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Action: Downgrade to Reduce; 12-month TP pegged at INR35
In our view, Adani Power's earnings outlook hinges on of a handful of
'binary outcome' events relating to PPAs and fuel sourcing, wherein the
timeline for securing clarity is difficult to assess; in the interim, we expect
current (default) coal sourcing mix, PPA tariffs and funding costs to take a
toll on earnings. Our revised FY13F/14F/15F earnings estimates for Adani
are sharply below consensus; valuation multiples are not compelling.
Catalyst: Consensus earnings yet to reflect 'financing risk'
Besides the 'operating risk' from fuel supply woes and zero/partial fuel cost
pass thru in its long-term PPAs and low utilization level, we believe
consensus earnings are yet to reflect the 'financing risk' emanating from
project cost overruns, sharply higher gearing (net debt to equity at ~6x)
and significant exposure to foreign currency (f/x) debt in the backdrop of a
weakening INR. Further, unless refinanced, USxD3.5bn of USD5.4bn total
f/x debt is likely to crystallize into higher-cost INR debt in 12-24 months.
Valuation: Absolute/ relative multiples are not inexpensive
We cut our 12-month TP (based on the milestone risk-adjusted FCFE of
feasible projects) for Adani to INR35 on account of weakened earnings
outlook, INR/USD depreciation, higher risk profile for projects and balance
sheet and lower feasible capacity (9.2GW now vs 13.2GW previously).
FY13F/14F valuation multiples (1.6x P/B, 7.8x EV/EBITDA and 12x P/E)
are at a premium to private IPPs; not a reason to own the stock.
Key risks to our view: Favourable outcome(s) of 'what-if' scenarios
Reworking of long-term PPAs; securing linkage coal for Tiroda-II / Kawai.
Investment summary – Downgrade to Reduce
We revisit our investment thesis for Adani Power (Adani) and downgrade the stock to
Reduce; our revised FCFE-based 12-month TP for the stock is pegged at INR35
(INR115 previously), implying potential 16.7% downside from the CMP. In our view,
Adani’s earnings outlook hinges on of a handful of ‘binary outcome’ regulatory/legal
events relating to PPAs and fuel sourcing, wherein the timeline for securing clarity is
difficult to assess; in the interim, we expect the existing combination of the coal sourcing
mix, long-term PPA tariffs and funding costs to take a toll on earnings. Our
FY13F/14F/15F earnings estimates for Adani are well below consensus. On our FY14F
earnings estimate, valuation multiples (1.6x P/B, 7.8x EV/EBITDA and 12.0x P/E) are not
inexpensive vis-à-vis its peers’.
In our view, the 32% YTD decline in Adani’s stock price and progressive consensus
earnings downgrades stem from a combination of: 1) persistent fuel supply woes at
Mundra (shortfall in supply from Bunyu); 2) diminished prospects of securing domestic
linkage coal for Tiroda-II and Kawai due to regulatory developments; 3) project cost
overruns and high gearing with significant exposure to f/x debt; and 4) non-remunerative
Power Purchase Agreements (PPAs), wherein fuel costs are not a pass thru. As moving
parts related to fuel sourcing/PPAs hang in the balance and entail potentially binary
outcomes, we believe the earnings outlook for the company appears highly volatile; in
the interim, the existing combination of the coal sourcing mix and PPA tariffs is likely to
continue to take toll on earnings, in our view.
We update our earnings model for Adani to capture reported financials and disclosures
in its FY12 annual report. Together with our revised house assumptions for benchmark
seaborne thermal prices, and a weaker INR/USD averaging at 55.5, inferences from
management commentary post 1QFY13 earnings and our recent interaction with
policymakers, we now expect Adani to post a normalized net loss of INR0.5/share (vs
our previous forecast for net profit of INR15.7/share) for FY13F; our revised FY14F/15F
normalized net profit forecasts for Adani are 17/40% below consensus, with the bulk of
the variance stemming from expected net interest outgo.
We continue to base our target price for Adani on the milestone risk-adjusted FCFE of
operational/feasible projects (9.2GW now, vs 13.2GW previously). Our 12-month TP for
the stock is now pegged at INR35/share (vs INR115/share previously); the 69% cut
comes on: 1) significant deterioration in the earnings outlook; 2) higher risk profile for
projects and balance sheet; and 3) exclusion of the proposed capacity at Dahej and
Chhindwara (which the company has put on the backburner). On our FY14F earnings,
the valuation multiples (1.6x P/B, 7.8x EV/EBITDA and 12.0x P/E) are not inexpensive
vis-a-vis its peers’.
What do we build in to our base-case earnings forecast?
• Macro: [1] We peg the average INR/USD at 55.0 for FY13F and 55.5 for FY14F/15F, in
line with current INR/USD rates. [2] Our imported coal price assumption is derived from
our Global Metals & Mining team’s seaborne thermal coal price forecasts, adjusted for
indicative GCV of non-Bunyu coal procured by Adani. [3] Based on short/medium-term
PPAs tied up by Adani and the merchant/PPA capacity mix, we peg FY13F, FY14F and
FY15F merchant realization at INR4.25/kWh, INR4.1/kWh and INR4/kWh, respectively.
