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Tata Power Co
Indonesian Coal Re-Pricing
to Hurt Earnings; Move to UW
What's Changed
Rating Equal-weight to Underweight
Price Target Rs1,221.00 to Rs900.00
F2012 Consolidated EPS Down 6%
F2013 Consolidated EPS Down 20%
We expect re-pricing of coal supply contracts with
the Indonesian coal companies to impact F2013e
and F2014e earnings due to higher coal costs.
Valuation at 12x F2013e P/E (consolidated) is
expensive relative to peers that are trading at 8-10x.
We believe the Indonesian re-pricing directives, that are
expected to be announced in September 2011, will have
a negative impact on F2012 to F2016 earnings – the
company will be procuring 0.15 mtpa in F2012, which is
expected to ramp-up to 3.24 mtpa in F2014 (as power
units get commissioned) wherein the coal price is
expected to double from the earlier estimate of US$40/t.
Our new price target also assigns a 30% probability to our
bear case (previously 10%) as we believe any weakness
in coal prices is due to a possible global economic
slowdown (as envisaged by our economists) which could
lower the value of the holding in Indonesian coal assets.
Consensus earnings are not building in impact for
higher coal costs: Our earnings estimate for F2013 is
15% lower than consensus. We expect consensus to take
down earnings estimates as directives come into force.
F1Q12 consolidated results were lacklustre:
Revenue was Rs58.2bn (up 13% YoY), EBITDA was
Rs14.4bn (up 38%) and adjusted profit was Rs3.6bn (up
5%). While the coal business was operationally strong, it
was impacted by higher interest expenses. Hence,
adjusted profit missed our estimate of Rs6.2bn.
Key triggers: Delay in roll-out of new Indonesian
regulations would be a positive. Also, any improvement
in the coal outlook could help earnings.
Investment Case
We are downgrading Tata Power to Underweight with a revised
price target of Rs900. The downgrade is premised on the
following points:
• Consolidated earnings for F2013e and F2014e are
expected to de-grow 9% and 11%, respectively, due to
losses incurred in the Mundra UMPP project. This is
primarily due to a potential change in Indonesian
regulations wherein all coal supply contracts will be reset
to reflect benchmark prices. Given that 25% of the coal
requirements for the Mundra UMPP were originally
contracted at lower than benchmark rates, an upward
revision will lead to higher losses.
• While execution on Mundra UMPP and Maithon projects is
pretty much on schedule, these are well known and should
be already in the price. While the company has several
projects in the pipeline, we are unsure on the schedule of
their development activities and hence don't expect any
significant increase in capacities beyond what is already
under construction, at least in the next 3-4 years. The
company has two projects that will be based on domestic
captive coal blocks (2,640 MW of Naraj Marthapur and
Tiruldih projects), however, they are still in nascent stages
of development.
• We are 15% lower than consensus for F2013 earnings
estimate. We expect consensus to cut estimates primarily
due to incremental losses in Mundra.
• Expensive valuations: The stock is trading at 12x P/E on
our F2013 consolidated estimates which is expensive
relative to peers which are trading in a range of 8-10x.
While Tata Power had traditionally traded at a premium to
IPPs, we believe the current premium of 20-50% is
excessive especially with earnings likely to de-grow in
F2014.
• Consensus is hugely positive on the stock with 25
brokers rating it a ‘buy’, 14 with a ‘hold’ and only 1 with a
‘sell’ currently. We believe this optimism on the stock
primarily stems from the belief that Tata Power is
construed as a defensive utility stock which also provides
upside from rising global coal prices. While we don't
disagree with this thesis and was the key reason for us
having an Equal-weight on the stock, our view now is that
earnings risk from the Mundra UMPP is still not fully
appreciated. Hence, the stock could underperform once
the Indonesian regulations actually come into force (which
is expected in September 2011) as these would result in
earnings downgrades for F2013 and beyond.
Re-pricing of Coal Supply Contract to Mundra UMPP
The Mundra UMPP has a 10.11 mtpa (+/- 20%) coal supply
contract with the Indonesian coal companies (KPC and
Arutmin). Given that Mundra UMPP will need about 11.3 mtpa
of coal during full operations, we assume almost the entire
supply from the Indonesian coal assets will be utilized for
Mundra. As per the original coal supply contract, the Mundra
UMPP would get 75% of the coal at index-linked prices while
the balance 25% was to be supplied at a lower price (assumed
as US$40/t) fixed for a period of 5-6 years.
