Ambit Utilities

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Its getting a little better Amongst several issues faced by the Indian power generation sector, at least coal production seems to be improving; our mining analyst expects Coal India’s production CAGR to improve to 5% over FY14-17 vs 1.6% over FY10-14. India’s real challenge is not shortage of capacities but shortage of domestic coal. Despite an installed capacity of 243GW, only 130GW was generated in FY14 (peak demand of 136GW). We map Indian power generating utilities on a competitive matrix based on PPA signed and coal linkages; Tata Power (TPWR), NTPC and NHPC stand out the best. We prefer TPWR instead of NTPC and NHPC due to adverse CERC regulation and execution challenges for the latter two. Torrent Power, despite being worst placed given stranded assets, is attractive, as stock prices trades below value of its operating assets.

Visibility on improved domestic coal production - A key catalyst Amongst the many issues facing the power sector, at least coal production appears to be improving; Coal India’s 1QFY15 production increased 5% YoY vs 1.6% CAGR over FY10-14. India’s challenge is not shortage of power capacity but shortage of domestic coal. Despite installed capacity of 243GW, only 130GW out of the peak demand of 136GW in FY14 could be met, as average PLF was dismal at 66%. Our Metals analyst expects Coal India’s production CAGR to improve to 5% over FY14-17 and 8% over FY18-24 due to construction of key railway lines in Jharkhand, Odisha and Chhattisgarh.

Competitive mapping of players and filters of quality In our competitive matrix, TPWR, NTPC and NHPC are best placed. We prefer TPWR over NTPC and NHPC (due to adverse CERC regulation and execution challenges). JP Power and Indiabulls Power appear cheap on P/B but face challenges on equipment quality and poor execution respectively. Torrent Power, despite being exposed to shortage of domestic gas, is attractive, given `182/share valuation for the operational assets. JSWE emerges as a ‘short candidate,’ due to its stretched valuation and negligible pipeline.

SELL JSWE which is the most exposed on our matrix; BUY TPWR

We recommend a switch from JSWE to TPWR. This is because JSWE is currently trading close to our bull-case price of `84/share which assumes acquisition of 2GW capacity; moreover, JSWE remains exposed to lower merchant tariff and higher imported coal prices. TWPR, on the other hand, has 90% of projects with fuel linkage and secured offtake. Alongside this, its net debt:equity may reduce to 1.0x by FY16 (vs 3.1x in FY14) if it is able to sell its stake in Arutmin and KPC. This can provide enough ammunition to fund the next leg of growth as clarity on fuel pass-through emerges on case 2 bids.

Utilities POSITIVE

THEMATIC September 03, 2014

Key Recommendations

Tata Power BUY

Target Price: 111 Upside : 23%

Torrent Power BUY

Target Price: 225 Upside : 62%

JSW Energy SELL

Target Price: 66 Downside : 14%

NTPC SELL

Target Price: 111 Downside : 21%

Analysts Details

Bhargav Buddhadev [email protected] +91 22 3043 3252

Deepesh Agarwal [email protected] +91 22 3043 3275

How to play the sector

Source: Bloomberg, Ambit Capital research, Note: Size of bubble represents the quality of management in a scale from 1 to 4 with higher the better; valuation as on 2 September 2014; risk-based score is calculated based on fuel and offtake agreements (higher the better)

NTPC

NHPC

Tata Power

JP Power

Adani Power

Reliance Power

CESC

Indiabulls

Torrent Power

JSW Energy

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

2.0 2.3 2.6 2.9 3.2 3.5 3.8 4.1

Risk Based Scores

FY1

6 P

/Bv

(x)

Attractive and undervalued

Attractive and fairly valued

SHORT candidate

Multibagger; waiting for the right catalysts

Utilities

September 03, 2014 Ambit Capital Pvt. Ltd. Page 2

CONTENTS SECTOR

Improving visibility on domestic coal production can re-rate the power sector………. 3

SEB restructuring - A big catalyst for the power sector but………………………………. 6 a long journey ahead

Compensatory tariff – A positive; but the SC’s stay order would delay receipt……….. 8

WHAT TO INVEST IN? ……………………………………………………………………….. 9

Relative valuations and risk mapping……………………………………………………… 12

Filtering for management quality…………………………………………………………... 15

Other risks looming on the sector………………………………………………………….. 16

COMPANIES

JSW Energy (SELL): Not capitalizing on balance sheet………………………………….. 17

Tata Power (BUY): Geared for the next leg of growth…………………………………... 33

Utilities


Improving visibility on domestic coal production can re-rate the power sector Domestic coal shortage - a big challenge; despite installed capacity of 243GW only 130GW out of 136GW of peak demand could be met India’s challenge in addressing the power deficit problem is not shortage of installed capacity but availability of domestic coal. Despite installed capacity of 243GW as on March 2014 only 130GW out of the peak demand of 136GW was met. This is because India’s average PLF for coal- and lignite-based power plants was at 66% in FY14 vs 79% in FY08. Average PLF for gas-based plants (22GW) was even more disappointing at 25% in FY14. The lower PLF was on account of shortage of domestic coal and domestic gas.