• Mundra (4620MW): [1] No domestic coal linkage for Mundra-I or Mundra-II, domestic
linkage coal supply for Mundra-III restricted to trigger level (minimum guarantee by
Coal India); [2] supply of Bunyu coal at 5.1mt / 7.5mt / 9.0mt in FY13F/14F/15F;
[3] Mundra-II (1320MW) to operate at a utilization level of 50% (indicative minimum
utilization level) at the existing PPA tariff of INR2.35/kWh (excluding customs duty);
[4] project cost pegged at INR250bn at a 80:20 D/E ratio, with ~50% of debt
denominated in f/x as of end-FY12.
• Tiroda (3300MW): [1] Commercial start-up of Tiroda-I (1980MW) by March 2013;
supply of domestic linkage coal restricted to trigger level; [2] no domestic coal linkage
for Tiroda-II (1320MW), with fuel mix assumed at 30% domestic non-linkage coal and
70% imported coal; [3] project cost pegged at INR156bn at 80:20 D/E ratio, with ~85%
invested up to FY12 wherein ~90% of debt is in f/x (mostly LCs to be converted into
term loans).
• Kawai (1320MW): [1] Commercial start-up by August 2013; [2] no domestic coal
linkage, with fuel mix assumed at 30% domestic non-linkage coal and 70% imported
coal; [3] project cost pegged at INR70bn at 80:20 D/E ratio, with ~70% invested up to
FY12 wherein ~90% of debt is in f/x (mostly LCs to be converted into term loans)
Key changes in assumptions behind our FY13F-15F earnings forecast
Overall, we expect that increased availability of ex-Bunyu coal and the start-up of
capacity fired primarily by domestic linkage coal to enable an improvement in Adani’s
bottom line starting from 2HFY13. Thereafter, we expect earnings to show a sharp rise
in FY14 as the majority of the under-construction capacity comes on-stream and Adani
utilizes the pre-LTPPA (long-term PPA) time window to sell electricity on a ‘merchant
basis’ (albeit on market-priced / imported coal). However, in the absence of long-term
domestic coal linkage for Tiroda-II and Kawai and lack of clarity on refinancing of its
project-linked f/x LCs (letters of credit), we expect FY15F net profit to be lower y-y. Our
FY14F/15F normalized net profit forecasts for Adani are 17/40% below consensus;
however, the disparity vs consensus is smaller at the EBIDTA level (Figure 3)
Key changes in our underlying assumptions for Adani’s earnings model –
• Coal sourcing / pricing: Our non-Bunyu imported coal price assumption is based on our
Global Metals & Mining team’s benchmark coal price forecast, adjusted for 1QFY13
actuals and indicative GCV of spot coal procured by Adani. We build in coal supply
from Bunyu at 9mtpa in FY15F (vs management guidance of 9mtpa in FY14). Our
revised overall coal requirement (in mt) for FY13F/14F/15F is lower than our previous
forecast on account of [1] non-availability of domestic linkage coal necessitating higher
imports (wherein the quantity required drops due to higher GCV of coal) and [2] push
back in capacity commission combined with lower utilization levels.
• INR/USD exchange rate: In line with the average INR/USD rate for FY13 (year to date),
we peg the average INR/USD rate at 55 for FY13F and 55.5 for FY14F and FY15F. Our
new INR/USD assumptions pegs the INR 30-35% lower (depreciated) versus the USD,
resulting in a higher CIF cost of imported coal.
• Merchant tariff realizations: Based on the existing short/medium-term PPA contracts for
Adani and probability merchant tariffs being ‘supported’ over the next 18 months in the
run up to general elections, we raise our merchant realization assumption for Adani by
6% for FY13F to INR4.25/kWh and 9% for FY14F to INR4.1/kWh. Long-term merchant
realizations are pegged at INR3.75/kWh (vs INR3.5/kWh previously).
Key risks to our investment thesis for Adani Power
Along the lines of favourable outcomes in our ‘what-if’ scenarios for a handful of key
variables
• Lower-than-expected landed cost of imported coal – Besides the domestic/imported
coal mix, Adani’s earnings are highly sensitive to the landed cost of imported coal (in
INR terms), which in turn is an interplay among [1] supply ramp-up from Bunyu, [2] FOB
price of seaborne thermal coal, and [3] INR/USD exchange rate fluctuation. A sharp
appreciation of the INR and/or below-expected CIF price of ex-Indonesia coal could
potentially lead to upward revision in our earnings outlook and TP for the stock.
• Termination/alteration of fixed cost PPAs – Adani is looking to rework / exit its long-term
PPAs from its Mundra-II (1000MW with GUVNL), Mundra-III (1424MW with Haryana
SEBs) and Tiroda-I (1320MW with MSEDCL) facilities, where its bid tariffs rule out
indexation of energy charges (ie, fuel cost recovery is fixed at the quoted tariff). A
positive outcome on these representations by management could potentially boost
Adani’s earnings prospects and reduce the risk profile of its projects.
• Securing domestic linkage coal – As elaborated in the ‘scenario analysis’ section of this
report, success in securing domestic coal linkages for Mundra I, Mundra-II, Tiroda-II
and Kawai could potentially merit an increase in Adani’s earnings and TP for the stock.
• Merchant tariff realizations – We currently peg Adani’s FY13F/14F/15F merchant
realizations at INR4.25/kWh, INR4.1/kWh and INR4/kWh, respectively; higher-thanexpected
merchant tariff realization could merit an earnings and TP increase.
