JSW Energy :Poised to scale up, but a tad overvalued: Nomura Research

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Robust FCF prospects, best-in-class RoE and further

M&A upside already seem priced in

Action/Catalysts: Raising estimates/TP; maintain Reduce on valuations

JSWE has hit a purple patch: [1] buyout of JPVL’s 1391MW hydro assets will

likely be earnings-accretive from FY16F itself, [2] interplay of macro drivers

(INR/USD, seaborne thermal coal prices, mgt. guidance on realisations)

appears favourable in the near term, and [3] FCF generation + comfortable

leverage (1.8x as of FY16F) provide room for more M&A without necessarily

raising fresh equity. However, at 1.9x FY17F P/B, we believe that robust FCF

prospects + theoretical value creation from buying up to 5GW of ‘distressed’

capacity is already priced in and somewhat ignores that [1] post-FY16F

earnings growth is contingent upon further inorganic expansion, [2] ~30% of

operational capacity would remain vulnerable to ‘uncontrollable’ factors, and

[3] there may be an equity overhang to fund incremental M&As. Our revised

SOTP-based 12-month TP for the stock is INR103 (effectively valuing FY16F

cash at 1.7x book to capture M&A upside), implying 14% potential downside.

Post-FY16 earnings growth contingent upon further inorganic expansion

Our revised EPS forecasts (up 12%/52%/53%) build in the buyout of 1391MW

of hydro assets from JPVL; we see a front-ended FY15-17F EPS CAGR of

17%. We build in INR/USD=62.5 (60 previously) in the medium term, raise our

coal-fired merchant realisation forecast by 6%/8% for FY16F/17F (+2% to

INR4.3/kwh in the long term) and cut the benchmark high-GCV/low-GCV FoB

coal price by 20%/13% to US$60/ton/US$33/ton for FY16F/17F, and cut by

13%/5% to US$70/ton/US$38/ton for the long term.

Valuation: At 1.9x, FY17F P/B multiple appears stretched

In the past 12 months, JSWE shares have doubled (vs BSE Sensex +25%)

and 1-year fwd P/B is up from 1.3x to 2.2x (>2SD from 3-year avg). Our

revised TP of INR103 (up 49%) = FCFE-based value of its projects + capacity

acquired from JPVL + investments (book) + FY16F cash + option value of

further M&As; the implied FY17F P/B is 1.6x (BVPS of INR64.4).