Exhibit 1: India’s peak deficit is not due to shortage of capacity…

Source: CEA, Ambit Capital research

Exhibit 2: …but due to shortage of domestic coal, which led to low PLFs

Source: CEA, Company, Ambit Capital research, Note: Peak deficit is for coal and lignite, which accounted for 60% of installed capacities in FY14

Domestic coal production CAGR likely to improve to 5% over FY14-17 and 8% over FY18-24 vs 1.6% over FY10-14 Our Metals and Mining team believes that the construction of the key railway lines in Jharkhand, Odisha and Chhattisgarh, which has been one of the reasons for lower coal production, could be expedited. Phase 1 of the Jharkhand line has received stage II forest clearance (FC) and ~49% of the land is in possession. With the balance land likely to be received in 2-3 months and with a construction timeline of ~2-3 years, this line might be completed by FY17. The Odisha line awaits stage II FC whilst forest land is yet to be acquired. If these are in place by November 2014, the Odisha line might be completed by FY18. Hence, our Metals and Mining team assumes volume benefits from the railway lines to begin from FY18 onwards, with volume CAGR of 8% over FY18-24 vs 5% over FY12-17.

0%

5%

10%

15%

20%

25%

-

50

100

150

200

250

300

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Installed capacity (GW)Peak demand(GW)Peak deficit(%) on RHS

-3%0%3%6%9%12%15%18%

60%

65%

70%

75%

80%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

PLF on LHSInstalled capacity YoYCIL's coal volumes YoY

FY14 average PLF declined to 66% due to shortage of domestic coal and domestic gas

Our Metals and Mining team believes that the construction on the key railway lines in Jharkhand, Odisha and Chhattisgarh, which has been one of the reasons for lower coal production, could be expedited

Utilities


Exhibit 3: Update on key railway lines

State Chhattisgarh Jharkhand Odisha

Built by JV: SECL (64%), IRCON (26%) and State Govt (10%) Railways Railways

Total Capex `40bn `24bn `11bn

Railway Stretch (a) East Corridor: Kharsia-Gharghoda-Dharamjaygarh-Korba (180km), (b) East West Corridor: Gevra Road to Dipka, Katghora, Sindurgarh and Pasan (112km)

Tori-Shivpur-Kathautia (91km) Jharsuguda-Barpalli-Sardega Railway line (53km)

Related coal field Mand Raigarh and Korba coalfields, SECL North Karanpura coalfields , CCL IB valley coal fields, MCL

Coal offtake potential ~110-120mtpa ~100mtpa ~60mtpa

Status of Phase I

Phase I for CIL EC: 74km stretch from Kharsia to Dharamjaygarh (Mand Raigarh coal field) with coal offtake potential of ~60mt EWC: 112km from Gevra to Pendra (Korba coalfield)

A broad-gauge line between Tori and Shivpur (43 kms) with coal offtake potential of ~60-70mt

Jharsuguda-Barpalli-Sardega line (53km) with offtake potential of ~60mt

Land acquisition

EC: Total land required of ~300ha, of which ~70ha is forest land; land acquisition is currently in progress and is likely to be completed by December 2013 EWC: This is ~2-3 months behind the East Corridor and land acquisition is likely to be completed by March 2015; however, forest land is ~250ha

Total land required of ~475ha, out of which forest land is of ~197ha, private land is 109ha and Government land is ~146ha; ~49% of the land has been acquired till date

Total land required of ~279ha, out of which 76 ha is forest land; ~56% of the land has been acquired till date

Forest Clearance FC awaited Stage II FC received in June 2013 Stage II FC received in June 2014

Construction Construction is likely to take ~2.5-3 years post land acquisition and clearances and hence, we expect this to be completed in FY19

Likely to take ~2 years and hence, we expect this to be completed in FY17

To take ~2-3 years and hence, we expect to be completed in FY18

Key milestones to watch out for

Pending forest clearance Stage I and Stage II FC to be received by Sept 2014 Both received Stage II FC by July 2014 Release of forest land and tree cutting

To be completed by December 2014 To be completed in next 2-3 months

To be completed by November 2014

Transfer of private and government land To be completed by December 2014

To be completed in next 2-3 months Largely acquired

Other Issues Law and order issues on the Tori-Shivpur stretch and hence, the Railways has asked for security

Shifting of high-power lines by Odisha Power Transmission by Aug 2014

Target completion June 2017 June 2016 December 2016

Source: Company, Ambit Capital research

Further, domestic coal production CAGR has also improved, with Coal India reporting a production of 34.6mt for June 2014 (up 6% YoY). Production growth for 1QFY15 was at 5.3% (vs 2.3% in FY14) and CIL’s key subsidiaries, MCL and NCL, reported a growth of 17% and 10% respectively. For August also, CIL reported an impressive production growth of 9.0% YoY (July growth though was dismal at 0.7% YoY). Our Metals and Mining team expects a 5% CAGR over FY14-17 vs 1.6% over FY10-14.

Exhibit 4: Our Mining team’s estimates of CIL’s subsidiary-wise coal production (mt)

Subsidiary FY12 FY13 FY14 FY15E FY16E FY17E

ECL 31 34 36 37 38 40

BCCL 30 31 33 33 34 35

CCL 48 48 50 52 56 60

NCL 66 70 69 72 75 77

WCL 43 42 40 42 42 42

SECL 114 118 124 131 137 142

MCL 103 108 110 122 130 138

Ambit estimate 436 452 462 489 512 534

YoY growth (%) 3.6% 2.3% 5.9% 4.8% 4.2%

CIL Target 436 452 462 507 529 555

Source: Company, Ambit Capital research; Note: * Estimates are as per CIL’s presentation

CIL’s production growth in 1QFY15 has increased to 5.3% YoY as compared to 1.6% CAGR over FY10-14

Utilities


Benign imported coal prices could act as a support until domestic coal production ramps up

Given the dismal production CAGR of Coal India, the share of imported coal to total coal consumption (primarily imported from Indonesia) has increased from 10% (50MT) in FY08 to 22% (169MT) in FY14.

