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Indian power utilities
Menu tailored to low-risk appetite
• Indian IPPs and utilities have been in freefall, severely
underperforming the market: Key issues: a) funding question marks
on ongoing and new projects; b) severe constraints on domestic coal /
gas supplies; c) falling merchant prices on the back of state-utility
buyers’ financial woes and unwillingness to buy expensive power; and
d) rampant delays in land acquisition and environmental clearance. We
do not foresee these concerns dissipating soon, and believe they could
affect execution in a meaningful way. Recent results (e.g. from Lanco,
JSW Energy) have sharpened concerns about these aspects.
• While these issues impact our entire universe, Lanco, Reliance
Power (RPWR), and JSW Energy (JSWE) are bearing the brunt:
We downgrade Lanco to Neutral with a revised PT of Rs45, as high
leverage, visible funding gap, and debt at the parent level make this IPP
particularly vulnerable to execution delays. We stay UW on RPWR (PT
Rs90) and further lower our PT for JSWE (PT Rs67). We recommend
avoiding RELI (downgraded to Neutral last month) given concerns on
regulated business cash flows and EPC execution. Most of these names
(barring RPWR) look cheap on traded multiples, but we expect them to
continue to trade at a discount to fair value, given further risk of earnings
downgrades on the back of execution / funding / power price concerns.
• We upgrade Tata Power (TPWR) to OW: While the recent correction
offers a buying opportunity, its stake in coal assets provides upside
potential if coal prices continue to rise. On the whole, TPWR stock has
displayed a defensive nature within the pack. We stay OW on Power
Grid Corp (PGCIL) as we believe it offers a safe and stable growth
haven relative to IPPs facing significantly higher uncertainties. Adani
Power’s best-in -class execution compels us to retain our OW, but we
reduce our PT to Rs138 to factor in lower PLF on projects beyond 2013.
• We recommend switching from Lanco, RPWR, JSWE, and RELI
into PGCIL, TPWR, Adani, and NTPC: A return of risk appetite, any
government steps to expedite project clearances, companies sorting out
their funding issues, and sharp spikes in merchant prices are upside risks
to our PTs for the former names.
Valuation and stock views
The IPP and utility space has seen a sharp price correction (Figures 1 & 2) – for good
reason, in our view. Concerns that we have been highlighting in the recent past have
materialized, and could snowball into widespread commissioning and execution
delays.
Companies have been racing to acquire new assets (e.g. coal) and grow their power
portfolios, in the process straining their balance sheets. Given the weak risk appetite
and liquidity situation, we believe the sector will remain out of favour. Particularly
for Lanco, RPWR, RELI, and JSWE we do not see any meaningful upside potential.
We foresee these stocks remaining cheap for a few more quarters until the issues are
sorted out.
Within the space, we recommend switching into defensives such as PGCIL and
TPWR. Both these stocks have traditionally shown defensive characteristics but have
interesting ‘growth’ aspects as well – Powergrid as we believe it offers a safe and
stable growth haven relative to IPPs facing significantly higher uncertainties, and
TPWR via its coal assets. For investors inclined towards more risk, we recommend
Adani, where relative confidence in execution is high, notwithstanding its merchant
exposure and vulnerability to coal supply problems.
A quick recap of key concerns
Funding for ongoing and new projects
We estimate a need for fresh funding in FY14 and beyond for Indian IPPs and the
most probable candidates are JSW, Lanco and RPWR. The risk is particularly high in
the case of Lanco, considering the company’s high leverage. Large acquistions of
overseas coal mines and incremental funding for less visible projects could put
pressure on balance sheets. Our defensive picks NTPC and PWGR both enjoy the
benefit of modest leverage and no funding need despite their large capex pipeline.
The scale of NTPC’s and PWGR’s operating cash flows are sufficient to fund the
capex plans for its 75GW pipeline and 12th plan capex of Rs1,100B respectively in
our view. For JSW Energy, TPWR and Adani we expect an inflection in operating
cash flow in FY12, after the complete commissioning of their under-construction
projects.
However, on an FCF basis we see a turnaround in store for JSW (back-ended
pipeline with low visibility), TPWR (less aggressive plans, steady operating
cashflow from coal mines), and Adani Power (capex to slow, unless the extended
6.6GW pipeline begins to get executed) before FY14.