• CERs could raise earnings, but marginally – As per a recent company press release of
1.8mn CERs per annum for Mundra-III (at 80-85% utilization level), if Adani were to
receive INR600mn annually (pre-tax at EUR4.54/CER, last 1 year average price), our
FY14F/15F earnings estimate could go up marginally by 6.3/5.8%.
• Coal price pooling would lower fuel costs – If implemented, coal price pooling
mechanism would likely improve profitability of Mundra-III and Tiroda-II (facilities
eligible to get linkage coal), in our view, as the cost of imported coal would likely
decline, albeit partially offset by a higher cost of domestic coal. Further, Adani could
divert its low-cost Bunyu coal from Mundra-III to meet coal requirements for its other
projects.
Assessing earnings outlook on ‘what-if’ scenarios
In our view, Adani’s earnings trajectory and fair value of the stock is contingent on a
handful of potentially ‘binary outcome’ scenarios (elaborated below) related to issues
including domestic fuel linkage, supply ramp-up from Bunyu and endgame regarding
non-remunerative PPAs. Favourable outcome on these issues forms the key risks to our
earnings forecast for Adani and investment thesis for the stock.
• Scenario I: Faster-than-assumed supply ramp up from Bunyu – Our base-case
earnings forecast for Adani assumes coal receipt from Bunyu at 5.1mt / 7.5mt / 9.0mt in
FY13F/FY14F/FY15F, respectively. Although supply from Bunyu has been below
management guidance over the past few quarters, if production ramp-up and
consequent supply is closer to management guidance of 6mt/9mt in FY13/FY14, our
FY13F/14F EPS forecast for Adani would rise by 28%/4% respectively; and our 12-mth
TP could rise by ~6% to INR37/share, based on our calculations.
• Scenario II: Termination of PPA with GUVNL (1000MW at INR2.35/kWh from Mundra –
Our base-case earnings forecast for Adani assumes Mundra-II (1320MW) to operate at
utilization level of 50% (indicative minimum utilization level as per management) at the
existing PPA tariff of INR2.35/kWh (excluding customs duty). Adani has filed a petition
in the Supreme Court to terminate this PPA and pay a penalty of INR1bn, as per the
terms of the PPA. If the Supreme Court rules in Adani’s favour, and Adani is able to
ramp-up the utilization level of Mundra-II to 80% and realize a tariff of even INR3/kWh,
we estimate our FY14F/15F EPS forecast for Adani could rise by 56-72%, respectively;
12-mth TP could rise by ~37% to INR48/share.
• Scenario III: 30% linkage coal for Mundra I & II starting FY14 – Our base-case earnings
forecast for Adani assumes no domestic coal linkage for Mundra-I, II. However, if the
Ministry of Power’s (MoPs) request for restoring 30% domestic coal linkage for Mundra-
I,II is accepted by the Standing Linkage Committee (SLC), we estimate our FY14F/15F
EPS forecast for Adani could rise by 29%/21% respectively; and our 12-mth TP could
rise by ~14% to INR40/share.
• Scenario IV: Availability of linkage coal for Tiroda-II and Kawai post FY15 – Our basecase
earnings forecast for Adani assumes no domestic coal linkage for Tiroda- II and
Kawai. Our interaction with policymakers suggests that unless the criterion of “LoA
being a pre-requisite for a project being considered by the CEA for eligibility to secure
an FSA” is altered, prospects of Kawai and Tiroda-II securing linkage coal, at least up
to FY15 (and probably until the end of the XIIth Plan [ie, FY17], in our view), appear
dim. If Adani were to secure 9.8mt coal linkage from FY16 onwards, we show the
resultant FCFE value of Tiroda-II and Kawai could rise significantly, raising our 12-mth
TP by as much as 77% to INR62/share.
• Scenario V: USD/INR slips to ~60 by FY14 – As against our base-case assumption of
USD/INR at 55.5 for the explicit term, if the rupee were to drop to ~60 vs the USD by
FY14F, as outlined by our economics team in their report titled Asia Special Report:
India's Chronic Balance of Payments, dated September 3, 2012, Adani’s earnings
outlook would likely be severely impacted (fuel cost would rise sharply, exchange raterelated
losses would rise, cash requirements for debt servicing/repayment would rise
potentially requiring an equity infusion). Our FY13F/14F/15F EPS forecasts for Adani
could decrease by 19%/42%/46%; our 12-mth TP could go down by ~26% to
INR26/share under such an f/x scenario.
Earnings hinge on fuel sourcing, reworking PPAs
Despite Adani Group’s vertical integration and credible execution capability together with
Adani Power’s front-ended capacity pipeline and a healthy off take mix, we believe the
earnings outlook is hampered by two factors – [1] zero/partial fuel-cost pass thru across
all its long-term PPAs; and [2] coal sourcing woes (slow ramp-up in supply from Bunyu
mines and diminished prospects of securing linkage coal for Tiroda-II, Kawai and
Mundra-I,II).
Adani looking to rework / exit a few of its long-term PPAs…
We note that Adani is looking to rework/exit its long-term PPAs from its Mundra-II
(1000MW with GUVNL), Mundra-III (1424MW with Haryana SEBs) and Tiroda-I
(1320MW with MSEDCL) facilities, where its bid tariffs rule-out indexation of energy
charges (ie, fuel cost recovery is fixed at the quoted tariff).
