JSW Energy IPO Analysis

JSW Energy's initial public offer is for investors willing to wait for returns in the medium term. The company has been operating a small capacity generating station for the last few years but the bulk of its new projects will be commissioned in stages over the next one year and more. These projects, which will be part-funded from the proceeds of this public offer, will start contributing to the earnings in full measure from 2011-12.

In the near term, especially in the immediate period post-listing, the stock may not deliver major returns mainly because of the market's saturation with power IPOs in the last few months; the price performance of some these recent listings tell the tale.

Therefore, while investors looking for listing gains may not find this offer attractive, those seeking a good power exposure in their portfolios over the medium-term can invest.

Valuation

By conventional valuation parameters based on historical earnings such as price-earnings multiple (33 on fully diluted equity at Rs 115) or price-to-book-value (4.3 at Rs 115, compared to industry average of less than 3), the offer does appear expensive. Yet, it is important to note that earnings from almost the entire generating capacity to be part-funded by this offer will kick in only in the medium-term.

Current earnings are based on a capacity of 260 MW; against this, the company will have a generating capacity of 3,140 MW by 2011. By the end of this fiscal, JSW's capacity will have risen to 1,295 MW. What is important is that fuel supply and offtake of power have been fully tied up for the entire capacity that will go on stream by 2011 and the projects will be commissioned in stages gradually, adding to earnings.

The finances for the projects under implementation have been fully secured, including debt from banks. Transmission infrastructure for one of the major projects in Ratnagiri is being implemented by a joint venture with the State utility. With all major aspects of the projects taken care of, the uncertainties in implementation appear limited.

Project profile

JSW owns a 260 MW plant at Vijayanagar, Karnataka, part of whose generation is sold to group company, JSW Steel, and the remaining on short-term basis to other buyers. To this was added 600 MW in two stages in June and September this year. While half the power produced here is again being sold to JSW Steel, the other half, save a small 6 MW, will be sold on short-term basis through the power-trading subsidiary, JSW Power Trading Company.

The two big generation projects that are under construction now are the 1,200 MW plant at Ratnagiri, Maharashtra, and the 1,080 MW station at Barmer in Rajasthan. Both of these are being executed by wholly-owned subsidiaries.

The Ratnagiri project is based on imported coal for which JSW has signed contracts with an Indonesian company, PT Sungai Belati and an affiliate company of JSW Steel in Mozambique to supply coal. In fact, coal from the 25-year supply deal with the two companies will fuel some of JSW's other projects on the drawing board now.

The Rajasthan project will use lignite mined by a joint venture with a State government company and will also supply its entire electricity to the state utility. The first 135 MW unit of this project will be commercialised shortly with the remaining seven units to be commissioned in stages over the next one year.

The first of four units at Ratnagiri will be commissioned by January 2010 with the remaining ones scheduled to go on stream in stages over the next one year. Half the power produced here will be sold on long-term PPAs to the Maharashtra state utility (300 MW) and Adani Enterprises (270 MW); the other half will be sold on short-term basis through the power trading subsidiary.

Eventually when all the projects are commissioned by 2011, JSW's sales will be shared equally between long-term PPAs with State utilities and short-term merchant buyers. Even in the unlikely event of merchant power prices falling, as some fear, JSW's balanced exposure to that market will help the company.

JSW is also planning a 240 MW hydroelectric plant in Himachal Pradesh but several approvals are yet to be received for this project including the crucial environmental approval. The company has included this project among those that will be part-financed by the public offer though it is not set for commissioning till the end of 2015.

We have not considered this project, as also others adding up to 7,740 MW on the drawing board, while valuing the offer. These projects, all of them coal-based, are projected for commissioning in 2014-15.

Risks to our recommendation

All the projects under construction now will be equipped with Chinese boilers and turbines. There have been misgivings on Chinese equipment following the failure of a turbine installed by a state utility. Yet, a number of private power projects under implementation in the country now use Chinese equipment to save on cost and time.

Indeed, JSW's original 260 MW plant uses Chinese equipment and the company appears to have been encouraged by the experience to follow suit with its other projects. However, group company JSW Steel is in the process of setting up a boiler and turbine manufacturing plant in joint venture with Toshiba Corporation near Chennai. This venture should be able to supply to JSW's future projects.

With the company adopting a 75:25 debt:equity ratio for funding its projects, as much as Rs 9,979 crore of the total Rs 14,055 crore capital outlay for the ongoing projects will have to be funded by bank loans. While these have been tied up, they have not been fully disbursed yet. Some of these loans are also contracted on a variable rate basis. These, along with the undisbursed part of the loans which will take prevailing higher rates, could exert some pressure on the internal accruals of the company. A lot will depend on realisations from short-term power sales to cover up for higher debt servicing costs.