Orient Green Power IPO Review

Investors with a stomach for risk can consider the initial public offer of Orient Green Power (OGPL), a pure play on the renewable energy segment. The company a leading renewable energy developer, plans to scale up its capacity from 209 MW to 1013 MW by end-FY-2013. Strong revenue growth coupled with tax benefits, preferential tariffs, incentives and carbon credit will aid margin expansion for OGPL. The execution time for renewable energy projects is lower than that for conventional ones.



Given that its parent/associate companies will supply and execute the major portion of the project, the risk of equipment delays is somewhat mitigated. The regulated tariff for renewable energy projects is pegged in such a way that Return on Equity (ROE) would work out to an attractive 19 per cent pre-tax.

However, these returns are lower compared with that generated by merchant power producers as the generation cost per unit is high in the case of renewable energy.

At the upper end of the price band (Rs 47-55), the offer price would discount the estimated FY-12 book by 1.72 times, after the IPO funds infusion of Rs 900 crore.

The price discounts the estimated FY-12 earnings 21 times. In terms of P/BV, other private power utilities enjoy valuations of over three times. Some discount is justified for OGPL due to the lower load factors likely for renewable energy, feedstock risks and the untested nature of the business. As their current portfolio of projects is small, investors need to hold on to the stock for a two-three year period to take advantage of the high earnings growth.

Risks to the offer include limited operational history, seasonal nature of the operations in case of wind energy and constraints in the availability of feedstock in the case of biomass projects.

Business

By end of FY-13, OGPL's energy mix may be as follows: 77 per cent wind energy, 21 per cent biomass and 1.4 per cent small hydro projects.

The current tariffs for the wind projects range between Rs 2.7 and Rs 5 per unit while the upcoming capacities have better rates and may range anywhere between Rs 4.17 and Rs 5.63 per unit.

The management expects tariffs on overseas projects to be Rs 5.5 per unit in Europe and Rs 8 in Sri Lanka . These tariffs are attractive and will help the project-specific ROEs to translate into overall ROEs.

Wind energy holds huge untapped potential, what with only 22 per cent of the estimated potential said to be utilised. OGPL, which now is the largest wind energy player is all set to take advantage of this opportunity. Wind energy, while devoid of fuel risk, is exposed to seasonality.

The company plans to foray into international markets (especially Eastern Europe) which have better incentive system for renewable energy. The upcoming wind projects use superior technology as compared with existing ones which will improve the overall wind PLF. Possibilities of brownfield expansions also emerge as some of the wind projects are nearing the end of their expected life span.

In biomass, decentralised nature of the feedstock availability increases the cost of procurement for biomass; costs may be pass-through but constraints in availability of feedstock are a bigger concern.

The company holds average inventory of 45-60 days of feedstock to mitigate this threat. Currently, some of the projects are operating at lower than their projected load factors which would mean lower profitability as the tariffs are derived based on normative load factors.

Regulatory incentives

To encourage renewable energy participation by private players in India, the government has come up with several incentives and sops for such projects.

Accelerated depreciation methodology is allowed for the renewable projects which would reduce the tax incidence in the initial years. In terms of tax incentives, these projects enjoy tax holidays for 10 years and also get Customs duty exemption on import of capital goods. In addition, wind power is given incentive of Rs 0.50 per unit generated and connected to the grid.

The companies can also sell carbon credits amounting to Rs 0.6-0.7 per unit for every unit of power sold.

The units generated from renewable energy have assured offtake, thanks to the renewable purchase obligation. State electricity boards are required to buy 5 per cent of their power requirements from renewable sources.

Funding

The total fund requirement to set up 800 MW of capacity stands at Rs 5,092 crore, of which some of the capex has been already incurred. At a 70:30 debt-equity, the company may require more than Rs 1,500 crore of equity funding.

However, of the Rs 900 crore funds raised, only Rs 590 crore will be utilised towards project development and the rest towards repaying part-debt.

As the company turns profitable and pays down debt, funds may be freed up to be ploughed back into the capex. Yet, a gap in equity financing is likely to remain.

While the company has not turned profitable, the projects' efficiencies may improve, making OGPL profitable this year.

via BL