• Adani is currently in litigation in the Supreme Court for its 1000MW PPA with Gujarat
Urja Vikas Nigam from its Mundra-II facility (PPA tariff is set at INR2.35/kWh) wherein it
seeks to exit the PPA upon payment of the INR1bn penalty stipulated in the contract.
Previously, the Gujarat Electricity Regulator (GERC) and the Appellate Tribunal
(APTEL) ruled against Adani on this matter.
• Separately, Adani has filed a petition with the Central Electricity Regulator (CERC)
seeking prompt development of a mechanism to revise the tariff under the PPAs with
GUVNL and Haryana SEBs (UHBVNL, DHBVNL) on account of: [1] unforeseeable/
uncontrollable change in circumstances for the allotment of domestic coal by the
Government of India/Coal India; and [2] enactment of New Coal Pricing Regulation by
the Government of Indonesia thereby impeding the existing contracts. The CERC is
currently examining the maintainability of Adani’s petition.
• Adani is also negotiating the tariff for its 1320MW PPA with MSEDCL (the PPA started
in August 2012 at a tariff of ~INR2.64/kWh).
At this time, the probability/timeline of Adani being able to rework PPA tariffs or to exit
PPAs is difficult to assess. Our base-case earnings forecasts and TP calculation for
Adani do not assume any tariff reworking or exit from its existing long-term PPAs
Prospects of Tiroda-II and Kawai projects securing linkage coal…
As per management, both Kawai and Tiroda-II are identified XIIth Plan projects by the
Government of India and domestic coal allocation (linkage) will be secured in the next 3-
4 months when the Standing Linkage Committee (SLC) on coal meets to decide on this
issue. We note the following:
• Based on the milestone achievements and offtake tie-ups, we believe both Kawai and
Tiroda-II would rank high on the parameters outlined by the Ministry of Power (MoP) in
its policy for allocating coal linkage for XIIth Plan projects (see Figure 13).
• However, in the absence of a Letter of Assurance (LoA) from Coal India, both projects
do not find a mention in the Central Electricity Authority’s (CEA) list of projects eligible
to secure linkage coal (via an FSA) from Coal India up to FY15.
• Fuel cost is partially a pass-thru in the case of the LT PPAs of Tiroda-II and Kawai
given that there are both an escalable and a fixed energy charge component in the
tariff build-up; accordingly, profitability prospects would vary directly with the proportion
of domestic linkage coal in the fuel mix.
Our interaction with policymakers suggests that unless the criterion of “a LoA from Coal
India being a pre-requisite for a project to be considered by the CEA for eligibility to
secure an FSA” is altered, prospects of Kawai and Tiroda-II securing linkage coal, at
least up to FY15 (and probably until the end of the XIIth Plan, [ie, FY17]), appear dim. In
the absence of further clarity on this issue, our base-case earnings forecast for Adani
assumes a fuel mix for Tiroda-II and Kawai of 30% domestic non-linkage coal and 70%
imported coal.
Valuation: 12-month TP lowered to INR35
Our milestone risk-adjusted FCFE-based valuation methodology (which we deploy to
value private IPPs) pegs Adani’s 12-month target price at INR35, implying 16.7%
downside from current levels. Our TP calculation for the stock values Adani’s 9240MW of
existing/pipeline capacity; we exclude 3960MW of pipeline capacity as the 2640MW
Dahej and 1320MW Chhindwara projects have been placed on the backburner. On our
FY14F earnings, the stock trades at 1.6x P/B, 7.8x EV/EBITDA and 12.0x P/E.
Projects still valued on FCFE, adjusted for milestone-risk discounts
We continue to deploy a milestone risk-adjusted FCFE-based methodology to value
Adani’s power generation projects that appear ‘feasible’ (ie, operational and under
construction/development, but with tangible progress and reasonable likelihood of
materializing). The six milestone risks, which capture the risk of a power project from
conception to commissioning, apply appropriate discounts to the FCFE value (provided it
is not negative) of an under-construction project – in our view, this approach allows
investors to objectively view the incremental value ascribed to a project as key
prerequisites for commissioning fall into place.
‘Milestone-risk’ adjustments lower base-case FCFE-based fair value by 5%
At 15% cost of equity, based on our earnings forecast, we calculate the FCFE-based
value of Adani’s 9240MW of projects to be INR22.8/share; adding FY13F cash-on-hand
of INR14/share, we estimate the unadjusted fair value of the stock would be INR37/share
(rounded). Accordingly, even if we were to disregard the milestone-risk discounts we
attribute to various projects, ceteris paribus, we find the current market price leaves no
room for upside.
Key points to note in the ‘milestone risk’ assigned to the FCFE-based value of projects:
• The 30% milestone-risk discount for Tiroda-II (1320MW) and Kawai-II (1320MW)
reflects the fuel security risk considering non-eligibility for securing domestic linkage
coal as per current regulations and no alternative source of coal being identified.
However, as our calculated FCFE for Kawai is negative, we do not apply the 30%
milestone-risk discount to its FCFE value in our TP build-up for Adani;
• The 10% milestone risk discount for Tiroda-I (1980MW) reflects off-take tie-ups under
long-term PPAs being in the range of 66-85% of the total capacity.
