Neyveli Lignite

Investors can consider booking partial profits in the Neyveli Lignite Corporation stock as valuations have run ahead of fundamentals, driven by divestment hopes.

At the current market price of Rs 153, the stock trades at 24 times its estimated FY-10 earnings. This is at a premium to NTPC’s earnings multiple of 20 times despite having lower capacity (2,490 MW) and return ratios.

Neyveli Lignite, a mini-ratna PSU, is an integrated lignite mining and power generation company. Neyveli plans to add around 750 MW by 2010, with the next tranche of capacity-addition coming up only after 2012. This may partly limit its ability to take advantage of the near-term power deficit scenario and recent Central Electricity Regulatory Commission (CERC) norms. The gradual phase-out of the Neyveli Thermal Power Station (TPS)-1 600 MW plant with the commissioning of new capacity also suggests that revenues may not witness strong growth over the next three years.

Execution delays on projects being commissioned also cannot be ruled out, given that the company has faced such delays in the past.
Strong business

The company’s key advantages are its strong balance-sheet with more than Rs 5,400 crore of cash and cash equivalents, a debt-equity ratio of just 0.43 and scope for improvement in the overall return on equity (ROE), thanks to favourable CERC norms. Neyveli Lignite has captive mines which not only eliminate fuel risk but also enable it to earn margins higher than peers, given that the company is allowed to retain some of the margins on mining of fuel. Neyveli’s ROE may also improve as it deploys excess cash in expansion projects instead of conservative investments.
Business

The company currently operates 24 million tonnes per annum (MTPA) of lignite mining facility, the output of which is used as a feedstock for generating 2490 MW capacity at Neyveli, Tamil Nadu. Neyveli Lignite is in the final stages of commissioning a 250 (125x2) MW Barsingsar Thermal project at Rajasthan and 500 (250x2) MW TPS-II extension projects; it plans to develop captive lignite mines for these projects. While the Barsingsar TPS and Neyveli TPS-II extension are expected to be fully commissioned by January 2010 and November 2010 respectively, there is no news yet on the Barsingsar’s first unit that was to be commissioned by October 2009, as per the revised schedule.

Bulk of the company’s projects, however, is set to be commissioned during the 12th Plan (2012-17). The company has a portfolio of more than 10,000 MW of power projects on the anvil for the next Plan period — including Jayamkondan 1600 MW, 1000 MW Tuticorin JV, 2000 MW Orissa project, Neyveli TPS-II extension and Neyveli TPS III.
Finance

The company’s net profits have not shown a secular trend over the last five years due to blips in operating income linked to monsoon-related disruptions and a spike in employee costs after the pay revisions last year. Profits have been impacted partly by a lag between the actual incurring of costs and their eventual payment of the revised tariff by electricity boards, based on CERC norms. For the first half of this year, while sales grew by 26 per cent (excluding the revenues arising out of adjustments related to previous years), net profit rose by 12 per cent, impacted by employee pay revisions. The profits may improve as the benefits of the CERC’s new tariff (2009-14) order start flowing.

According to CRISIL, the rise allowed on ROE may increase the tariffs by 6-8 per cent for a Central power project, thereby improving the company’s topline.

The new CERC norms also allow the company to charge higher operation and maintenance expenses, which can help it pass on employee pay revisions.

Bulk of the profits earned by Neyveli Lignite comes from lignite mining, which is supplied based on transfer pricing to its power business. The margins built into the captive mining business have enabled the company to earn steady returns. However, as the company diversifies from captive sources to seek coal linkages externally, this may put pressure on margins.
Risks and concerns

The company’s topline growth over the next fiscal will come from the 750 MW capacity-addition and favourable CERC norms. However, over the following two fiscal years, revenue drivers appear limited.

With power projects moving to competitive bidding, Neyveli Lignite may enjoy a cost advantage due to its captive fuel. However, operation and maintenance (O&M) costs and interest may have to be borne by the company, partly offsetting these benefits.

The company is also diversifying into wind projects by setting up a 50 MW project, whose capacity may be increased to 200 MW. Land acquisition delays for expansion of lignite mines are also a major hurdle for the company which wants to increase its mining capacity at Neyveli Mine-II from 10.5 to 15 MTPA.

The current quarter may see some disruption in mining activity due to its open cast mines, exposing it to monsoon, which may, in turn, disrupt power generation. PLF at plants especially from TPS-I extension and TPS-II may improve post-monsoon. However, large improvements may not be possible as these plants are operating at their lifetime high PLFs.

The current disinvestment expected in Neyveli Lignite may be a “offer for sale by the government” given the company’s comfortable liquidity position.

As the Neyveli Lignite stock’s valuations are stretched, follow-on public offer (FPO) offer price may be pegged at a discount to the current market price, paring the gains.

via BL