Coal and gas availability
Given the firm coal prices and a postive bias (JPM est. of $120/ton for Newcashtle
Coal in CY11) backed by demand from India and China, fuel sourcing and
availability has become a key risk for IPPs, particularly since Coal India is expected
to have a thermal coal deficit of 186MT by FY14, according to our Metals & Mining
analysts Pinakin Parekh and Neha Manpuria. Hence meeting all signed LoAs is
highly unlikely. In fact in our conversations with IPPs, most are indicating a blending
of up to 30% imported coal to meet PLFs of 70-80% for linkage coal-based projects.
The development of captive coal blocks has not had a great track record either.
Similarly, some IPPs have also invested significant capex in gas-based capacities
coming online in the 11th plan, and a halt in gas production ramp-up from RIL could
postpone allocation by EGoM and plants could be idle for a while. Imported LNG
(priced at $9.5-10/mmbtu vs. $4.2/mmbtu for gas) would be an expensive alternative.
Our Oil & Gas team (Pradeep Michandani and Neil Gupte) estimate gas production
at 67.5/90mmscmd for FY12/13 for RIL and 55/60mmscmd, assuming a worst-case
scenario. Currently RIL is producing only 51mmscmd vs. its current capacity of
58mmscmd.
JSW Energy has the maximum MW expoure to imported coal, that too at spot rates,
with 46% of operating and under-construction merchant capacity. While Lanco and
Adani run the risk of a shortfall in linkage coal, Adani for the near-to-medium term is
insulated by imports from Bunyu at fixed prices. Lanco also has 41% exposure to
gas; we factor in a 70% PLF to account for shortfalls. TPWR has the most diversified
fuel mix with a hedge in place for imported coal price for Mundra. NTPC should
remain relatively insulated since it requires the just-about-adequate amount of fuel to
declare the plant to be available.
We assume lower PLFs for domestic linkage and gas-based projects and higher for
projects with an assured imported fuel source with a previous track record. For
projects with captive coal blocks we have applied a middle of the range PLF.
Weak financials of buyer-utilities and falling merchant
prices
Weakness in the balance sheet of state utilities puts constraints on it from purchasing
more expensive merchant power from the market despite the energy deficit in the
country. Hence power demand, which is more a function of supply in India, maybe
impacted if SEBs decide to go for power cuts. Our merchant estimates at Rs4/unit in
FY12 and Rs3.3/unit beyond FY15 are below street estimates, incorporating the
SEB-related risk partly.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian power utilities
Menu tailored to low-risk appetite
• Indian IPPs and utilities have been in freefall, severely
underperforming the market: Key issues: a) funding question marks
on ongoing and new projects; b) severe constraints on domestic coal /
gas supplies; c) falling merchant prices on the back of state-utility
buyers’ financial woes and unwillingness to buy expensive power; and
d) rampant delays in land acquisition and environmental clearance. We
do not foresee these concerns dissipating soon, and believe they could
affect execution in a meaningful way. Recent results (e.g. from Lanco,
JSW Energy) have sharpened concerns about these aspects.
• While these issues impact our entire universe, Lanco, Reliance
Power (RPWR), and JSW Energy (JSWE) are bearing the brunt:
We downgrade Lanco to Neutral with a revised PT of Rs45, as high
leverage, visible funding gap, and debt at the parent level make this IPP
particularly vulnerable to execution delays. We stay UW on RPWR (PT
Rs90) and further lower our PT for JSWE (PT Rs67). We recommend
avoiding RELI (downgraded to Neutral last month) given concerns on
regulated business cash flows and EPC execution. Most of these names
(barring RPWR) look cheap on traded multiples, but we expect them to
continue to trade at a discount to fair value, given further risk of earnings
downgrades on the back of execution / funding / power price concerns.
• We upgrade Tata Power (TPWR) to OW: While the recent correction
offers a buying opportunity, its stake in coal assets provides upside
potential if coal prices continue to rise. On the whole, TPWR stock has
displayed a defensive nature within the pack. We stay OW on Power
Grid Corp (PGCIL) as we believe it offers a safe and stable growth
haven relative to IPPs facing significantly higher uncertainties. Adani
Power’s best-in -class execution compels us to retain our OW, but we
reduce our PT to Rs138 to factor in lower PLF on projects beyond 2013.
• We recommend switching from Lanco, RPWR, JSWE, and RELI
into PGCIL, TPWR, Adani, and NTPC: A return of risk appetite, any
government steps to expedite project clearances, companies sorting out
their funding issues, and sharp spikes in merchant prices are upside risks
to our PTs for the former names.
Valuation and stock views
The IPP and utility space has seen a sharp price correction (Figures 1 & 2) – for good
reason, in our view. Concerns that we have been highlighting in the recent past have
materialized, and could snowball into widespread commissioning and execution
delays.