Action: Downgrade to Reduce; 12-month TP pegged at INR35
In our view, Adani Power's earnings outlook hinges on of a handful of
'binary outcome' events relating to PPAs and fuel sourcing, wherein the
timeline for securing clarity is difficult to assess; in the interim, we expect
current (default) coal sourcing mix, PPA tariffs and funding costs to take a
toll on earnings. Our revised FY13F/14F/15F earnings estimates for Adani
are sharply below consensus; valuation multiples are not compelling.
Catalyst: Consensus earnings yet to reflect 'financing risk'
Besides the 'operating risk' from fuel supply woes and zero/partial fuel cost
pass thru in its long-term PPAs and low utilization level, we believe
consensus earnings are yet to reflect the 'financing risk' emanating from
project cost overruns, sharply higher gearing (net debt to equity at ~6x)
and significant exposure to foreign currency (f/x) debt in the backdrop of a
weakening INR. Further, unless refinanced, USxD3.5bn of USD5.4bn total
f/x debt is likely to crystallize into higher-cost INR debt in 12-24 months.
Valuation: Absolute/ relative multiples are not inexpensive
We cut our 12-month TP (based on the milestone risk-adjusted FCFE of
feasible projects) for Adani to INR35 on account of weakened earnings
outlook, INR/USD depreciation, higher risk profile for projects and balance
sheet and lower feasible capacity (9.2GW now vs 13.2GW previously).
FY13F/14F valuation multiples (1.6x P/B, 7.8x EV/EBITDA and 12x P/E)
are at a premium to private IPPs; not a reason to own the stock.
Key risks to our view: Favourable outcome(s) of 'what-if' scenarios
Reworking of long-term PPAs; securing linkage coal for Tiroda-II / Kawai.
Investment summary – Downgrade to Reduce
We revisit our investment thesis for Adani Power (Adani) and downgrade the stock to
Reduce; our revised FCFE-based 12-month TP for the stock is pegged at INR35
(INR115 previously), implying potential 16.7% downside from the CMP. In our view,
Adani’s earnings outlook hinges on of a handful of ‘binary outcome’ regulatory/legal
events relating to PPAs and fuel sourcing, wherein the timeline for securing clarity is
difficult to assess; in the interim, we expect the existing combination of the coal sourcing
mix, long-term PPA tariffs and funding costs to take a toll on earnings. Our
FY13F/14F/15F earnings estimates for Adani are well below consensus. On our FY14F
earnings estimate, valuation multiples (1.6x P/B, 7.8x EV/EBITDA and 12.0x P/E) are not
inexpensive vis-à-vis its peers’.
In our view, the 32% YTD decline in Adani’s stock price and progressive consensus
earnings downgrades stem from a combination of: 1) persistent fuel supply woes at
Mundra (shortfall in supply from Bunyu); 2) diminished prospects of securing domestic
linkage coal for Tiroda-II and Kawai due to regulatory developments; 3) project cost
overruns and high gearing with significant exposure to f/x debt; and 4) non-remunerative
Power Purchase Agreements (PPAs), wherein fuel costs are not a pass thru. As moving
parts related to fuel sourcing/PPAs hang in the balance and entail potentially binary
outcomes, we believe the earnings outlook for the company appears highly volatile; in
the interim, the existing combination of the coal sourcing mix and PPA tariffs is likely to
continue to take toll on earnings, in our view.
We update our earnings model for Adani to capture reported financials and disclosures
in its FY12 annual report. Together with our revised house assumptions for benchmark
seaborne thermal prices, and a weaker INR/USD averaging at 55.5, inferences from
management commentary post 1QFY13 earnings and our recent interaction with
policymakers, we now expect Adani to post a normalized net loss of INR0.5/share (vs
our previous forecast for net profit of INR15.7/share) for FY13F; our revised FY14F/15F
normalized net profit forecasts for Adani are 17/40% below consensus, with the bulk of
the variance stemming from expected net interest outgo.
We continue to base our target price for Adani on the milestone risk-adjusted FCFE of
operational/feasible projects (9.2GW now, vs 13.2GW previously). Our 12-month TP for
the stock is now pegged at INR35/share (vs INR115/share previously); the 69% cut
comes on: 1) significant deterioration in the earnings outlook; 2) higher risk profile for
projects and balance sheet; and 3) exclusion of the proposed capacity at Dahej and
Chhindwara (which the company has put on the backburner). On our FY14F earnings,
the valuation multiples (1.6x P/B, 7.8x EV/EBITDA and 12.0x P/E) are not inexpensive
vis-a-vis its peers’.
What do we build in to our base-case earnings forecast?
• Macro: [1] We peg the average INR/USD at 55.0 for FY13F and 55.5 for FY14F/15F, in
line with current INR/USD rates. [2] Our imported coal price assumption is derived from
our Global Metals & Mining team’s seaborne thermal coal price forecasts, adjusted for
indicative GCV of non-Bunyu coal procured by Adani. [3] Based on short/medium-term
PPAs tied up by Adani and the merchant/PPA capacity mix, we peg FY13F, FY14F and
FY15F merchant realization at INR4.25/kWh, INR4.1/kWh and INR4/kWh, respectively.
