KSK Energy Ventures

KSK Energy Ventures

KSK Energy

KSK Energy

KSK Energy

Shareholders with a high risk appetite and long-term horizon can continue to stay invested in the KSK Energy stock. KSK Energy now develops and operates small (captive) power projects but is set to enter the big league with more than 10,000 MW of capacity additions in the pipeline.

At the current price of Rs 176.7, the stock is trading at 27 times its estimated FY11 earnings. However, valuations based on market cap per mega watt (assuming 4462 MW of power capacity) are reasonable and work out to Rs 1.4 crore/ MW compared with peer valuations of more than Rs 3 crore/ MW. The company attaining financial closure for the 3600 MW of upcoming capacity would be a key trigger to the stock. KSK Energy's earnings may expand over the next couple of years on new capacity, however it is the execution of the bigger projects that will hold the key to appreciation in the stock price.

The company, which hasn't seen significant capacity addition since its mid-2008 IPO owing to delays , is expected to witness five times' jump in its capacity by this time next year.

The current operating capacity of 144 MW is expected to go up to 862 MW in a year's time, as projects such as VS Lignite (with capacity of 135 MW), Wardha Warora (540 MW) and Arasmeta expansion (43 MW) come on stream. However, the manifold increase in top-line growth may not get translated into equivalent growth in profits owing to higher interest costs and depreciation likely for the larger capacity addition programmes in the pipeline.

In addition to the above 862 MW of capacity, projects with 10,000 MW of capacity are in various stages of planning and development and are expected to start delivering benefits to the company only beyond FY12.

The company plans to commission 1,075 MW of hydro power projects with 945 MW in planning stages. Operations of the existing plants have been encouraging with weighted average PLF of 76 per cent for the year 2008-09.

Fuel agreements tied up

The company has tied up fuel requirements for most of the projects that are under development. The company has secured coal linkages from Coal India and tied up with state mining development corporations that own captive blocks and lignite mines.

This may result in lower fuel costs when compared with peers who rely on imported coal. Domestic fuel linkages put the company in a better position to earn higher returns from surplus power. The company's model of selling equity stakes in its projects to users provides assurance on off-take, even while retaining economic interest with the parent company.

The company has signed off-take agreements for most of its projects for the medium to long-term with majority of customers being private industries . KSK Energy is selling power from VS Lignite and Wardha Warora at an average tariff of about Rs 2.85/unit. In case of offtake from GMDC (at least 1,010 MW) for the Wardha Chattisgarh (3,600 MW) project the tariff is at Rs 1.9/unit; this unit, however, enjoys low cost fuel supply from its captive mines.

Initially, KSK Energy plans to sell 38 per cent of the total power generated through short-term power purchase agreements (tied up with Maharashtra and Rajasthan SEBs) and as merchant power. As users ramp up capacity, this will later be sold at fixed tariffs to industrial customers.

Even as the delays in the expansion projects of some of its users have given it a longer window to realise higher tariffs, KSK's own project delays have reduced the opportunity to take advantage of these tariffs.

Concerns

As the size of the projects increases, the financing requirements for these projects are getting bigger, requiring it to infuse fresh equity from time-to-time.

In its IPO, the company raised around Rs 1,200 crore (including the pre-IPO placement). Since then, the company has also raised Rs 515 crore through QIPs in the current fiscal. These funds, including internal accruals, may be enough to fund the equity contribution for the 3,600 MW Chhattisgarh power project .

Equity contribution required for the projects in the planning stage would be more than Rs 7,000 crore and getting access to these funds would require that the 3,600 MW Chattisgarh project is fully operational by FY13. The debt-equity ratio on a consolidated basis stood at 1.54 times as of June 30 2009, and is expected to go up significantly. The company also has majority of its debt in the form of floating rate loans which exposes it to interest rate risk. KSK Energy is relying on Chinese equipment for its projects which may expose the company to operational risk, as there have been reports of incompatibility with domestic coal.

