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UBS Investment Research
India Power Utilities
N ot all doom and gloom [EXTRACT]
�� We believe investors overlook the importance of electricity as a political issue
Share prices of India power utilities under our coverage have corrected 34% YTD on
average due to: 1) state electricity boards’ (SEB) losses; 2) fuel shortages; 3) lower
merchant tariffs; and 4) the sector’s high financial leverage. However, we believe
investors have overlooked the importance of electricity as a political issue and a key
input of India’s GDP growth.
�� Electricity is important for the elections; SEBs proposing to cut losses
We think the Indian states will seek to avoid extended power cuts, as they could lead to
a backlash during the elections. In addition, as they are unlikely to receive help from
the central government, the states are making progress in lowering their SEB losses;
more than 70% of the SEBs had either no or small losses in FY09. The states can also:
1) convert loans made to the SEBs to equity; and 2) they have raised tariffs and
released subsidies to the SEBs. FY12 merchant tariffs declined 60% from FY09, which
could reduce power purchase costs by Rs125-150bn.
�� Pressure on PLFs and merchant tariffs should remain in the near term
Plant load factors (PLF) for power companies have declined (National Thermal Power
Corporation [NTPC] and Adani Power’s Q1 FY12 PLFs declined 266bp and 600bp
YoY, respectively). However, we believe PLFs for long-term power purchase
agreements (PPA) are not under threat (either 80% or 85% on a case-by-case basis).
The PLFs and tariffs for the merchant plants (merchant tariffs are around Rs3.75/unit)
may continue to be under pressure.
�� Our top picks: low risk (Power Grid); compelling valuation (Lanco)
We prefer companies with low risk (Power Grid and NTPC) or those with compelling
valuations (Lanco Infratech [Lanco] and Reliance Infrastructure). We upgrade Reliance
Power to a Buy given its strong advantage in captive coal. Investors who are bearish on
tariff hikes may prefer Power Grid, NTPC and Reliance Infrastructure.
Price target derivations
�� Power Grid. We derive our price target from a DCF-based methodology and
explicitly forecast long-term valuation drivers using UBS’s VCAM tool. We
assume a 9.6% WACC.
�� Lanco. We base our price target on a sum-of-the-parts methodology. We
value Lanco as a conglomerate, with power contributing 81% of the
valuation and the engineering, procurement and construction (EPC) business
contributing 13%.
�� NTPC. The key assumptions for our DCF-based price target are: 1) a riskfree
rate of 8.3%; 2) intermediate growth of 7.5%; and 3) terminal growth of
5%.
�� Reliance Infrastructure. We base our price target on a sum-of-the-parts
methodology. We value Reliance Power on a 50% discount to our new price
target of Rs105.00 (Rs52/share).
�� Tata Power. We base our price target on a sum-of-the-parts methodology.
The power segment comprises 64% of our valuation, the stake in Bumi’s
mines make up 25%, and its investments form 11%.
�� Reliance Power. We use a DCF valuation methodology and only include
13,680 MW of projects. Our key assumptions are: 1) a risk-free rate of 8.3%;
2) a risk premium of 5.5%; and 3) an FY15 tariff of Rs2.75/unit for the
Chitrangi power station.
�� Adani Power. We derive our price target from a plant-by-plant DCF,
assuming cost of equity (COE) of 13.8% for projects under construction and
12.3% for its operational projects.
�� Lanco Infratech Investment Case
We think its key challenges are: 1) its core power generation business, which
has problems related with fuel availability and state electricity board losses; 2) a
lawsuit pending against Lanco Infratech in Australia; 3) its engineering,
procurement and construction (EPC) business’ dependence on power projects;
and 4) its unpredictable reported earnings. We believe its core strength is a
strong generation capacity base (3,300MW), which is not easy to replicate.
Lanco Infratech also has a robust pipeline of generation projects (around
6,000MW) and we think it has a tighter control over timelines and costs due to a
captive EPC division that handles the execution of its power projects.
�� Reliance Infrastructure Investment Case
We like its strong infrastructure portfolio, which consists of eleven road projects,
five airports, five transmission projects, three metros, and one sea-link. We also
like the diversified nature of the infrastructure business as the company has no
particular preference for any sub-sectors. We think Reliance Infrastructure could
be a key beneficiary of India’s infrastructure growth. As more projects become
operational, there is a possibility that the company could monetise some of these
assets.
�� Reliance Power Investment Case
Reliance Power has one of the largest coal reserves among India’s nongovernment
companies. The company has been allotted 2bn tonnes of coal mine
reserves, which we think is its core strength. We also believe the company does
not have any risk of its coal blocks being de-allocated as its mine development is
on track. We think its key positives are: 1) mine plan approval for 40 MTPA for
the Tilaiya mines; 2) a Rs450bn contract signed with Shanghai Electric for main
plant equipment of 30,000MW of coal-based projects; 3) a Rs34bn contract with
General Electric for a 2,400MW gas project; and 4) a memorandum of
understanding with the Chinese banks and US banks for around Rs750bn in
financing.
�� Tata Power Investment Case
In addition to its high corporate governance standards, we also think Tata
Power’s captive coal is its key strong point. We believe fuel ownership will be a
key factor for the success of the power generation companies (Tata Power’s
proportionate share in the Bumi mine’s output is around 20 MTPA). We believe
the Mundra Ultra Mega Power Project has been a significant overhang on Tata
Power’s profitability. However, Tata Power has delivered on execution
(commendable considering this was one of the largest infrastructure projects
ever undertaken in India).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Power Utilities
N ot all doom and gloom [EXTRACT]
�� We believe investors overlook the importance of electricity as a political issue
Share prices of India power utilities under our coverage have corrected 34% YTD on
average due to: 1) state electricity boards’ (SEB) losses; 2) fuel shortages; 3) lower
merchant tariffs; and 4) the sector’s high financial leverage. However, we believe
investors have overlooked the importance of electricity as a political issue and a key
input of India’s GDP growth.