However, the Indonesian authorities have decided that all coal
supplies from the country need to happen at benchmark prices
and hence the contracts would need to be reset accordingly.
The directives are expected to be announced and introduced in
September 2011. As a result of this, the price agreed by Bumi
and Tata Power for the supply of 25% of the quantity would
have to be revised upwards to match the average realization
which are linked to benchmark prices. Exhibit 1 shows the
additional coal cost that will hit the project which could
aggregate US$544mn for the period F2012-16e.
Tata Power has mentioned that if the directives were to
become effective, it could see an upward revision of about
US$30-40/ton
While, the additional cost will be a hit to Mundra UMPP’s
profitability, Tata Power on a consolidated basis will recoup
about 30% of this through its equity holding in the Indonesian
coal assets. However, the net result will still be a meaningful
impact to the consolidated profitability of Tata Power. Our
F2013 and F2014 EPS estimates have come off by 18% and
22%, respectively, due to this additional cost impact.
A few possibilities with Tata Power to potentially mitigate this
impact could be:
1. Upward renegotiation of Mundra UMPP power tariff:
The Company has already written to the Ministry of Power
highlighting the risk faced by power plants given the sharp
increase in imported coal prices. However, as anticipated,
the Ministry has said that such negotiations have to be
done with the beneficiaries (i.e. SEBs with whom PPAs
have been signed) which in our view may either not lead to
any upward revision as SEBs are already loss-making
entities or if they do agree then it may come with a lag. We
have assumed the impact of an upward renegotiation in
tariffs in our Bull Case scenario.
2. The company is also evaluating options of sourcing lower
quality coal from other sources to reduce its exposure to
higher priced coal. However, this may lower the efficiency
of the plant.
3. Negotiation with Bumi 1: Tata Power may consider
negotiations with Bumi management from whom it had
purchased the 30% stake in June 2007. The genesis of the
talks may be that the total consideration of US$1.1bn
potentially included a compensation for the supply of some
quantity of coal at a lower price. Given that situation may
not exist anymore, there may be a case for Bumi to make
good that loss to Tata Power. However, this would also
depend on the terms of the investment agreement
between the companies
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Power Co
Indonesian Coal Re-Pricing
to Hurt Earnings; Move to UW
What's Changed
Rating Equal-weight to Underweight
Price Target Rs1,221.00 to Rs900.00
F2012 Consolidated EPS Down 6%
F2013 Consolidated EPS Down 20%
We expect re-pricing of coal supply contracts with
the Indonesian coal companies to impact F2013e
and F2014e earnings due to higher coal costs.
Valuation at 12x F2013e P/E (consolidated) is
expensive relative to peers that are trading at 8-10x.
We believe the Indonesian re-pricing directives, that are
expected to be announced in September 2011, will have
a negative impact on F2012 to F2016 earnings – the
company will be procuring 0.15 mtpa in F2012, which is
expected to ramp-up to 3.24 mtpa in F2014 (as power
units get commissioned) wherein the coal price is
expected to double from the earlier estimate of US$40/t.
Our new price target also assigns a 30% probability to our
bear case (previously 10%) as we believe any weakness
in coal prices is due to a possible global economic
slowdown (as envisaged by our economists) which could
lower the value of the holding in Indonesian coal assets.
Consensus earnings are not building in impact for
higher coal costs: Our earnings estimate for F2013 is
15% lower than consensus. We expect consensus to take
down earnings estimates as directives come into force.
F1Q12 consolidated results were lacklustre:
Revenue was Rs58.2bn (up 13% YoY), EBITDA was
Rs14.4bn (up 38%) and adjusted profit was Rs3.6bn (up
5%). While the coal business was operationally strong, it
was impacted by higher interest expenses. Hence,
adjusted profit missed our estimate of Rs6.2bn.
Key triggers: Delay in roll-out of new Indonesian
regulations would be a positive. Also, any improvement
in the coal outlook could help earnings.
Investment Case
We are downgrading Tata Power to Underweight with a revised
price target of Rs900. The downgrade is premised on the
following points:
• Consolidated earnings for F2013e and F2014e are
expected to de-grow 9% and 11%, respectively, due to
losses incurred in the Mundra UMPP project. This is
primarily due to a potential change in Indonesian
regulations wherein all coal supply contracts will be reset
to reflect benchmark prices. Given that 25% of the coal
requirements for the Mundra UMPP were originally
contracted at lower than benchmark rates, an upward
revision will lead to higher losses.
