Tata Power �� Coal business to continue to drive growth in 2Q ::HSBC Research

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Tata Power
�� Coal business to continue to drive growth in 2Q, while performance
in the power segment to remain modest due low plant load factor
�� Mundra to remain an overhang; stock to be range-bound though
some relief on tariffs could act as a positive catalyst
�� Maintain Neutral (V) rating with a target price of INR118 as a result
of stock split

2Q preview – decent quarter driven
by strong coal business
We expect revenue growth of 21% y-o-y for 2Q,
on the back of robust revenue growth in the coal
business (up 27% y-o-y for the period) while
revenue from the power business should be driven
by higher fuel costs with partial pass-through and
no significant capacity additions coming on
stream. We expect the Maithon power project will
only start contributing from 3Q FY12.
We expect realizations in the coal business to
increase by 29% y-o-y to USD95/ton in 2Q
(versus USD74/ton a year ago), while production
is expected to be up by a modest 5% y-o-y. This
should result in EBIT growth of 66% y-o-y for the
coal business in 2Q. EBIT for the power business
is expected to grow by a modest 6% y-o-y.
Accordingly, we expect overall profit before tax
for the company to grow 13% y-o-y to INR8.9bn.
We expect a higher effective tax rate at 40%
versus last year’s 35%, on account of a larger
contribution from the coal business as well as
deferred tax on wind assets. This is expected
result in moderate net profit growth of 2% y-o-y
to INR4.8bn for 2Q.


Mundra to remain an overhang unless
there is regulatory change
Indonesia’s new coal pricing policy, which aligns
all Indonesian coal sales to international markets
through a benchmark index (irrespective of prior
contracts), has resulted in higher input costs for
the power plant at Mundra. The Mundra plant
runs on imported coal but can only partially pass
through any higher costs as it must maintain a
competitive tariff. We expect Mundra will incur
losses at least for 10 years based on the existing
tariff of INR2.1-2.2 per unit (HSBC estimate
using Central Electricity Regulatory Commission
(CERC) escalation rates). The first unit will be
commissioned by February 2012 and all five units
by end FY14.
On the flip side, the new Indonesian coal pricing
policy has resulted in higher profits at the
company’s two 30%-owned Indonesian coal
mines from where the Mundra plant’s coal is
sourced. This partially offsets losses at the
Mundra plant. See exhibit 18-19 for our
assumptions and forecast for Tata Power’s
Mundra project and coal business.
We value Mundra plant at -INR13.9 per share and
the coal mines at INR63.9 per share for a
combined value of INR50 per share.
Upside risks. The main upside risk is customers
accepting a tariff hike from the Mundra project.
Exhibit 20 shows the sensitivity of Tata Power’s
consolidated EPS to potential tariff hikes by the
Mundra plant.


Investor focus on loss containment at
Mundra and coal business outlook
Management has indicated it plans to use low-grade
coal at Mundra and operate the plant at contracted
capacity with the lowest allowable PLF (72-78%) to
reduce its losses but this is not likely to happen for
another 1-2 years.
On the parent level, Mundra may be able to claim
tax benefits on any losses incurred at Mundra.
Management has also indicated it is considering
merging Mundra and the coal special purpose
vehicles (SPVs) from a cash flow perspective.
For the coal business, management has indicated that
it would ramp up production from 60MT to 75MT,
but this is taking more time than expected time given
the infrastructure and other constraints.
Remain Neutral (V) rating and target
price of INR118
We use a sum-of-the-parts (SOTP) method to value
Tata Power, given the differing risk-reward profiles
of its various businesses. Based on our assumptions,
as shown in Exhibit 21, we are keeping our target
price of INR118 (post stock split), which implies a
potential return of 20.8% (including dividend yield),
which is within the Neutral band for volatile Indian
stocks of 1-21%; hence we remain Neutral (V) on
the stock. We add the volatility flag in recognition of
the stock’s historical volatility having increased.
Our target price of INR118 implies an FY13e PB of
1.6x versus a current FY12e PB of 1.5x, and FY13e
PE of 11.4x versus the current FY12e PE of 11.4x.
Risks
Key upside risk is customers of Mundra accepting a
tariff hike. Downside risks: execution delays,
higher-than-expected mining costs, increased interest
rates and unfavourable regulatory changes in India
or Indonesia.

see sector view and other company details (click link below):

Indian Power- A muted quarter ::HSBC Research