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Highlights
After a site visit to Reliance Power's Butibori power station in Maharashtra, a meeting with RPWR's CEO
JP Chalasani and attending NTPC's analyst day, we are more convinced of the ability of India's power
sector to add 15-20GW of new capacity both this year and next… and less convinced of the ability of the
Indian coal mining and distribution segments to provide fuel and pay for the power. The implications for
the power generation sector as a whole are poor.
The Indian power generation sector is expanding installed capacity at a steady high-single digit
growth rate. The sector added 13GW last financial year and is on track to add at least as much this year.
We saw no indication of a slowdown: Reliance Power expressed the view that the single greatest
constraint to completing the Butibori project on time is availability of skilled labor, given the number of
similar projects currently ongoing in eastern Maharashtra. Installed capacity growth isn't the issue.
The problem is a lack of domestic (cheap) coal production growth combined with an inability to pay
for (expensive) imported coal. Few market participants have any confidence in the ability of Coal India
to increase coal production at a rate faster than 4-5%. The only available source of fuel to make up the
difference in the medium term is imported coal. But, at current retail tariffs, State Electricity Boards
can't afford to pay for electricity generated from imported coal.
Imported coal is – according to NTPC - 2.5x more expensive than domestic coal, after adjusted for
calorific value. NTPC's power stations are being backed down because State Electricity Boards don't
have cash to pay for electricity. Use of imported coal exacerbates pricing pressures and the risk of being
backed down. Even in NTPC's long range forecasts, imported coal makes up only 10% of total coal
supply (up from 7.7% today). This modest increase is a function of the fact that imported coal effectively
prices the power station using it out of the market.
This is the fundamental wrinkle at the core of any bullish view on Indian power consumption growth.
NTPC expects real GDP growth of ~8% in coming years and power consumption growth at roughly the
same number. Yet, power consumption growth was 3.8% in FY2011 and has topped 8% in only one of
the last eight years. Since the power multiplier has been below 1.0x for the last nine years in India, and
given the coal supply constraints, maybe this lower multiplier qualifies as "normal".
The solution is to increase retail tariffs and reform the distribution sector to reduce commercial and
technical losses. But this has always been the solution. We did not speak to anyone who was optimistic
about distribution sector reform in the near term. That means more installed capacity growth, lower
utilization… and limited opportunities for generation companies to surprise to the upside.
Investment Conclusion
We rate NTPC Market-perform (Target Price INR190). Given NTPC's regulated rate of return business,
we believe that the upside to current valuation is limited.
We rate Reliance Power Underperform (Target Price INR100). Reliance Power continues to target over
20GW of coal-fired capacity and coal investment in Indonesia. All this expansion requires cash. Reliance
Power raised INR135.5 billion in its IPO in January 2008. Reliance Power has stated that – through project
financing – it can lever its power stations 75%:25% debt-to-equity. This effectively quadruples the amount
of cash Reliance Power has to spend on building power stations to INR542 billion. To date, the company
has spent ~INR100 billion and therefore has – at the beginning of 2011 – an additional INR440 billion
remaining to spend.
In discussions with the company, management is clear that it recognizes cash flow deficiencies in its current
expansion plan but not until 2014 or 2015. The company maintains that it is planning to manage the roll-out
of projects to preserve cash. Of course, delays in capital spending also serve to delay earnings. We remain
cautious about the stock given its cash flow profile, the difficult pricing environment in which it is
operating and the challenging projects that it needs to complete successfully and on budget in order to start
generating meaningful cash flows.
Valuation Methodology
Our valuation for NTPC of INR 190 is based on a Price/Forward Earnings multiple and a DCF valuation.
On a Price/Forward Earnings basis, we assign the historical multiple of 15x to our FY2012 EPS of INR
12.72. Our DCF valuation assumes a WACC of 11.1% and a terminal growth rate of 4%.
Our valuation for Reliance Power of INR 100 is based on a DCF valuation, adjusted downward to reflect
concerns about the terms on which the company may raise additional equity. Our DCF valuation assumes a
WACC of 14.8% and a terminal growth rate of 4%. Reliance Power is still in the early stages of
commissioning its fleet of power plants. Earnings are currently dominated by interest and investment
income and accordingly provide little guide as the company's core business or sustainable long-term
earnings power.
Risks
The primary risk to our thesis on the India utilities is that electricity demand growth may be higher than we
anticipate or the level of newly commissioned power stations may be lower than anticipated. In other
words, the long-term demand-supply imbalance may continue indefinitely.
In addition, for NTPC significant changes in the regulation of the power sector, or a statutorily required
reduction in Government ownership in NTPC over a short timeframe, or a significant investment in foreign,
non- regulated, non-generation assets (all floated in India in the last six months) would have negative
implications for NTPC valuation, in our view.
The primary risk to our thesis on Reliance Power is that if the long-term demand-supply imbalance
continues indefinitely, Reliance Power's IPP fleet – once built – will operate at higher than anticipated
utilization levels and sell electricity at higher than anticipated prices. In that circumstance, commissioning
the fleet in full and on time with minimal additional equity and through the use of large amounts of
inexpensive debt financing would create value over the long term that is not currently reflected in our
valuation.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Highlights
After a site visit to Reliance Power's Butibori power station in Maharashtra, a meeting with RPWR's CEO
JP Chalasani and attending NTPC's analyst day, we are more convinced of the ability of India's power
sector to add 15-20GW of new capacity both this year and next… and less convinced of the ability of the
Indian coal mining and distribution segments to provide fuel and pay for the power. The implications for
the power generation sector as a whole are poor.