• While execution on Mundra UMPP and Maithon projects is
pretty much on schedule, these are well known and should
be already in the price. While the company has several
projects in the pipeline, we are unsure on the schedule of
their development activities and hence don't expect any
significant increase in capacities beyond what is already
under construction, at least in the next 3-4 years. The
company has two projects that will be based on domestic
captive coal blocks (2,640 MW of Naraj Marthapur and
Tiruldih projects), however, they are still in nascent stages
of development.
• We are 15% lower than consensus for F2013 earnings
estimate. We expect consensus to cut estimates primarily
due to incremental losses in Mundra.
• Expensive valuations: The stock is trading at 12x P/E on
our F2013 consolidated estimates which is expensive
relative to peers which are trading in a range of 8-10x.
While Tata Power had traditionally traded at a premium to
IPPs, we believe the current premium of 20-50% is
excessive especially with earnings likely to de-grow in
F2014.
• Consensus is hugely positive on the stock with 25
brokers rating it a ‘buy’, 14 with a ‘hold’ and only 1 with a
‘sell’ currently. We believe this optimism on the stock
primarily stems from the belief that Tata Power is
construed as a defensive utility stock which also provides
upside from rising global coal prices. While we don't
disagree with this thesis and was the key reason for us
having an Equal-weight on the stock, our view now is that
earnings risk from the Mundra UMPP is still not fully
appreciated. Hence, the stock could underperform once
the Indonesian regulations actually come into force (which
is expected in September 2011) as these would result in
earnings downgrades for F2013 and beyond.
Re-pricing of Coal Supply Contract to Mundra UMPP
The Mundra UMPP has a 10.11 mtpa (+/- 20%) coal supply
contract with the Indonesian coal companies (KPC and
Arutmin). Given that Mundra UMPP will need about 11.3 mtpa
of coal during full operations, we assume almost the entire
supply from the Indonesian coal assets will be utilized for
Mundra. As per the original coal supply contract, the Mundra
UMPP would get 75% of the coal at index-linked prices while
the balance 25% was to be supplied at a lower price (assumed
as US$40/t) fixed for a period of 5-6 years.
However, the Indonesian authorities have decided that all coal
supplies from the country need to happen at benchmark prices
and hence the contracts would need to be reset accordingly.
The directives are expected to be announced and introduced in
September 2011. As a result of this, the price agreed by Bumi
and Tata Power for the supply of 25% of the quantity would
have to be revised upwards to match the average realization
which are linked to benchmark prices. Exhibit 1 shows the
additional coal cost that will hit the project which could
aggregate US$544mn for the period F2012-16e.
Tata Power has mentioned that if the directives were to
become effective, it could see an upward revision of about
US$30-40/ton
While, the additional cost will be a hit to Mundra UMPP’s
profitability, Tata Power on a consolidated basis will recoup
about 30% of this through its equity holding in the Indonesian
coal assets. However, the net result will still be a meaningful
impact to the consolidated profitability of Tata Power. Our
F2013 and F2014 EPS estimates have come off by 18% and
22%, respectively, due to this additional cost impact.
A few possibilities with Tata Power to potentially mitigate this
impact could be:
1. Upward renegotiation of Mundra UMPP power tariff:
The Company has already written to the Ministry of Power
highlighting the risk faced by power plants given the sharp
increase in imported coal prices. However, as anticipated,
the Ministry has said that such negotiations have to be
done with the beneficiaries (i.e. SEBs with whom PPAs
have been signed) which in our view may either not lead to
any upward revision as SEBs are already loss-making
entities or if they do agree then it may come with a lag. We
have assumed the impact of an upward renegotiation in
tariffs in our Bull Case scenario.
2. The company is also evaluating options of sourcing lower
quality coal from other sources to reduce its exposure to
higher priced coal. However, this may lower the efficiency
of the plant.
3. Negotiation with Bumi 1: Tata Power may consider
negotiations with Bumi management from whom it had
purchased the 30% stake in June 2007. The genesis of the
talks may be that the total consideration of US$1.1bn
potentially included a compensation for the supply of some
quantity of coal at a lower price. Given that situation may
not exist anymore, there may be a case for Bumi to make
good that loss to Tata Power. However, this would also
depend on the terms of the investment agreement
between the companies
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