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KSK Energy Ventures IPO

KSK Energy Ventures IPO

KSK Energy Ventures IPO Analysis

KSK Energy Ventures (KEVL) develops and operates power generation projects through various special purpose vehicles (SPVs). It is a step-down subsidiary of KSK Power Venture Plc, listed on the London Stock Exchange. Through its wholly owned subsidiary KSK Energy of Mauritius, KSK Power Venture Plc will hold a 55.24% stake in post-issue equity capital (pre-issue 61.39%)of KEVL. S. Kishore and K.A. Sastry are the promoters of the company.

Currently , KEVL operates three power projects with an aggregate capacity of around 144 MW. It has two projects with an aggregate power generation capacity of 675 MW under construction. The aggregate generation capacity of projects in the pipeline is 8,318 MW.

Of the three operational power plants, two are dedicated coal-based captive power plants of 43 MW each in Chattisgarh and Andhra Pradesh. The Chattisgarh power plant is owned by Arasmeta Captive Power Company, with KEVL owning a 51% stake, and is dedicated to the captive power requirement of Lafarge Cements. The Andhra Pradesh plant is owned by Sitapuram Power, with KEVL’s stake at 49%, and is dedicated to the captive power needs of Zuari Cements. The third operational power plant,, Sai Regency Power Corporation, is a gas-based combined cycle group captive power plant in Tamil Nadu, with KEVL holding a 73.92% stake ,and meets the captive power requirement of companies such as Chemplast Sanmar, Lakshmi Mills, Orchid Pharma, and Elforge. The Arasmeta, Sai Regency and Sitapuram power projects were synchronized with the grid on May 2006, February 2007 and July 2007, respectively.

Of the projects under development, a lignite-based power project with an generation capacity of 135 MW in Rajasthan is scheduled to be operational by October 2008. Another 540-MW coal-based power project at Warora in Chattisgarh is likely to be operational by December 20’09. KEVL has secured debt financing and intends to commence construction for the three projects with an aggregate generation capacity of 1,973 MW. The company has plans for three more projects with an aggregate capacity of 6,345 MW.

In January 2008, KEVL divested its stake in the SPVs of the three operating power companies, under the restructuring plan between the promoter groups of the company and LB India Holdings Mauritius I, to the ‘Small is Beatutiful Fund’. Besides this divestment, the company picked up 100% of the shareholding in KSK Electricity Financing India, previously a 51:49 joint venture between the company and LB India. It has divested its stake fully in RVK Energy (20 MW), Kasargod Power (20 MW) and Coramandel Power. The stakes in these erstwhile subsidiaries along with investment in Athena Projects were transferred to promoter group company KSK Energy Company, in which parent Mauritius-based KSK Energy holds 100% stake.

KEVL is tapping the capital market with an IPO to facilitate equity infusion in Wardha Power Company to meet the equity component of the 1,800-MW Wardha Chattisgarh power project and to meet general corporate expenses.

Strengths

On completion of all planned projects, there will be a fairly diversified plant mix of geography and fuel supply. The plants will be spread over seven states, with eight coal-based plants, one lignite-based plant, one natural gas-based plant and three run-of-the-river hydroelectric plants.

Weaknesses

Power generation capacity, operational or under construction, amounts to just 819 MW of the proposed power generation capacity of 9,137 MW by 2013. Yet to appoint engineering, procurement and construction (EPC) contractors for the balance 8,318-MW power generation capacity. The supply constraints at the equipment as well as the execution contractors side expose it to high level of execution risk. With rising commodity prices, escalation in project cost can also be significantly higher.

Lacks experience in developing and operation of power plants of higher capacity as well as the magnitude proposed. Current operational projects and projects under construction are thermal power units and execution of hydel power projects, which are more complex with long gestation periods, needs to be seen.

Yet to sign a definite fuel supply agreement (FSA) for the 540-MW Wardha Warora Power Project in Maharashtra, expected to be operational by December 2009. Similarly, still in negotiating for fuel supply for the 43-MW Arsmeta expansion project. Yet to sign definite FSA for three 1,800-MW coal-based power projects (one at Chattisgarh and two in Orissa) even though an MOU has been signed.