• Mundra (4620MW): [1] No domestic coal linkage for Mundra-I or Mundra-II, domestic
linkage coal supply for Mundra-III restricted to trigger level (minimum guarantee by
Coal India); [2] supply of Bunyu coal at 5.1mt / 7.5mt / 9.0mt in FY13F/14F/15F;
[3] Mundra-II (1320MW) to operate at a utilization level of 50% (indicative minimum
utilization level) at the existing PPA tariff of INR2.35/kWh (excluding customs duty);
[4] project cost pegged at INR250bn at a 80:20 D/E ratio, with ~50% of debt
denominated in f/x as of end-FY12.
• Tiroda (3300MW): [1] Commercial start-up of Tiroda-I (1980MW) by March 2013;
supply of domestic linkage coal restricted to trigger level; [2] no domestic coal linkage
for Tiroda-II (1320MW), with fuel mix assumed at 30% domestic non-linkage coal and
70% imported coal; [3] project cost pegged at INR156bn at 80:20 D/E ratio, with ~85%
invested up to FY12 wherein ~90% of debt is in f/x (mostly LCs to be converted into
term loans).
• Kawai (1320MW): [1] Commercial start-up by August 2013; [2] no domestic coal
linkage, with fuel mix assumed at 30% domestic non-linkage coal and 70% imported
coal; [3] project cost pegged at INR70bn at 80:20 D/E ratio, with ~70% invested up to
FY12 wherein ~90% of debt is in f/x (mostly LCs to be converted into term loans)
Key changes in assumptions behind our FY13F-15F earnings forecast
Overall, we expect that increased availability of ex-Bunyu coal and the start-up of
capacity fired primarily by domestic linkage coal to enable an improvement in Adani’s
bottom line starting from 2HFY13. Thereafter, we expect earnings to show a sharp rise
in FY14 as the majority of the under-construction capacity comes on-stream and Adani
utilizes the pre-LTPPA (long-term PPA) time window to sell electricity on a ‘merchant
basis’ (albeit on market-priced / imported coal). However, in the absence of long-term
domestic coal linkage for Tiroda-II and Kawai and lack of clarity on refinancing of its
project-linked f/x LCs (letters of credit), we expect FY15F net profit to be lower y-y. Our
FY14F/15F normalized net profit forecasts for Adani are 17/40% below consensus;
however, the disparity vs consensus is smaller at the EBIDTA level (Figure 3)
Key changes in our underlying assumptions for Adani’s earnings model –
• Coal sourcing / pricing: Our non-Bunyu imported coal price assumption is based on our
Global Metals & Mining team’s benchmark coal price forecast, adjusted for 1QFY13
actuals and indicative GCV of spot coal procured by Adani. We build in coal supply
from Bunyu at 9mtpa in FY15F (vs management guidance of 9mtpa in FY14). Our
revised overall coal requirement (in mt) for FY13F/14F/15F is lower than our previous
forecast on account of [1] non-availability of domestic linkage coal necessitating higher
imports (wherein the quantity required drops due to higher GCV of coal) and [2] push
back in capacity commission combined with lower utilization levels.
• INR/USD exchange rate: In line with the average INR/USD rate for FY13 (year to date),
we peg the average INR/USD rate at 55 for FY13F and 55.5 for FY14F and FY15F. Our
new INR/USD assumptions pegs the INR 30-35% lower (depreciated) versus the USD,
resulting in a higher CIF cost of imported coal.
• Merchant tariff realizations: Based on the existing short/medium-term PPA contracts for
Adani and probability merchant tariffs being ‘supported’ over the next 18 months in the
run up to general elections, we raise our merchant realization assumption for Adani by
6% for FY13F to INR4.25/kWh and 9% for FY14F to INR4.1/kWh. Long-term merchant
realizations are pegged at INR3.75/kWh (vs INR3.5/kWh previously).
Key risks to our investment thesis for Adani Power
Along the lines of favourable outcomes in our ‘what-if’ scenarios for a handful of key
variables
• Lower-than-expected landed cost of imported coal – Besides the domestic/imported
coal mix, Adani’s earnings are highly sensitive to the landed cost of imported coal (in
INR terms), which in turn is an interplay among [1] supply ramp-up from Bunyu, [2] FOB
price of seaborne thermal coal, and [3] INR/USD exchange rate fluctuation. A sharp
appreciation of the INR and/or below-expected CIF price of ex-Indonesia coal could
potentially lead to upward revision in our earnings outlook and TP for the stock.
• Termination/alteration of fixed cost PPAs – Adani is looking to rework / exit its long-term
PPAs from its Mundra-II (1000MW with GUVNL), Mundra-III (1424MW with Haryana
SEBs) and Tiroda-I (1320MW with MSEDCL) facilities, where its bid tariffs rule out
indexation of energy charges (ie, fuel cost recovery is fixed at the quoted tariff). A
positive outcome on these representations by management could potentially boost
Adani’s earnings prospects and reduce the risk profile of its projects.
• Securing domestic linkage coal – As elaborated in the ‘scenario analysis’ section of this
report, success in securing domestic coal linkages for Mundra I, Mundra-II, Tiroda-II
and Kawai could potentially merit an increase in Adani’s earnings and TP for the stock.
• Merchant tariff realizations – We currently peg Adani’s FY13F/14F/15F merchant
realizations at INR4.25/kWh, INR4.1/kWh and INR4/kWh, respectively; higher-thanexpected
merchant tariff realization could merit an earnings and TP increase.