�� Electricity is important for the elections; SEBs proposing to cut losses
We think the Indian states will seek to avoid extended power cuts, as they could lead to
a backlash during the elections. In addition, as they are unlikely to receive help from
the central government, the states are making progress in lowering their SEB losses;
more than 70% of the SEBs had either no or small losses in FY09. The states can also:
1) convert loans made to the SEBs to equity; and 2) they have raised tariffs and
released subsidies to the SEBs. FY12 merchant tariffs declined 60% from FY09, which
could reduce power purchase costs by Rs125-150bn.
�� Pressure on PLFs and merchant tariffs should remain in the near term
Plant load factors (PLF) for power companies have declined (National Thermal Power
Corporation [NTPC] and Adani Power’s Q1 FY12 PLFs declined 266bp and 600bp
YoY, respectively). However, we believe PLFs for long-term power purchase
agreements (PPA) are not under threat (either 80% or 85% on a case-by-case basis).
The PLFs and tariffs for the merchant plants (merchant tariffs are around Rs3.75/unit)
may continue to be under pressure.
�� Our top picks: low risk (Power Grid); compelling valuation (Lanco)
We prefer companies with low risk (Power Grid and NTPC) or those with compelling
valuations (Lanco Infratech [Lanco] and Reliance Infrastructure). We upgrade Reliance
Power to a Buy given its strong advantage in captive coal. Investors who are bearish on
tariff hikes may prefer Power Grid, NTPC and Reliance Infrastructure.
Price target derivations
�� Power Grid. We derive our price target from a DCF-based methodology and
explicitly forecast long-term valuation drivers using UBS’s VCAM tool. We
assume a 9.6% WACC.
�� Lanco. We base our price target on a sum-of-the-parts methodology. We
value Lanco as a conglomerate, with power contributing 81% of the
valuation and the engineering, procurement and construction (EPC) business
contributing 13%.
�� NTPC. The key assumptions for our DCF-based price target are: 1) a riskfree
rate of 8.3%; 2) intermediate growth of 7.5%; and 3) terminal growth of
5%.
�� Reliance Infrastructure. We base our price target on a sum-of-the-parts
methodology. We value Reliance Power on a 50% discount to our new price
target of Rs105.00 (Rs52/share).
�� Tata Power. We base our price target on a sum-of-the-parts methodology.
The power segment comprises 64% of our valuation, the stake in Bumi’s
mines make up 25%, and its investments form 11%.
�� Reliance Power. We use a DCF valuation methodology and only include
13,680 MW of projects. Our key assumptions are: 1) a risk-free rate of 8.3%;
2) a risk premium of 5.5%; and 3) an FY15 tariff of Rs2.75/unit for the
Chitrangi power station.
�� Adani Power. We derive our price target from a plant-by-plant DCF,
assuming cost of equity (COE) of 13.8% for projects under construction and
12.3% for its operational projects.
�� Lanco Infratech Investment Case
We think its key challenges are: 1) its core power generation business, which
has problems related with fuel availability and state electricity board losses; 2) a
lawsuit pending against Lanco Infratech in Australia; 3) its engineering,
procurement and construction (EPC) business’ dependence on power projects;
and 4) its unpredictable reported earnings. We believe its core strength is a
strong generation capacity base (3,300MW), which is not easy to replicate.
Lanco Infratech also has a robust pipeline of generation projects (around
6,000MW) and we think it has a tighter control over timelines and costs due to a
captive EPC division that handles the execution of its power projects.
�� Reliance Infrastructure Investment Case
We like its strong infrastructure portfolio, which consists of eleven road projects,
five airports, five transmission projects, three metros, and one sea-link. We also
like the diversified nature of the infrastructure business as the company has no
particular preference for any sub-sectors. We think Reliance Infrastructure could
be a key beneficiary of India’s infrastructure growth. As more projects become
operational, there is a possibility that the company could monetise some of these
assets.
�� Reliance Power Investment Case
Reliance Power has one of the largest coal reserves among India’s nongovernment
companies. The company has been allotted 2bn tonnes of coal mine
reserves, which we think is its core strength. We also believe the company does
not have any risk of its coal blocks being de-allocated as its mine development is
on track. We think its key positives are: 1) mine plan approval for 40 MTPA for
the Tilaiya mines; 2) a Rs450bn contract signed with Shanghai Electric for main
plant equipment of 30,000MW of coal-based projects; 3) a Rs34bn contract with
General Electric for a 2,400MW gas project; and 4) a memorandum of
understanding with the Chinese banks and US banks for around Rs750bn in
financing.
�� Tata Power Investment Case
In addition to its high corporate governance standards, we also think Tata
Power’s captive coal is its key strong point. We believe fuel ownership will be a
key factor for the success of the power generation companies (Tata Power’s
proportionate share in the Bumi mine’s output is around 20 MTPA). We believe
the Mundra Ultra Mega Power Project has been a significant overhang on Tata
Power’s profitability. However, Tata Power has delivered on execution
(commendable considering this was one of the largest infrastructure projects
ever undertaken in India).
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