The Indian power generation sector is expanding installed capacity at a steady high-single digit
growth rate. The sector added 13GW last financial year and is on track to add at least as much this year.
We saw no indication of a slowdown: Reliance Power expressed the view that the single greatest
constraint to completing the Butibori project on time is availability of skilled labor, given the number of
similar projects currently ongoing in eastern Maharashtra. Installed capacity growth isn't the issue.
The problem is a lack of domestic (cheap) coal production growth combined with an inability to pay
for (expensive) imported coal. Few market participants have any confidence in the ability of Coal India
to increase coal production at a rate faster than 4-5%. The only available source of fuel to make up the
difference in the medium term is imported coal. But, at current retail tariffs, State Electricity Boards
can't afford to pay for electricity generated from imported coal.
Imported coal is – according to NTPC - 2.5x more expensive than domestic coal, after adjusted for
calorific value. NTPC's power stations are being backed down because State Electricity Boards don't
have cash to pay for electricity. Use of imported coal exacerbates pricing pressures and the risk of being
backed down. Even in NTPC's long range forecasts, imported coal makes up only 10% of total coal
supply (up from 7.7% today). This modest increase is a function of the fact that imported coal effectively
prices the power station using it out of the market.
This is the fundamental wrinkle at the core of any bullish view on Indian power consumption growth.
NTPC expects real GDP growth of ~8% in coming years and power consumption growth at roughly the
same number. Yet, power consumption growth was 3.8% in FY2011 and has topped 8% in only one of
the last eight years. Since the power multiplier has been below 1.0x for the last nine years in India, and
given the coal supply constraints, maybe this lower multiplier qualifies as "normal".
The solution is to increase retail tariffs and reform the distribution sector to reduce commercial and
technical losses. But this has always been the solution. We did not speak to anyone who was optimistic
about distribution sector reform in the near term. That means more installed capacity growth, lower
utilization… and limited opportunities for generation companies to surprise to the upside.
Investment Conclusion
We rate NTPC Market-perform (Target Price INR190). Given NTPC's regulated rate of return business,
we believe that the upside to current valuation is limited.
We rate Reliance Power Underperform (Target Price INR100). Reliance Power continues to target over
20GW of coal-fired capacity and coal investment in Indonesia. All this expansion requires cash. Reliance
Power raised INR135.5 billion in its IPO in January 2008. Reliance Power has stated that – through project
financing – it can lever its power stations 75%:25% debt-to-equity. This effectively quadruples the amount
of cash Reliance Power has to spend on building power stations to INR542 billion. To date, the company
has spent ~INR100 billion and therefore has – at the beginning of 2011 – an additional INR440 billion
remaining to spend.
In discussions with the company, management is clear that it recognizes cash flow deficiencies in its current
expansion plan but not until 2014 or 2015. The company maintains that it is planning to manage the roll-out
of projects to preserve cash. Of course, delays in capital spending also serve to delay earnings. We remain
cautious about the stock given its cash flow profile, the difficult pricing environment in which it is
operating and the challenging projects that it needs to complete successfully and on budget in order to start
generating meaningful cash flows.
Valuation Methodology
Our valuation for NTPC of INR 190 is based on a Price/Forward Earnings multiple and a DCF valuation.
On a Price/Forward Earnings basis, we assign the historical multiple of 15x to our FY2012 EPS of INR
12.72. Our DCF valuation assumes a WACC of 11.1% and a terminal growth rate of 4%.
Our valuation for Reliance Power of INR 100 is based on a DCF valuation, adjusted downward to reflect
concerns about the terms on which the company may raise additional equity. Our DCF valuation assumes a
WACC of 14.8% and a terminal growth rate of 4%. Reliance Power is still in the early stages of
commissioning its fleet of power plants. Earnings are currently dominated by interest and investment
income and accordingly provide little guide as the company's core business or sustainable long-term
earnings power.
Risks
The primary risk to our thesis on the India utilities is that electricity demand growth may be higher than we
anticipate or the level of newly commissioned power stations may be lower than anticipated. In other
words, the long-term demand-supply imbalance may continue indefinitely.
In addition, for NTPC significant changes in the regulation of the power sector, or a statutorily required
reduction in Government ownership in NTPC over a short timeframe, or a significant investment in foreign,
non- regulated, non-generation assets (all floated in India in the last six months) would have negative
implications for NTPC valuation, in our view.
The primary risk to our thesis on Reliance Power is that if the long-term demand-supply imbalance
continues indefinitely, Reliance Power's IPP fleet – once built – will operate at higher than anticipated
utilization levels and sell electricity at higher than anticipated prices. In that circumstance, commissioning
the fleet in full and on time with minimal additional equity and through the use of large amounts of
inexpensive debt financing would create value over the long term that is not currently reflected in our
valuation.
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