Jindal Steel and Power Limited
Facing multiple challenges;
lower PO
Cut estimates, PO on multiple challenges; Underperform
We cut our FY13-14E EPS 3-9% and PO to Rs428 due to (1) potential delays in
key growth projects; (2) lower margin outlook at the Tamnar II project; & (3) lower
captive power valuation. We expect EPS growth to be muted over FY12-14E.
While downside appear limited post recent correction based on our base case
valuation, we maintain our Underperform rating as risk reward still appears
skewed to the downside, as upside catalysts are limited & further delays in mining
lease approval & adverse policy changes could dent valuation further.
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Angul steel, captive power expansion likely to be delayed
Approval of the Utkal 1B coal block mining lease is delayed. It may remain on
hold until (1) the Orissa government’s washery reject coal-based power policy is
approved; (2) the enquiry for the CAG report on coal block allocation is complete.
JSPL may not commission its 4x135MW captive power and steel units at Angul
unless coal supply is secured. Execution of upstream units (coal gasification)
appears delayed until March 2013 and could impede the start of steel production.
Tamnar II (4x600MW) expansion margin outlook lower
JSPL may not be able to source low cost linkage coal and sell power at higher
merchant tariffs as planned (our earlier base case) as Coal India plans to offer
linkage coal only to firms with PPA, under the new FSA norms. JSPL may have to
(1) sell power at lower PPA tariff if it plans to source linkage coal, or (2) sell power
on merchant basis & source coal at higher cost. Hence margins should be lower.
Policy headwinds could dent valuation further
Orissa govt.’s proposed policy requires 33% (may be revised to 13%) of power
from washery reject coal-based power plants to be given to the State free. This
hits our captive power valuation by Rs14 (assuming 13% free power). Possible
cap on tariffs for captive coal based power could hit our valuation by Rs45.
Cut estimates and PO, maintain Underperform
We cut our FY13-14E EPS by 3-9% and our SOTP NPV-based PO from Rs525 to
Rs428 due to (1) potential delays in key growth projects; (2) lower margin outlook
at the Tamnar II project and (3) lower captive power valuation. We expect EPS
growth to be muted at 5.6 over FY12-15E.
Recent correction in JSPL’s stock price appears to reflect our concerns
somewhat and downside now appears limited based on our base case SOTP
valuation of Rs428. However, risk reward appears still skewed to the downside in
our view as a) upside catalysts appear limited given muted earnings outlook near
term and b) potential more delays in mining lease approval and adverse policy
changes related to merchant power tariff/ captive coal could dent valuation
further. A potential bear case scenario assuming capping of power tariff based on
captive coal and no mining lease approval at Utkal could potentially reduce our
valuation by 18% as per our estimates. Thus, we think it may still be premature to
get more constructive on the stock at this stage as these concerns are likely to
weigh on JSPL’s valuation in our view. Hence, we maintain our Underperform
rating on the stock.
Angul steel and captive power expansion could be delayed: We
believe key growth projects could be delayed as (1) the Utkal coal mining
lease is delayed and approval may take longer; (2) the remaining 4x135MW
captive power units and 1.6mt steel plant at Angul are unlikely to be
commissioned until coal supply is secured; and (3) potential delays in
execution of upstream coal gasification units may delay the start of steel
production at Angul. Separately, we also note that, as of March 2012, JSPL
had invested only 19% of Tamnar II capex even though the first two units are
expected to come on-stream in 1H14.
Expect lower margins at Tamnar II expansion: While, JSPL intends to
use linkage coal (lower cost) and sell power at higher merchant tariffs at its
Tamnar II (4x600MW) expansion project, we think this may be difficult given
new FSA norms for Coal India. We believe JSPL may have to (1) enter into
PPA (power purchase agreements) and sell power at lower PPA-based tariffs
in case it plans to source low cost linkage coal from Coal India or (2) sell at
higher merchant tariffs, but source coal through alternate sources (e-auction,
imports) at higher costs. We believe profitability for the project would be
lower in either scenario. Our SOTP NPV is hit by 12.5% as a result.
