there is no risk of coal blocks being de-allocated as mine development is on
track.
The key positives in the past 12 months were: 1) approval for 40mtpa at the
Tilaiya mine; 2) a Rs450bn contract with Shanghai Electric for main plant
equipment for 30,000MW of coal-based projects; 3) a Rs34bn contract with GE
for a 2,400MW gas project; and 4) MOUs with Chinese banks and Ex-Im Bank
for Rs750bn in financing. We think Reliance Power could emerge as a cost
leader due to its captive coal, less expensive Chinese equipment, and external
debt financing.
Adani Power (Sell, DCF-based PT of Rs80)
We are negative on Adani Power as the risks do not seem to be priced in. We
like the company for its strong execution, but think the share price does not
factor in risks such as: 1) a decline in merchant tariffs; and 2) no fuel price
escalation clauses in long-term PPAs. We believe the share price risk is to the
downside.
According to media reports, the Indonesian government has decided to link the
price of coal exported from the country with a benchmark based on international
coal prices. However, we expect the impact on Adani Power to be limited
(Adani Enterprises Limited has captive mines and it was subsidising supply to
Adani Power). We assume a price of US$36/tonne for imported coal to Adani
Power.
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