Companies have been racing to acquire new assets (e.g. coal) and grow their power
portfolios, in the process straining their balance sheets. Given the weak risk appetite
and liquidity situation, we believe the sector will remain out of favour. Particularly
for Lanco, RPWR, RELI, and JSWE we do not see any meaningful upside potential.
We foresee these stocks remaining cheap for a few more quarters until the issues are
sorted out.
Within the space, we recommend switching into defensives such as PGCIL and
TPWR. Both these stocks have traditionally shown defensive characteristics but have
interesting ‘growth’ aspects as well – Powergrid as we believe it offers a safe and
stable growth haven relative to IPPs facing significantly higher uncertainties, and
TPWR via its coal assets. For investors inclined towards more risk, we recommend
Adani, where relative confidence in execution is high, notwithstanding its merchant
exposure and vulnerability to coal supply problems.
A quick recap of key concerns
Funding for ongoing and new projects
We estimate a need for fresh funding in FY14 and beyond for Indian IPPs and the
most probable candidates are JSW, Lanco and RPWR. The risk is particularly high in
the case of Lanco, considering the company’s high leverage. Large acquistions of
overseas coal mines and incremental funding for less visible projects could put
pressure on balance sheets. Our defensive picks NTPC and PWGR both enjoy the
benefit of modest leverage and no funding need despite their large capex pipeline.
The scale of NTPC’s and PWGR’s operating cash flows are sufficient to fund the
capex plans for its 75GW pipeline and 12th plan capex of Rs1,100B respectively in
our view. For JSW Energy, TPWR and Adani we expect an inflection in operating
cash flow in FY12, after the complete commissioning of their under-construction
projects.
However, on an FCF basis we see a turnaround in store for JSW (back-ended
pipeline with low visibility), TPWR (less aggressive plans, steady operating
cashflow from coal mines), and Adani Power (capex to slow, unless the extended
6.6GW pipeline begins to get executed) before FY14.
Coal and gas availability
Given the firm coal prices and a postive bias (JPM est. of $120/ton for Newcashtle
Coal in CY11) backed by demand from India and China, fuel sourcing and
availability has become a key risk for IPPs, particularly since Coal India is expected
to have a thermal coal deficit of 186MT by FY14, according to our Metals & Mining
analysts Pinakin Parekh and Neha Manpuria. Hence meeting all signed LoAs is
highly unlikely. In fact in our conversations with IPPs, most are indicating a blending
of up to 30% imported coal to meet PLFs of 70-80% for linkage coal-based projects.
The development of captive coal blocks has not had a great track record either.
Similarly, some IPPs have also invested significant capex in gas-based capacities
coming online in the 11th plan, and a halt in gas production ramp-up from RIL could
postpone allocation by EGoM and plants could be idle for a while. Imported LNG
(priced at $9.5-10/mmbtu vs. $4.2/mmbtu for gas) would be an expensive alternative.
Our Oil & Gas team (Pradeep Michandani and Neil Gupte) estimate gas production
at 67.5/90mmscmd for FY12/13 for RIL and 55/60mmscmd, assuming a worst-case
scenario. Currently RIL is producing only 51mmscmd vs. its current capacity of
58mmscmd.
JSW Energy has the maximum MW expoure to imported coal, that too at spot rates,
with 46% of operating and under-construction merchant capacity. While Lanco and
Adani run the risk of a shortfall in linkage coal, Adani for the near-to-medium term is
insulated by imports from Bunyu at fixed prices. Lanco also has 41% exposure to
gas; we factor in a 70% PLF to account for shortfalls. TPWR has the most diversified
fuel mix with a hedge in place for imported coal price for Mundra. NTPC should
remain relatively insulated since it requires the just-about-adequate amount of fuel to
declare the plant to be available.
We assume lower PLFs for domestic linkage and gas-based projects and higher for
projects with an assured imported fuel source with a previous track record. For
projects with captive coal blocks we have applied a middle of the range PLF.
Weak financials of buyer-utilities and falling merchant
prices
Weakness in the balance sheet of state utilities puts constraints on it from purchasing
more expensive merchant power from the market despite the energy deficit in the
country. Hence power demand, which is more a function of supply in India, maybe
impacted if SEBs decide to go for power cuts. Our merchant estimates at Rs4/unit in
FY12 and Rs3.3/unit beyond FY15 are below street estimates, incorporating the
SEB-related risk partly.
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