The sudden 15% YoY increase in installed capacities for power generation in FY12 coupled with flat domestic coal production in FY12, led to a 49% YoY increase in import of coal although coal prices had peaked in the Indonesian market in FY12. Consequently, the share of imported coal to total demand increased from 11% in FY11 to 22% in FY14.

Exhibit 5: Share of imported coal in India’s coal consumption has more than doubled to 22% in FY14 vs 10% in FY08

Demand (MT) Domestic coal Production (MT) Import (MT) % of demand met

by imported coal

FY08 493 457 50 10%

FY09 550 492 59 11%

FY10 604 532 73 12%

FY11 656 533 69 11%

FY12 696 540 103 15%

FY13 773 556 138 18%

FY14 770 566 169 22%

CAGR 8% 4% 23%

Source: Industry, Ambit Capital research

However, we believe that coal prices are unlikely to decline significantly from hereon. Our discussions with miners in Indonesia suggests that capital expenditure for new mine capacities in Australia and Indonesia has reduced significantly, which may lead to tight supply in CY16 and CY17. If demand recovers (assuming a modest recovery in industrial demand in India and China) then the prices of imported coal in Indonesia could shoot up. Further, prevailing prices are very close to the production cost. Bumi, Indonesia’s largest miner is at a risk of default on bond repayments, as it does not have enough cash to meet more than US$1bn of obligations which are due in the next 18 months.

Indonesian coal prices have declined by 34% in the past three years

Imported coal prices are unlikely to decline significantly from hereon, as current market prices are closer to the production cost

Utilities


SEB restructuring - A big catalyst for the power sector but a long journey ahead India’s peak deficit could have been fully eliminated if India’s AT&C losses of 27.0% in FY12 had declined to 15.1%

SEB restructuring is a big catalyst for reforming the power sector. India’s power deficit of 14GW in FY12 would have been fully eliminated, if India’s AT&C losses of 27.0% in FY12 had been reduced to 15.1%. Even if India’s AT&C losses had reduced to 18.9%, which is similar to the prevailing AT&C loss in Gujarat (India’s most-efficient state as far as AT&C loss is concerned), India’s peak deficit of 14GW (i.e. 11.9%) in FY12 would have declined to a marginal 4GW (i.e. 3.8%).

Exhibit 6: India’s peak deficit remains high due to high AT&C losses

Source: CEA, Ambit Capital research

Exhibit 7: Had FY12’s AT&C losses reduced to 15.1%, India’s peak deficit would have been fully eliminated

(In %) Case 1 Case 2 Case 3 Case 4 Case 5

% reduction in AT&C losses of FY12 10.0 30.0 44.0 60.0 80.0

Original Peak deficit 11.9 11.9 11.9 11.9 11.9

Original AT&C losses 27.0 27.0 27.0 27.0 27.0

Revised AT&C losses 24.3 18.9 15.1 10.8 5.4

Revised Power deficit / (surplus) 9.2 3.8 0.0 (4.3) (9.7)

Source: CEA, Ambit Capital research; Note: Data for FY13 and FY14 is not available

SEBs hiked tariffs by 4-24% in FY14; however, this has been subdued in FY15

Several SEBs increased tariffs by 4-24% in FY14, as several of them had signed debt restructuring agreements which mandated SEBs to increase tariffs periodically. The SEBs of Uttar Pradesh, Rajasthan, Haryana, and Tamil Nadu, successfully implemented debt restructuring over FY13 and FY14.

However, FY15 has been a disappointing year, with several SEBs not opting for tariff hikes and the ones which opted for tariff hikes also opted for a lower percentage increase. This is despite the restructuring agreements signed in FY13 and FY14 soliciting periodical tariff hikes. Note that states like Haryana, Andhra Pradesh, Bihar and Maharashtra could increase tariffs in FY16, as their state elections are in FY15.

Exhibit 8: Whilst many states took tariff increases in FY14

`/kwh 2012-13 2013-14 % Increase

Andhra Pradesh 3.98 4.94 24.1%

Punjab 5.02 5.53 10.2%

Bihar 3.53 3.85 9.1%

Meghalaya 3.3 3.58 8.5%

Gujarat 3.92 4.18 6.6%

Haryana 4.71 5.02 6.6%

Daman & Diu 1.73 1.83 5.8%

Nagaland 4.35 4.57 5.1%

Odisha 4.17 4.32 3.6%


Exhibit 9: FY15 tariff hikes have been disappointing

2014-15

Andhra Pradesh On hold

Punjab 3%

Bihar NIL

Meghalaya 15%

Gujarat 7.5%

Haryana NIL

Daman & Diu NIL

Nagaland NIL

Odisha NIL


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5

10

15

20

25

30

35

40

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Peak deficit (%)

AT&C losses (%)

If India’s AT&C losses had reduced to 18.9% which is the prevailing AT&C loss in Gujarat, India’s peak power deficit would have declined to 3.8%

After a promising FY14 where several SEBs increased tariffs by 4-24%, FY15 has been disappointing with several SEBs not raising tariffs and others opting for a lower percentage increase

Utilities


Feeder separation system could be a game-changer but budget allocation of `5bn is paltry

The Feeder Separation Scheme announced in the budget is a very promising initiative, as it has been one of the big reasons for lower AT&C losses especially in a state like Gujarat where it has been implemented successfully (already rolled out across eight states). However, the amount of `5bn allocated is paltry, as the estimated outlay, going by the outlay incurred in Gujarat and Madhya Pradesh, for the pan-India feeder separation programme is ~`481bn.

