Tata Power

Investors can buy the Tata Power stock with a long-term horizon. Though historic valuations appear stretched, the stock holds value in the medium-to-long term with generation capacity expected to double in the next three years.

The company enjoys high earnings visibility on new capacities, for which the power purchase agreements (PPAs) have already been signed. At the current market price of Rs 1,290, the stock trades at 16 times its estimated 2010-11 consolidated earnings which is at a discount to NTPC. Investors should note that appreciation in the stock from hereon could be at a slower pace than in the past.

Merchant power capacities commissioned during the last fiscal at Haldia (100 MW) and Trombay Unit 8 (100 MW out of 250 MW) have potential for higher return on equity as they get fully operational. Given the demand-supply gap in Western and Eastern Regions, off-take for these capacities is practically certain. Steady earnings from licence business, coupled with higher return on investments in projects, will fetch optimal returns to the shareholders.
Capacity addition

Tata Power is present across the energy value chain starting from fuel supply to logistics (recently ventured) to the retail distribution of power. By 2013, Tata Power is expected to commission all its ongoing projects including five units of 800 MW each under the Mundra Ultra Mega Power Project (UMPP), taking the total capacity to 8242 MW. The two projects that will add to a bulk of the future capacity — Mundra UMPP and the 1,050 MW Maithon project in joint venture with Damodar Valley Corporation — are currently on schedule with a 25 per cent completion status for Mundra project and 54 per cent in the case of Maithon.

Tata Power also plans for generation stations at the Mandakini and Tubed coal blocks in which it has acquired stakes. The coal mining is expected to start by 2012 and the company will set up two stations that will generate a total of 1,500 MW. Including these, and the 525 MW captive plant that it will set up for Corus in the Netherlands, Tata Power plans to add 6,200 MW in the period after 2012 .

The company has already tied up fuel for most of these projects. It has also sought to de-risk its power business from fluctuating fuel costs by investing in leading Indonesian coal mining companies, KPC and Arutmin.

The capacity expansion plans will require a capital expenditure of Rs 23,600 crore. Of this, a significant part of debt (Rs 14,000 crore) and equity (Rs 2,800 crore) has been arranged. Tata Power raised $335 million in July 2009 through a GDR issue which will help it fund the capex for the Mundra, Maithon and other projects. This will take care of Rs 1,600 crore of the Rs 2,800-crore equity required for the next three years.

Some of these funds will be utilised to repay short-term debt (Rs 700 crore) raised to fund the equity portion in Mundra and Maithon, thus reducing interest costs. The company could also offload a part of its investments to fund the expansion.
Finances

Tata Power’s profits grew by a modest 14 per cent annualised over the period 2005-09 due to the company’s reliance on Mumbai licence area . Despite increase of 8 per cent in generation, Tata Power’s revenues fell by 12 per cent (excluding Rs 232.4 crore pertaining to previous years, due to MERC tariff orders received during this financial year) in the first quarter of this fiscal.

Revenues fell due to decrease in fuel cost which, in turn, brought down the price of power per unit sold as the fuel cost is passed through. Operating margin for the standalone company improved to 26 per cent in the first quarter of this fiscal compared to 15 per cent in the quarter ended June 2008. The exceptional income received due to the MERC tariff order and ‘other income’ helped net profits to zoom by 97 per cent; standalone profits were flat if we exclude these two items. The consolidated profit showed a growth of 123 per cent.
Subsidiaries

The distribution business in Delhi (North Delhi Power Limited) and Powerlinks Transmission may earn steady revenues, while among the new businesses, Tata BP Solar (Solar panels) and the Indonesian coal companies may help scale up revenues.

Tata Power’s non-generation subsidiaries have begun contributing to profits. For the June quarter, the coal subsidiary reported profit before interest and tax (PBIT) of Rs 373 crore.Tata Power Trading Company, its power trading arm, is the third largest power trading company through which Tata Power sells its surplus power from merchant and captive power plants.
Outlook

With the Central Electricity Regulatory Commission (CERC) recently notifying higher tariffs for central power generation companies, the MERC is likely to take cues from these tariffs to increase the ROE on the capital investments to 15.5 per cent. This may provide an additional push to Tata Power’s earnings. With the litigation with Reliance Energy (REL) resolved, Tata Power may also be in a position to sell about 500 MW of power from its Trombay project through open access. The lower tariffs of Tata Power Company may give it an advantage over REL.

Tata Power may also benefit from the favourable CERC norms for non-conventional energy as it already operates wind power plants of 193 MW, with 98 MW is to be added in future. Tata Power has tied up PPAs for the capacities that will come on stream in the next three years.

However, projects that will be commissioned post-2012 (about 3,900 MW) will fall under competitive tariff bidding norms. This may exert pressure on returns as the sector sees more competition from the private players.

High interest costs and depreciation pertaining to the UMPP may also put pressure on the profits of the company in the initial years.

via BL