Still to finalise the power purchase agreement and fuel supply for generation capacity of 8,500 MW.

Of the three operational power projects, the Sitapuram Power SPV continues to be in red with net loss of Rs 1.91 crore in the year ended March 2008 (FY 2008). A shareholder agreement with Zuari Cements relating to Sitapuram Power SPV contains an onerous provision giving option to ZCL to pick up the entire 49% stake in the SPV after the third anniversary ( 1 March 2011) of commercial operation of the Sitapuram power plant .

Proposes to add 8,993 MW of power generation capacity by 2013. The estimated infusion of equity into SPVs will be a staggering Rs 8000 crore on the assumption that all the proposed projects will be funded through a debt: equity mix of 70:30. Currently, only about Rs 883 crore is to be raised by the IPO. So there will be significant equity dilutions in future.

Certain SPVs will pay project development and support fees to group company KSK Energy Company .

The power purchase agreement for captive power plants provides for fixed rates and have limited passthrough.

An affiliate of Lehman Brothers will hold 28.41% of the equity capital after the IPO. Lehman has been in the news for the severe subprime problems it is facing.

Valuation

Due to the benefits of commissioning two new power projects, the restated consolidated net sales of KEVL were up 208% to Rs 239.13 crore in the fiscal ended March 2008 (FY 2008). Net profit rose 476% to Rs 108.65 crore. The figures for FY 2008 are not comparable with those of FY 2007 as the company has divested three of its operating power plants to a group company under the restructuring plan implemented n January 20’08. Further, the sales were boosted by project-development fees of Rs 23.36 crore and power-arrangement income of Rs 23 crore. On post-IPO equity of Rs 346.11 crore, the EPS for FY 2008 works out to Rs 3.3. The P/E is 72.7-77.3 at the price band of Rs 240-Rs 255.

KEVL will have the full benefit of the operation of Sitapuram plant in FY 2009. And with the 135-MW lignite power project getting commissioned by December 2008, the company will get significant revenue upside in FY 2010 as well.

With 144-MW (current) power generation capacity, KSK Energy Ventures will have a market capitalisation of Rs 8826 crore at the higher price band, while an equivalent payer like GIPCL has a market cap of Rs 1305 crore with higher 555-MW power generation capacity. Having learnt the lessons, stock markets are unlikely to give huge market capitalisation to companies like KEVL just based on their lofty plans.

KSK Energy Ventures IPO Analysis

Investors can stay away from the initial public offering of KSK Energy Ventures Ltd. (KSK). The offer appears expensively priced (PEM of 42-44 times on consolidated earnings) even as revenue and earning visibility is low in the medium to long-term.

The kind of earnings necessary to justify the asking price in the IPO is unlikely to come in before 2012-13. That the company has no experience in managing projects of the size that it now plans to implement is also a source of concern.
Outsourced power developer

KSK is an outsourced power developer that builds and operates small-sized captive power plants for either a single customer or a cluster of buyers. It now has three operational power plants adding up to a total capacity of 144 MW, but if its plans are executed without any glitches, it could achieve a capacity of over 9,000 MW in the next six years.

As with other power generating companies, KSK has structured each of its projects as a separate subsidiary. As per regulations, captive power buyers should own a minimum of 26 per cent equity in the company supplying the power and they should consume at least 51 per cent of the power generated. Thus, KSK shares equity ownership with its buyers in all its captive power supplying companies. For instance, cement manufacturer, Lafarge India, owns 49 per cent equity in the 43 MW Arasmeta project that supplies power to it.

The equity-sharing agreement is such that a majority of the economic benefits of equity ownership flows to KSK. In the case of Arasmeta, Lafarge has preferential dividend rights of just 0.1 per cent of the face value of the shares.

Where Lafarge gains is in lower tariff and in the assurance of uninterrupted supply of quality power. It pays just Rs 2.65 per unit for the power it buys from Arasmeta.

The tariff is so structured that increase in fuel costs are passed on to Lafarge but KSK has to bear increases in other expenses such as finance costs, taxes and duties, and maintenance.