Exhibit 10: Budget allocation on the feeder separation programme is ~1% of the total requirement

Particulars

Total Outlay in MP (` bn) 11.3

Villages likely to be benefitted 15,006

Cost per village (` mn) 0.75

Number of villages in India (in mn) 0.64

Pan-India Outlay required (̀ bn) 480.9

Allocation in Budget (̀ bn) 5.0

Allocation as % of total requirement 1%

Source: Ambit Capital research

The Feeder separation system is a rural feeder separation programme, wherein the transmission lines are bifurcated between agricultural and domestic use. Consequently, this helps the states to differentiate the tariffs between agricultural consumption (heavily subsidised) and domestic consumption in rural areas, resulting in a lower subsidy burden. Also, a state can assure fixed hours of supply for agricultural consumption. The feeder separation programme was one of the key reasons for the reduction of T&D losses in Gujarat from ~35% to 17% over five years.

Utilities


Compensatory tariff – A positive; but the SC’s stay order would delay receipt The recent order by CERC awarding a compensatory tariff hike retrospectively to Tata Power and Adani Power (APL) and the interim order by APTEL seconding the CERC’s decision to award this tariff hike prospectively (i.e. from FY14 onwards) were a positive. These tariff hikes would have allowed both TPWR and APL to at least break even vs a loss of `15bn and `14bn (adjusting for the revenue booked pertaining to the tariff hike in 4QFY14) in FY14 for Mundra UMPP and APL respectively.

Exhibit 11: Consequent to the compensatory tariff hike, TPWR’s and APL’s FY16 EPS is likely to increase by 11% and 22% respectively

TPWR APL

Pre-compensatory tariff hike

Post-compensatory

tariff hike

Improvement consequent to compensatory

tariff hike

Pre-compensatory tariff hike

Post-compensatory

tariff hike

Improvement consequent to compensatory

tariff hike TP (̀ /share) 107 111 4% NO STANCE

Revenue (̀ mn) FY15 383,200 401,116 5% 213,281 227,494 7%

FY16 417,463 426,971 2% 215,016 223,506 4%

FY17 422,011 431,519 2% 216,769 225,259 4%

PAT (̀ mn) FY15 12,354 23,820 93% 6,648 18,019 171%

FY16 21,022 27,538 31% 11,147 18,057 62%

FY17 22,600 30,089 33% 16,250 23,251 43%

EPS (̀ ) FY15 4.6 8.8 91% 2.3 6.3 174%

FY16 7.8 10.2 31% 3.9 6.3 62%

FY17 8.4 11.1 32% 5.7 8.1 42%

Book Value (̀ ) FY15 52.9 57.1 8% 25.1 29.1 16%

FY16 60.7 67.3 11% 29 35.3 22%

FY17 69 78.4 14% 34.6 43.4 25%


However, on 25 August 2014, the Haryana SEB approached the Supreme Court for a stay on APTEL’s interim order. The Supreme Court stayed the interim order and informed APTEL to pass the final order expeditiously. The stay order is clearly negative for both companies, as it implies a further delay in the receipt of a compensatory tariff hike. However, we continue to assume that both companies will receive the compensatory tariff hikes due to the regulatory change in Indonesian law which were made effective retrospectively. Consequently, the negotiated contracts entered by both Adani and Tata Power with mining companies in Indonesia became void and they had to import coal at market prices which made the PPA unviable. TPWR’s Mundra project was envisaged to be operated on imported coal, for which the company also purchased a 30% stake in Bumi’s mines. However, subsequently, owing to a change in Indonesian law, the increase in the cost of coal was greater than anticipated and the PPA at the agreed tariffs became unviable. Consequently, the company filed a tariff increase petition before the CERC. APL had entered into two power purchase agreements (PPAs) with the Gujarat (1,000MW) and Haryana (1,424MW) state electricity boards (SEBs) for 25 years at a levelised tariff of `2.35/kWh and `2.94/kWh respectively. However, owing to a change in Indonesian law, the cost of coal increased multi-fold, which led to the PPAs becoming unviable. Consequently, the CERC admitted APL’s tariff increase petition in October 2012.

The CERC’s decision of awarding a compensatory tariff hike and APTEL’s decision to second it were positives

Supreme Court’s stay order on compensatory tariff is a negative but we believe APTEL will pass an order in favour of TPWR and APL

Utilities


WHAT TO INVEST IN? We have always preferred companies with assured fuel linkages and minimal exposure to merchant power. In this note, we map each project of India’s top-11 listed power generation companies on offtake and fuel risk.

Our methodology is as follows:

Our universe consists of APL, Torrent Power, CESC, Indiabulls Power, Lanco Infratech, JP Power, NTPC, TPWR, JSWE, Reliance Power and NHPC.