• CERs could raise earnings, but marginally – As per a recent company press release of
1.8mn CERs per annum for Mundra-III (at 80-85% utilization level), if Adani were to
receive INR600mn annually (pre-tax at EUR4.54/CER, last 1 year average price), our
FY14F/15F earnings estimate could go up marginally by 6.3/5.8%.
• Coal price pooling would lower fuel costs – If implemented, coal price pooling
mechanism would likely improve profitability of Mundra-III and Tiroda-II (facilities
eligible to get linkage coal), in our view, as the cost of imported coal would likely
decline, albeit partially offset by a higher cost of domestic coal. Further, Adani could
divert its low-cost Bunyu coal from Mundra-III to meet coal requirements for its other
projects.
Assessing earnings outlook on ‘what-if’ scenarios
In our view, Adani’s earnings trajectory and fair value of the stock is contingent on a
handful of potentially ‘binary outcome’ scenarios (elaborated below) related to issues
including domestic fuel linkage, supply ramp-up from Bunyu and endgame regarding
non-remunerative PPAs. Favourable outcome on these issues forms the key risks to our
earnings forecast for Adani and investment thesis for the stock.
• Scenario I: Faster-than-assumed supply ramp up from Bunyu – Our base-case
earnings forecast for Adani assumes coal receipt from Bunyu at 5.1mt / 7.5mt / 9.0mt in
FY13F/FY14F/FY15F, respectively. Although supply from Bunyu has been below
management guidance over the past few quarters, if production ramp-up and
consequent supply is closer to management guidance of 6mt/9mt in FY13/FY14, our
FY13F/14F EPS forecast for Adani would rise by 28%/4% respectively; and our 12-mth
TP could rise by ~6% to INR37/share, based on our calculations.
• Scenario II: Termination of PPA with GUVNL (1000MW at INR2.35/kWh from Mundra –
Our base-case earnings forecast for Adani assumes Mundra-II (1320MW) to operate at
utilization level of 50% (indicative minimum utilization level as per management) at the
existing PPA tariff of INR2.35/kWh (excluding customs duty). Adani has filed a petition
in the Supreme Court to terminate this PPA and pay a penalty of INR1bn, as per the
terms of the PPA. If the Supreme Court rules in Adani’s favour, and Adani is able to
ramp-up the utilization level of Mundra-II to 80% and realize a tariff of even INR3/kWh,
we estimate our FY14F/15F EPS forecast for Adani could rise by 56-72%, respectively;
12-mth TP could rise by ~37% to INR48/share.
• Scenario III: 30% linkage coal for Mundra I & II starting FY14 – Our base-case earnings
forecast for Adani assumes no domestic coal linkage for Mundra-I, II. However, if the
Ministry of Power’s (MoPs) request for restoring 30% domestic coal linkage for Mundra-
I,II is accepted by the Standing Linkage Committee (SLC), we estimate our FY14F/15F
EPS forecast for Adani could rise by 29%/21% respectively; and our 12-mth TP could
rise by ~14% to INR40/share.
• Scenario IV: Availability of linkage coal for Tiroda-II and Kawai post FY15 – Our basecase
earnings forecast for Adani assumes no domestic coal linkage for Tiroda- II and
Kawai. Our interaction with policymakers suggests that unless the criterion of “LoA
being a pre-requisite for a project being considered by the CEA for eligibility to secure
an FSA” is altered, prospects of Kawai and Tiroda-II securing linkage coal, at least up
to FY15 (and probably until the end of the XIIth Plan [ie, FY17], in our view), appear
dim. If Adani were to secure 9.8mt coal linkage from FY16 onwards, we show the
resultant FCFE value of Tiroda-II and Kawai could rise significantly, raising our 12-mth
TP by as much as 77% to INR62/share.
• Scenario V: USD/INR slips to ~60 by FY14 – As against our base-case assumption of
USD/INR at 55.5 for the explicit term, if the rupee were to drop to ~60 vs the USD by
FY14F, as outlined by our economics team in their report titled Asia Special Report:
India's Chronic Balance of Payments, dated September 3, 2012, Adani’s earnings
outlook would likely be severely impacted (fuel cost would rise sharply, exchange raterelated
losses would rise, cash requirements for debt servicing/repayment would rise
potentially requiring an equity infusion). Our FY13F/14F/15F EPS forecasts for Adani
could decrease by 19%/42%/46%; our 12-mth TP could go down by ~26% to
INR26/share under such an f/x scenario.
Earnings hinge on fuel sourcing, reworking PPAs
Despite Adani Group’s vertical integration and credible execution capability together with
Adani Power’s front-ended capacity pipeline and a healthy off take mix, we believe the
earnings outlook is hampered by two factors – [1] zero/partial fuel-cost pass thru across
all its long-term PPAs; and [2] coal sourcing woes (slow ramp-up in supply from Bunyu
mines and diminished prospects of securing linkage coal for Tiroda-II, Kawai and
Mundra-I,II).
Adani looking to rework / exit a few of its long-term PPAs…
We note that Adani is looking to rework/exit its long-term PPAs from its Mundra-II
(1000MW with GUVNL), Mundra-III (1424MW with Haryana SEBs) and Tiroda-I
(1320MW with MSEDCL) facilities, where its bid tariffs rule-out indexation of energy
charges (ie, fuel cost recovery is fixed at the quoted tariff).