Muted earnings growth over FY12-14E: We expect earnings growth to
remain flat over FY12-14E as (1) we see limited earnings contributions from
growth projects near term and gains from expansions are likely to be back
ended; and (2) we expect profits from existing 1,000MW (33% of EBIDTA)
assets in JPL to continue to slide in FY13e due to lower merchant tariffs.
Policy headwinds could dent valuation further and could remain an
overhang on the stock: (1) Partial free power sale of 13% as per the
Orissa government’s proposed washery reject coal-based power policy hits
our valuation for Angul captive power unit (6x135MW) by Rs14 (total
valuation hit of Rs21 including project delays); and (2) CAG report
controversy may lead to policy tightening around pricing of power based on
captive coal. The potential hit to our base case valuation, in the case power
tariffs for captive coal-based power plants are capped (at Rs3/kwh) will be
around Rs45 (about 11%) by our estimates.
Our revised earnings estimates for FY13-14e are 8-20% below consensus.
Recent correction in JSPL’s stock price reflects our concerns somewhat and
downside now appears limited based on our base case SOTP NPV of Rs428.
However, valuations at 8.4x FY13E EBITDA is not yet compelling, in our view,
given flat earnings growth outlook over next two years.
Also we see scope for more downsides due to further delays in projects and Utkal
mining lease resolution, uncertainty around the Sarda mine issue and potential
adverse policy changes around captive coal/merchant power policy. A potential
bear case scenario assuming capping of merchant power tariff based on captive
coal at Rs3/kwh in FY13e and assuming linkage coal at Utkal, due to no mining
lease approval could potentially reduce our valuation by 18% as per our estimates.
Angul project facing multiple challenges
JSPL’s Angul steel and captive power project has been delayed and the project
continues to face multiple challenges due to (1) delays in Utkal mining lease
approval; (2) disruptions to construction activity (in January 2012) due to protests
from affected locals/land losers; and (3) delays in execution of coal gasification
units. JSPL had earlier indicated commissioning the remaining 4x135MW captive
power units by 1H FY13 and 1.6mtpa steel plant by March 2013, but this could be
delayed in our view for the following reasons.
Utkal 1B coal block mining lease delayed; resolution may take longer
JSPL has got forest and other approvals for its Utkal 1B coal block (captive coal
source for Angul steel and captive power project), but mining lease approval has been
delayed. This is due to differences with the Orissa government regarding its proposed
washery reject coal-based thermal power plant policy, which stipulates sale of 33%
free power from power plants based on washery reject coal to the state.
We understand the Orissa government and JSPL have now agreed to 13% free
power sale. However, mining lease approval is still pending. JSPL is hopeful of
getting the mining lease approval any time soon, but timing remains uncertain in
our view. We think, the approval may come thru only after the washery reject
coal-based power policy is approved by the Orissa government.
Also, approvals may remain on hold till the enquiry related to the CAG report on
coal block allocation is complete, (though Utkal 1B allocation was prior to the
period considered in the CAG report). JSPL expects mine development and
production to take 6-8 months after mining lease approval, but we do not rule out
further delays.
Orissa government's proposed washery reject coal based policy requires partial
sale of power free to the state
Date Event
24-Mar-11 Orissa Govt Committee recommends 33% of power from washery reject coal based power
plants to be given free to Orissa.
4-May-11 Orissa Govt's high powered committee accepts the policy recommendations.
8-Sep-11 Orissa issues notification with 33% free power provision for washery reject based power plant.
5-Dec-11 Committee constituted to suggest policy recommendations following JSPL's objections.
23-Apr-12 Committee recommends 13% free power, including 1% free power for the villages near plants.
Final approval by the Chief Minister of Orissa awaited before policy is implemented.
Source: BofAML Global Research
JSPL plans to commission the remaining 4x135 MW captive power units and
upstream steel plant at Angul only after coal supply is secured. Thus, mining
lease resolution is the key for a timely ramp up and profitability of these projects.
Our base case estimates assume coal production starts by March 2013.
Construction activities were impacted by protests by locals
Construction activities at the Angul project were affected by protests and violence
by locals in January 2012. While the issue was resolved and construction
activities have normalized, there were recent media reports indicating recent
protests by affected locals demanding higher compensation and employment
opportunity.