For each of these companies and for each of their projects, we have examined the two most critical variables: (1) percentage of fuel supply tied-up (a project needs to have a Fuel Supply Agreement at the minimum for it to qualify as having a fuel tie-up) for operational plus upcoming projects which are likely to be commissioned by FY17 and (2) percentage of power off-take secured through PPAs for operational and under-construction projects which are likely to be commissioned by FY17. Note that we have not considered Letter of Assurance (LOA) as fuel linkage given the low rate of conversion of LOA to FSA by Coal India in the past three years.

Then we have aggregated the project-wise data to build a picture of where the overall firm is placed i.e. we have taken the weighted average of the percentage of fuel tied-up and weighted average of the percentage of offtake for each of these companies. Then we have classified each of these companies into four different quadrants. As explained below, quadrant 1 is the worst and quadrant 4 is the best.

Quadrant 1: Companies with low fuel linkage and low off-take. This is obviously the most exposed quadrant to be in.

Quadrant 2: High fuel linkage and low off-take tie-up. This is a moderately exposed quadrant.

Quadrant 3: Low fuel linkage and high off-take tie up. This too is a moderately exposed quadrant.

Quadrant 4: High fuel linkage and high off-take tie-up. This is the safest quadrant to be in.

Exhibit 12: The consolidated view – JSWE and Torrent Power are the most exposed on fuel and offtake whereas TPWR, NHPC and NTPC appear to be relatively well poised

Source: Ambit Capital research; Note: Size of the bubble represents FY14 net debt:equity

Lanco

Adani Power

IndiabullsPower

CESC

Reliance Power

Torrent Power

Tata Power

JP PowerNTPC

JSW Energy

NHPC

0%

20%

40%

60%

80%

100%

120%

30% 50% 70% 90% 110%PPA

FSA

We map each project of India’s top-eleven listed power generation companies on fuel and offtake risk

For assured fuel supply we consider only those projects which have signed FSAs

Utilities


Key findings at the consolidated level JSWE (39% fuel linkage and 52% offtake tie-up) and Torrent Power (15% fuel

linkage and 46% offtake tie-up) stand out to be the most exposed power generation companies.

NHPC (100% of fuel linkage and 100% offtake tied-up), TPWR (90% of fuel linkage and 99% offtake tied-up) and NTPC (79% of fuel linkage and 100% offtake tied-up) are the least exposed.

CESC (63% fuel linkage and 68% offtake tied-up), Lanco Infratech (62% fuel linkage and 54% offtake tied-up) and Reliance Power (94% fuel linkage and 71% offtake tied-up) are moderately exposed due to poor offtake tie-ups. Further, Lanco’s FY14 net debt:equity puts it in an adverse position.

JP Power (67% of fuel linkages and 88% offtake tied up), Indiabulls Power (30% of fuel linkages and 81% offtake tied-up) and APL (38% of fuel linkages and 83% offtake tied-up) are moderately exposed due to poor fuel linkages.

The next two sub-sections provide more details on how we reached these conclusions at the consolidated level using megawatt-based analysis and project-level analysis.

Megawatt-based analysis In this analysis we focus on the megawatts (MW) commissioned and under development. To identify risky projects in an IPP’s portfolio, we classify each project of an IPP into four buckets again based on the percentage of fuel linkage and percentage of offtake tie-up (with bucket 1 being the worst and bucket 4 being the best). The classification works as follows:

Bucket 1 (highest risk): Fuel linkage <=50% and offtake tie-up <=50%

Bucket 2 (moderate risk): Fuel linkage >50% and offtake tie-up <=50

Bucket 3 (moderate risk): Fuel linkage <=50% and offtake tie-up >50%

Bucket 4 (lowest risk): Fuel linkage >50% and offtake tie-up >50%

Exhibit 13: Proportion of the operational and under-construction power capacity (MW) of each of the IPPs in various buckets

Bucket 1 Bucket 2 Bucket 3 Bucket 4 Total Risk-based

scores*

NTPC 0% 0% 0% 100% 100% 4.0

NHPC 0 0% 0 100% 100% 4.0

TPWR 0% 0% 7% 93% 100% 3.9

APL 0% 0% 57% 43% 100% 3.4

Reliance Power 0% 29% 0% 71% 100% 3.4

CESC 12% 12% 0% 75% 100% 3.4

JP Power 17% 0% 14% 69% 100% 3.4

Indiabulls Power 0% 0% 70% 30% 100% 3.3

Lanco 15% 20% 18% 47% 100% 3.0

JSWE 33% 0% 43% 25% 100% 2.6

Torrent Power 49% 0% 36% 15% 100% 2.2

Source: Company, Ambit Capital research. Note: * Calculated by assigning Bucket 1 a score of 1, Bucket 2 a score of 2 and so on. Higher the score, better the ranking.

NHPC, TPWR and NTPC are best placed on fuel and offtake

Utilities


Key findings from MW-level analysis Torrent Power with only 15% of power portfolio in Bucket 4 is the most

exposed power generation company. Its new power projects, Dahej and Unosugen, are struggling with fuel linkages given the domestic gas shortage. Consequent to the pending fuel linkage, PPAs for these projects have not been approved yet.

JSWE, with only 25% of power portfolio in Bucket 4, is the second most-exposed utility. Vijayanagar (860MW) is dependent on un-tied imported coal with 100% exposure to merchant power. Ratnagiri (1,200MW) is again dependent on un-tied imported coal and has 50% exposure to merchant power.

