JPMorgan:: Know Your Power --Stocks still underperforming but risks remain high

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 IPPs  continue  to  underperform,  but  a  ‘rotation’  is  evident:  RPWR and
TPWR (potential increase in Indonesian coal costs), JSW (weak execution and
increasing  coal  costs)  and  JPVL (despite  the  commissioning  of  Karcham
Wangtoo)  underperfomed the market. Defensives NTPC and PWGR,  relative
outperformers  so  far,  underperformed  the  market,  too.  On  the  other  hand,
Lanco and  Adani,  which  had  corrected  sharply  over  three  months,  saw
marginal recovery. Lack of progress in Govt initiatives to improve fuel security,
concerns  on  health  of  SEBs,  IPPs’  high  leverage,  onerous  PPAs  and  poor
operating performance have combined to keep investors at bay, in our view.
 Energy  deficit  at  its  lowest  in  4.5  years,  as  capacity  additions  catch  up;
merchant  outlook  weak:  The energy  deficit  of  5% in  July was  350bps lower
than last  year. Demand growth has  continued to  recover  sharply,  but  supply is
catching up as private IPPs beef up execution – notably  Adani, JPVL, TPWR.
The YTD  forward curve indicates an average merchant rate of ~Rs4/unit April
through Nov-11  vs. Rs4.45  for  the  same  period last  year. We  recently  cut  our
FY12 merchant estimate by 5% to Rs3.8/unit.
 PLFs for high cost gencos continue to be weak in August. PLFs for the more
expensive imported coal based plants like Lanco’s Udupi, JSW's all three plants
and  now  even  RPWR’s  Rosa;  and  that  of  gas  based  plants  like  Lanco's
Kondapalli,  GMR's  three  plants  and  NTPC's  gas  based  capacities  were  weak.
Adani’s Mundra  showed  a  comeback,  after maintenance  shutdowns in the last
two months. The  performance  of the  domestic coal-based  plants  of NTPC and
JSPL was relatively stronger.
 Risks  not  abating  anytime  soon. We  don’t think it is time to jump  back into
the  sector  yet,  as  fuel  constraints,  high  leverage  and  onerous  PPAs  still  pose
downside risk. We recommend trimming Adani Power concerns on fixed-tariffPPAs and rising coal costs, which might  belie high  growth expectations. We’d
continue to avoid Lanco, RPWR and JSWE. A defensive strategy might pay off
over the next  six months; we  stay  OW  on TPWR, Power Grid, and Neutral  on
NTPC.


Valuation and stock picks
RPWR and TPWR (potential increase in Indonesian coal costs), JSW (weak
execution & increasing coal costs) and JPVL (despite commissioning of Karcham
Wangtoo) all underperfomed the market. Defensives NTPC and PWGR, which have
been relative outperformers so far also underperformed the market. Lanco, which
performed relatively better than others (cancelling its coal supply agreement with
Perdaman, Australia) and Adani were relative outperformers. Lack of progress in
Govt initiatives to improve fuel security, concerns on health of SEBs and on ability
of IPPs to service debt in light of poor operating performance have kept investors at
bay, in our view.
We don’t think it is time to jump back into the sector yet, as fuel constraints, high
leverage and onerous PPAs still pose downside risk. We recommend trimming Adani
Power concerns on fixed-tariff-PPAs and rising coal costs might belie high growth
expectations. We’d continue to avoid Lanco, RPWR and JSWE. A defensive strategy
might pay off over the next six months; we stay OW on TPWR, Power Grid, and
Neutral on NTPC.