Aiming high

From these modest beginnings, KSK now aims to become a large-sized power developer and the proceeds of this IPO will fuel a part of this ambition.

Under construction now are two projects aggregating 675 MW; the first, of 135 MW will be commissioned by the end of this calendar year, while the second and bigger one of 540 MW is slated for commissioning by the end of 2009.

Apart from this, there are three more projects under development adding up to 1973 MW. The IPO proceeds will be used to finance the biggest of the three — the 1,800 MW coal-fired project in Chattisgarh being implemented by Wardha Power Company Pvt. Ltd.

Besides these, there are projects, a mix of thermal and hydel, adding up to 6,345 MW in the planning stages now.
Fuel security

KSK’s strategy is to tie up with state mineral development corporations (SMDC) for coal supply.

Assuming that it is able to successfully tie-up agreements with such SMDCs and the latter follow those agreements in letter and spirit, KSK should not have a problem in fuel supply for its planned projects.

It has entered into an agreement with Gujarat Mineral Development Corporation (GMDC) for coal supply for the Chattisgarh project. GMDC will be acquiring 26 per cent equity in Wardha Power Company which will supply up to 1,010 MW to it at a fixed price of Rs 1.92 a unit. Importantly, there will be no increases in tariff during the term of the PPA, including for fuel cost increase.

Apart from this, KSK will also have to supply 540 MW to the Chattisgarh government as its share, leaving it with 250 MW to sell to other consumers at higher prices. The company is also negotiating with other state mineral development corporations such as in Madhya Pradesh and Puducherry for tying up coal supply for its other projects adding up to 3,600 MW capacity.
What troubles us

While there is a reasonable visibility in earnings in the near-term when the under-construction projects will be commissioned, the same cannot be said of the long-term.

There is not enough clarity on the pricing or on the quantum of free power available to KSK for sale to the market after accounting for the supplies to the host government and to the fuel supplier, as these are yet to be negotiated.

Besides, the company will have to raise almost Rs 22,000 crore in debt over the next five years to finance the projects that are in the planning stage.

How efficiently the company manages this exercise and how much of the interest cost it is able to build into the power tariff from each of those projects, will determine its earnings growth in the next five years.

Here, the lack of experience in managing large-sized projects is a definite cause for worry.

Besides, creating the management bandwidth required to simultaneously manage such large, diverse projects will be a major challenge, especially given the sharp ramp-up in the size of the overall business in a relatively short period of time.

The offer is priced aggressively with the company being valued at Rs 8,826 crore at the upper end of the price band. The PEM of 42-44 at the price band (based on consolidated 2007-08 EPS) is higher than what NTPC (18 times) and Tata Power (38 times) command. Given that there is clear visibility only to the extent of 992 MW of different projects that will be commissioned by 2011-12, the price being asked of investors does appear on the high side.

The prevailing market conditions anyway do not offer any comfort of gains either on listing or in the period immediately after that.

There are also a couple of other factors that trouble us. There appear to be too many companies in the group with complex holding patterns.

The holding company of KSK Energy Ventures is KSK Energy Ltd. which is registered in Mauritius.

This company is, in turn, a wholly-owned subsidiary of KSK Power Ventur Plc, registered in the Isle of Man. A few group companies with operating power plants and generating cash flows were transferred to another outfit owned by the promoters a few months ahead of the IPO.

Though power projects are typically housed in independent special purpose vehicles with a holding company, in KSK’s case, the presence of a wholly-promoter-owned company in the midst and the possible conflict of interests that could arise because of thi,s are a cause for concern.

Also worrying is a recent communication from GMDC that the fuel supply agreement that it signed with KSK for the 1,800 MW Chattisgarh project is subject to government approval (which is awaited).

What this communication means to the agreement for fuel supply and power offtake is not known at this point in time.

Offer details: KSK is offering 3.46 crore shares in the band of Rs 240-255 a share. The offer, lead-managed by Kotak Investment Banking and IDFC-SSKI, is open between June 23-25.