Lanco Infratech with only 33%, 20% and 18% exposure in Bucket 1, 2 and 3 is the third most-exposed power generation company. This exposure arises from Kondapalli II and III (1,098MW) which neither have fuel linkage nor PPA; Amarkantak III and IV (1,320MW) which have yet not signed PPAs; and Vidarbha (1,320MW) with pending fuel tie-ups.

NTPC and NHPC emerge as the safest power generation companies with 100% of their portfolios falling under Bucket 4. Also, TPWR emerges as a safe power generation company, with ~92% of its portfolio falling under Bucket 4.

75% of JSWE’s projects face risks on fuel and offtake; Lanco follows closely at 53%

49% of Torrent’s projects neither have fuel linkages nor offtake agreement

NTPC, NHPC and TPWR emerge as the safest power generation companies; Indiabulls Power with only 30% power portfolio in Bucket 4 is the fourth most-exposed power generation company, as 1,890MW of its capacity is still under the LOA stage

Utilities


Relative valuations and risk mapping Exhibit 14: Relative valuation

Companies CMP Mcap 3m ADV P/B (x) EV/EBITDA (x) P/E (x) CAGR (%)

(FY14-16) RoE (%)

INR US$ mn US$ mn FY15 FY16 FY15 FY16 FY15 FY16 Revenue EPS FY14 FY15 FY16

NTPC 141 19,208 5.4 1.3 1.2 8.8 8.2 11.7 11.3 1% -3% 13% 11% 11%

Reliance Power 77 3,567 14.9 1.1 1.0 15.8 9.8 20.4 15.9 40% 17% 5% 5% 6%

JSWE 77 2,086 3.4 1.6 1.4 6.2 6.0 10.3 8.9 0% 11% 18% 17% 17%

CESC 700 1,442 5.4 1.4 1.3 8.9 6.6 15.1 10.3 18% 26% 10% 9% 13%

JP Power ventures 15 714 5.6 0.6 0.6 10.0 7.0 10.9 6.6 61% 81% 3% 6% 10%

KSK Energy 93 634 0.4 1.0 1.0 15.4 6.3 N.A. 18.2 68% N.A. -6% -5% 6%

NHPC 22 3,996 4.6 0.8 0.8 8.2 7.9 10.4 9.5 10% 8% 7% 8% 8%

SJVN 14 355 2.3 0.9 0.8 16.8 9.8 N.A. N.A. 35% N.A. -4% -18% -16%

APL 51 2,420 10.9 1.8 1.4 6.4 6.7 8.1 8.1 19% 121% 7% 24% 20%

Torrent Power 139 1,085 3.8 1.0 0.9 6.2 6.0 13.7 11.4 7% 131% 2% 7% 8%

TPWR 90 4,022 14.9 1.6 1.3 4.5 4.4 10.8 9.0 9% NA -2% 17% 16%

Sector Average 1.2 1.1 9.7 7.1 12.4 10.9 24% 49% 5% 7% 9%

Source: Bloomberg, Ambit Capital research, Note: Valuation as on 2 September 2014. APL, Torrent Power, TPWR, JSWE and NTPC’s figures are on Ambit estimates; other companies’ figures are Bloomberg estimates.

Exhibit 15: P/B with respect to risk-based score

Source: Bloomberg, Ambit Capital research; Note: Size of bubble represents the quality of management in a scale from 1 to 4 with higher the better; valuation as on 2 September 2014

NTPC

NHPC

Tata Power

JP Power

Adani Power

Reliance Power

CESC

Indiabulls

Torrent Power

JSW Energy

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

2.0 2.3 2.6 2.9 3.2 3.5 3.8 4.1

Risk Based Scores

FY16 P

/Bv

(x)

Attractive and undervalued

Attractive and fairly valuedSHORT candidate

Multibagger; waiting for the right catalysts

Utilities


Key findings When we map the FY16 P/B and the risk-based scores, some interesting conclusions emerge:

Given JSWE’s stretched valuation with only 39% fuel linkage and only 52% offtake tied up, JSWE emerges as a SHORT candidate.

Torrent Power emerges as a multi-bagger stock: Our SOTP valuation on Torrent Power is `225/share which values the operational asset at `182/share (implied FY14 P/B of 1.2x for the regulated operational assets; annuity income at 10x FY14 P/E and cash and investments at book value) and the stranded assets at 0.5x invested equity; we do not assign any value to Sugen’s merchant power plant and assigned 0.5x FY14 P/B to Unosugen and Dahej given our belief that if these assets are sold today, Torrent will be able to recover 0.5x of its invested equity after repaying the loan.

Sensitivity analysis if domestic gas production revives

First scenario: Torrent’s FY16 EPS increases by ~78% to `22/share

The rationale for assuming this is that the regulator, given the limited domestic gas availability, may restrict the use of domestic gas to the extent of the regulated portfolio.