• Adani is currently in litigation in the Supreme Court for its 1000MW PPA with Gujarat
Urja Vikas Nigam from its Mundra-II facility (PPA tariff is set at INR2.35/kWh) wherein it
seeks to exit the PPA upon payment of the INR1bn penalty stipulated in the contract.
Previously, the Gujarat Electricity Regulator (GERC) and the Appellate Tribunal
(APTEL) ruled against Adani on this matter.
• Separately, Adani has filed a petition with the Central Electricity Regulator (CERC)
seeking prompt development of a mechanism to revise the tariff under the PPAs with
GUVNL and Haryana SEBs (UHBVNL, DHBVNL) on account of: [1] unforeseeable/
uncontrollable change in circumstances for the allotment of domestic coal by the
Government of India/Coal India; and [2] enactment of New Coal Pricing Regulation by
the Government of Indonesia thereby impeding the existing contracts. The CERC is
currently examining the maintainability of Adani’s petition.
• Adani is also negotiating the tariff for its 1320MW PPA with MSEDCL (the PPA started
in August 2012 at a tariff of ~INR2.64/kWh).
At this time, the probability/timeline of Adani being able to rework PPA tariffs or to exit
PPAs is difficult to assess. Our base-case earnings forecasts and TP calculation for
Adani do not assume any tariff reworking or exit from its existing long-term PPAs
Prospects of Tiroda-II and Kawai projects securing linkage coal…
As per management, both Kawai and Tiroda-II are identified XIIth Plan projects by the
Government of India and domestic coal allocation (linkage) will be secured in the next 3-
4 months when the Standing Linkage Committee (SLC) on coal meets to decide on this
issue. We note the following:
• Based on the milestone achievements and offtake tie-ups, we believe both Kawai and
Tiroda-II would rank high on the parameters outlined by the Ministry of Power (MoP) in
its policy for allocating coal linkage for XIIth Plan projects (see Figure 13).
• However, in the absence of a Letter of Assurance (LoA) from Coal India, both projects
do not find a mention in the Central Electricity Authority’s (CEA) list of projects eligible
to secure linkage coal (via an FSA) from Coal India up to FY15.
• Fuel cost is partially a pass-thru in the case of the LT PPAs of Tiroda-II and Kawai
given that there are both an escalable and a fixed energy charge component in the
tariff build-up; accordingly, profitability prospects would vary directly with the proportion
of domestic linkage coal in the fuel mix.
Our interaction with policymakers suggests that unless the criterion of “a LoA from Coal
India being a pre-requisite for a project to be considered by the CEA for eligibility to
secure an FSA” is altered, prospects of Kawai and Tiroda-II securing linkage coal, at
least up to FY15 (and probably until the end of the XIIth Plan, [ie, FY17]), appear dim. In
the absence of further clarity on this issue, our base-case earnings forecast for Adani
assumes a fuel mix for Tiroda-II and Kawai of 30% domestic non-linkage coal and 70%
imported coal.
Valuation: 12-month TP lowered to INR35
Our milestone risk-adjusted FCFE-based valuation methodology (which we deploy to
value private IPPs) pegs Adani’s 12-month target price at INR35, implying 16.7%
downside from current levels. Our TP calculation for the stock values Adani’s 9240MW of
existing/pipeline capacity; we exclude 3960MW of pipeline capacity as the 2640MW
Dahej and 1320MW Chhindwara projects have been placed on the backburner. On our
FY14F earnings, the stock trades at 1.6x P/B, 7.8x EV/EBITDA and 12.0x P/E.
Projects still valued on FCFE, adjusted for milestone-risk discounts
We continue to deploy a milestone risk-adjusted FCFE-based methodology to value
Adani’s power generation projects that appear ‘feasible’ (ie, operational and under
construction/development, but with tangible progress and reasonable likelihood of
materializing). The six milestone risks, which capture the risk of a power project from
conception to commissioning, apply appropriate discounts to the FCFE value (provided it
is not negative) of an under-construction project – in our view, this approach allows
investors to objectively view the incremental value ascribed to a project as key
prerequisites for commissioning fall into place.
‘Milestone-risk’ adjustments lower base-case FCFE-based fair value by 5%
At 15% cost of equity, based on our earnings forecast, we calculate the FCFE-based
value of Adani’s 9240MW of projects to be INR22.8/share; adding FY13F cash-on-hand
of INR14/share, we estimate the unadjusted fair value of the stock would be INR37/share
(rounded). Accordingly, even if we were to disregard the milestone-risk discounts we
attribute to various projects, ceteris paribus, we find the current market price leaves no
room for upside.
Key points to note in the ‘milestone risk’ assigned to the FCFE-based value of projects:
• The 30% milestone-risk discount for Tiroda-II (1320MW) and Kawai-II (1320MW)
reflects the fuel security risk considering non-eligibility for securing domestic linkage
coal as per current regulations and no alternative source of coal being identified.
However, as our calculated FCFE for Kawai is negative, we do not apply the 30%
milestone-risk discount to its FCFE value in our TP build-up for Adani;
• The 10% milestone risk discount for Tiroda-I (1980MW) reflects off-take tie-ups under
long-term PPAs being in the range of 66-85% of the total capacity.
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