Potential delays in coal gasification unit may impede start of steel
production
While construction of the steel and captive plant has been broadly on track (70%
of capex was incurred as of March 2012), execution of the coal gasification units
has been lagging behind schedule. JSPL now expects these seven units to be
completed by March 2013, but further delays are possible in our view. Also, JSPL
is unlikely to start the coal gasification unit until coal production from Utkal 1B
captive coal mines commences.
We believe any delays in coal gasifier units could delay the start of the upstream
DRI unit and the steel plant as we expect the DRI/steel plant to be commissioned
with a lag. Thus commissioning of the DRI/steel plant may be pushed beyond
March 2013. We believe Angul expansion is likely to contribute to volumes mainly
post 1H FY14. We forecast steel volumes of 2.7mt in FY13E and 3.24mt in FY14E.
Tamnar II (4x 600MW) project margin outlook has declined
JSPL plans to source low cost linkage coal and sell most of the power at higher
merchant tariffs at its Tamnar II (4x600MW) expansion. However, this may be
difficult as Coal India now plans to offer low cost linkage coal only to companies
with PPA, under the new FSA norms. We believe JSPL may have to enter into a
PPA and sell power at the lower PPA rate if it plans to source linkage coal.
Alternately, JSPL may source coal externally at higher costs (e-auction coal,
imported coal) and sell on a merchant basis. In either scenario, we expect
profitability for the Tamnar II expansion to be lower than we anticipated.
In our base case, at Tamnar II (4x600MW), we assume 70% of power produced
to be sold on a PPA basis and 30% of power to be sold on a merchant basis
(100% merchant earlier). We assume 70% linkage coal and 30% e-auction coal in
our model. We also incorporate higher linkage coal costs led by CIL’s shift to
GCV-based pricing. Our valuation of JSPL reduces by Rs66 (12.5%) as a result.
Policy headwinds could dent valuation further
In addition to issues related to growth projects, JSPL is exposed to potential
adverse changes in policy in our view.
Proposed washery reject coal-based power policy to dent valuation
We assume 13% of power produced from the Angul captive power plant will be
sold free to the state as per the proposed washery reject coal-based power plant
policy. This impacts our Angul captive power valuation by Rs14 (Rs31 assuming
33% free power sales). We note that Rs21 per share reduction in our captive
power valuation also reflects the impact of delay in commissioning of the
remaining 4x135MW captive power units.
Potential cap on tariff for power produced from captive coal
Recent CAG coal report controversy has initiated debate around discretionary
allocation of coal blocks, pricing of power produced from captive coal. A potential
fall out of the controversy could be potential changes/tightening of the policy
around captive coal blocks or pricing of power produced from captive coal. JSPL
has been allocated coal reserves of 2.6bn tons (including 1.5bn tons related to
coal to liquid project) and is hence exposed to any adverse policy changes.
The coal ministry has recently threatened to cancel coal block allocation to
power companies using captive coal and selling power on a merchant basis.
The ministry wants such companies to enter into PPA.
JSPL’s core Tamnar I (1000MW) project (52% of valuation) is based on
captive coal and is exposed to potential capping of power tariffs for power
produced from captive coal. Assuming Tamnar I (1000MW captive coal
based project) is required to sell on a PPA basis, our valuation for JSPL
could be hit by Rs45 per share (assuming power tariff of Rs3/kwh).
Uncertainty around Sarda mines issue is a risk
The ongoing probe (Table 3) around alleged violation of Mining Concession Rules
by Sarda mines (key third-party supplier or iron ore to JSPL) is a potential risk to
JSPL’s low iron ore cost advantage. JSPL sources about 56% (around 4mt) of its
iron ore requirement (approximately 7mt) from Sarda mines at about US$24/t,
which is at a substantial discount to the market price (US$55-60/t locally).
JSPL management expects the issue to be resolved. While we expect the issue
to be resolved, JSPL could be adversely impacted if (1) leases of Sarda mines
are terminated or (2) Sarda mines are required to sell iron ore at market prices.
We estimate JSPL’s consolidated EPS could be hit by 12% in such a
scenario. We believe the issue also casts doubt over the sustainability of JSPL’s
low cost iron ore sourcing advantage.
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