Exhibit 16: Under scenario 1, FY16 PAT likely to increase to `10.3bn (Figures pertain to FY16)

`mn Regulated Generation businesses

Regulated distribution

business Merchant Other income Truing-up

income Total PAT

Operational (Sugen,

Sabarmati and Vatva)

Unosugen (278MW)

Dahej (800MW)

Ahmedabad, Surat and

Gandhinagar Sugen Unosugen Dahej Operational Non-

operational

Relating to under

recovery of FY14

Invested Equity 14,372 3,310 9,600 20,849 4,090 1,190 4,800 NA NA NA NA

RoE 15.5% 15.5% 15.5% 15.5% Loss Loss 0.0% NA NA NA NA

PAT 2,228 513 1,116 3,232 (2,390) (384) - 500 420 4,694 10,299

Source: Ambit Capital Research

Second scenario: Torrent’s FY16 EPS increases by 250% to `30.4/share

The rationale for assuming this is that Torrent may tie up the merchant portfolio into long-term PPAs to get access to domestic gas. Further, the RoE for this long-term PPA portfolio will be similar to the regulated RoE of 15.5%. If the distribution franchisee model picks up and if the new arrangement allows the franchisee to also tie up the power for selling in the circle then Torrent may divert the merchant portfolio into feeding the distribution franchisee.

Exhibit 17: Under scenario 2, FY16 PAT is likely to increase to ̀ 14.6bn (Figures pertain to FY16)

`mn Regulated Generation businesses

Regulated distribution

business Merchant Other income

Truing-up

income Total PAT

Operational (Sugen,


Unosugen (278MW)

Dahej (800MW)



operational

Relating to under recovery of FY14


RoE 15.5% 15.5% 15.5% 15.5% 15.5% 15.5% 15.5% NA NA NA NA

PAT 2,228 513 1,116 3,232 634 185 744 500 420 4,694 14,636

Source: Ambit Capital Research

Third scenario: Torrent’s FY16 EPS increases by 316% to `38.6/share

This is a blue sky scenario which assumes a recovery in power demand to such an extent that the merchant power prices more than double from the current `4.4/unit in Gujarat and Torrent’s merchant portfolio earns an RoE of ~25%. Also, the regulated portfolio starts earning higher RoEs (~21%) through incentives and sale of carbon credits.

Utilities


Exhibit 18: Under scenario 3, FY16 PAT is likely to increase to `18.2bn (Figures pertain to FY16)

Figures pertain to FY16

Regulated Generation businesses Regulated distribution

business Merchant Other income

Truing-up income

Total PAT

Operational (Sugen,


Unosugen (278MW)

Dahej (800MW)



operational

Relating to under recovery of FY14


ROE 21% 21% 21% 21% 25% 25% 25% NA NA NA NA

PAT 3,018 695 2,016 4,378 1,022 298 1,200 500 420 4,694 18,241


JP Power, Indiabulls Power, Reliance Power and NHPC appear cheap on P/B but appear weak on our qualitative filter which is covered in the next section (see Exhibit 19). This filter is based on the management’s experience and maps the management’s track record in Exhibit 19 on the next page.

JP Power’s biggest challenge is its over-leveraged balance sheet (FY14 net debt:equity was at 3.8x). Further, Indiabulls Power has no execution track record and hence the stock is likely to be re-rated only if the management is able to abide by its guidance of commissioning 2.7GW by FY15. Reliance Power suffers from a limited execution track record and high exposure to Chinese equipments. Also, it may face coal linkage issues if its captive coal blocks (excluding the coal blocks awarded to Sasan UMPP) are de-allocated {~76% of coal requirement for coal-based power plants which are currently operational (except Sasan) or likely to be commissioned by FY17 is from captive mines}. Note that the Supreme Court has declared the allocation of captive coal blocks after 1993 as illegal.

NHPC despite scoring well on our risk-based matrix has seen several delays in execution. For instance, NHPC has written down expenses of `12.7bn in 4QFY14 owing to delays in the construction of the 2,000MW Subansiri (Arunachal Pradesh) and 800MW Parbati-II (Himachal Pradesh) projects and the 160MW Teesta low dam (West Bengal).

TPWR is a must-have stock in the portfolio despite reasonable valuations (FY16 P/B of 1.3x), as it is the best-placed company amidst the IPPs in our competitive matrix. Note that 93% of its portfolio is in Bucket 4 which is the safest. Further, the company has announced that it will sell its stake in Arutmin mine for US$0.5bn, which will provide enough ammunition to fund the next leg of growth; the company could bid for UMPPs, provided there is more clarity on the proposed regulatory changes for the power sector.

Utilities


Filtering for management quality Exhibit 19: NTPC and TPWR emerges as the best company in our management quality framework

Experience Aggression

Equipment quality

FY14 Net debt:equity

Overall Comment

score

NTPC

NTPC scores the best given its three-decade track record of strong execution, large pipeline, and quality equipments (majority procured from BHEL) and low net debt:equity

JSWE

JSWE scores average, as it has high exposure to Chinese equipments and lacks aggression.

APL

APL ranks scores relatively weak, as it has high exposure to Chinese equipments, high net debt: equity and one of the lowest operating track records

CESC

CESC scores relatively strong, as it is one of the oldest power companies with low exposure to Chinese equipments and large pipeline

Indiabulls

Indiabulls scores average, as it does not have any operating track record whatsoever; also, it has high leverage on balance sheet

Torrent Power

Torrent Power scores relatively strong, as it has zero exposure on Chinese equipments coupled with a decade of operating track record and low net debt: equity

Lanco Infratech

Lanco Infratech scores relatively weak, as it has high exposure to Chinese equipments and high leverage on balance sheet

TPWR

TPWR is the second-best company, as it has one of the highest operating track record coupled with zero exposure to Chinese equipments

Reliance Power

Reliance Power scores average as it has high exposure to Chinese equipments and limited operating track record

JP Power

JP Power scores average, as the concerns over poor Chinese equipment are the highest in case of JP Power

NHPC

Despite quality equipments from BHEL and low leverage, NHPC scores only relatively strong due to lack of aggression, resulting in significant delays in project execution

Source: Company, Ambit Capital research; Note: - Strong - Relatively strong - Average - Relatively weak; Note: Experience – Number of years of experience in operating power plants, Aggression: Capacity planned/Installed capacity

On a qualitative basis, NTPC emerges as the best, closely followed by TPWR, NHPC CESC and Torrent Power. All these companies have the right mix of experience, aggression and strong balance sheet. It is also pertinent to note that all of these companies have low reliance on Chinese equipment. Companies that emerge weak are Lanco Infratech, APL, JSWE, Reliance Power and Indiabulls Power, given their leveraged balance sheets, higher use of Chinese equipment and lack of execution track record.

Utilities


Other risks looming on the sector Bankers resist new BOOT model

Bankers have shown resistance in funding new projects on a BOOT basis wherein the developer has to transfer the assets to the utility after 30 years (which can be further extended by another 10 years). Such projects entail huge investments, which could impact their sustainability in the long term if developers are required to transfer them to the utilities. Whilst the BOOT model is being successfully implemented in several highways projects, this may not be suitable for the power sector given the size of the capital investment and the nature of the counterparty risk.

Lack of clarity on fuel pass-through for case 2 projects has led to private sector shying away from making investments

Recently, the Odisha UMPP and Tamil Nadu UMPP have lacked clarity on fuel pass-through which has resulted in developers refraining from bidding in the Request for Proposal (RFP) round. Whilst eight private sector players submitted their bids in the recent pre-qualification bids for the Odisha UMPP, the financial bids have not been made given the lack of clarity on the fuel cost pass-through. The Tamil Nadu UMPP has no clarification on the energy escalation cost. The RFQ document for the Cheyyur UMPP has not clarified on the escalation allowed on the energy cost (to be quoted in US dollars) every year.


Not capitalizing on balance sheet JSW Energy’s operational performance has been stellar, with average PLF at 76% in FY14 vs India’s 66%. Also, its balance sheet, with FY14 net debt:equity of 1.3x, is superior than its peers’ 3.5x. However, the share is trading near our bull-case valuation (of `84/share), which assumes JSW Energy (JSWE) would acquire 2GW of thermal capacity, the probability of which is low given JSWE fails to capitalize on its strong balance sheet. At CMP, the stock is trading at 1.4x FY16 P/B, a 32% premium to its peers. We change our stance to SELL, with a target price of `66/share (15% downside), implying FY16 P/B of 1.2x.

Competitive position: STRONG Changes to this position: NEUTRAL

Stellar operational performance, but is it sustainable? JSWE’s operational performance has been stellar, with average PLFs of 76% vs India’s average of 66%. Strong merchant tariff in south India and fall in imported coal prices have helped JSWE. This may change with the integration of the National Grid with the Southern Grid and imported coal prices no more likely to decline. With negligible pipeline and gross margin compression (due to falling merchant price and rise in fuel cost), JSWE’s PAT could decline.

Fails to capitalise on its strong balance sheet positioning JSWE’s FY14 net debt:equity at 1.3x was strong vs its listed peers’ 3.5x. However, JSWE has not been able to capitalise on this, as the management is sceptical on a recovery of domestic coal production and power demand (given SEBs’ dismal financial health). The management’s scepticism is valid, but there is a risk of good assets getting sold; recently, Lanco’s Udupi plant, with 100% fuel pass-through, was sold to Adani and JP’s hydro assets was sold to Reliance.

Greenfield capex unlikely JSWE may go slow on bidding for new projects, as the BOOT model is discouraging lenders from funding projects (as they have to be transferred to utilities after 30 years). Also, lack of clarity on fuel pass-through in the Odisha and Tamil Nadu UMPPs has led to developers refraining from bidding.

Fully valued; Not much left in bull case too JSWE’s CMP is 6% below our bull-case valuation of `84/share. Our bull case assumes: (a) JSWE acquires 2GW of coal-fired thermal power plant with 100% fuel pass-through for an EV of `110bn/P/B multiple of 1.0x; (b) 85% PLF with 15.5% RoE; and (c) the entire acquisition is funded using debt; implied net debt:equity of 3.1x on FY14’s equity.

JSW Energy SELL

COMPANY INSIGHT JSW IN EQUITY September 03, 2014

Key financials

YE March (̀ mn) FY13 FY14 FY15E FY16E FY17E

Operating income 89,343 87,054 87,731 86,717 87,135

EBITDA 27,931 32,514 34,284 35,151 35,653

Net profit 9,124 11,544 12,350 14,204 15,723

EPS (`) 5.6 7.0 7.5 8.7 9.6

RoE (%) 15.3 18.1 17.2 16.7 15.7

P/E (x) 14.2 11.2 10.5 9.1 8.2

P/BV (x) 2.1 2.0 1.7 1.4 1.2


Utilities

Recommendation Mcap (bn): `128/US$2.1 6M ADV (mn): `177/US$3.3 CMP: `79 TP (12 mths): `66 Downside (%): 15

Flags Accounting: GREEN Predictability: RED Earnings Momentum: GREEN

Catalyst Decline in merchant tariff post

synchronisation of the Southern Grid

Increase in imported coal prices

Performance (%)

Source: Bloomberg, Ambit Capital research

Analysts Details

Bhargav Buddhadev +91 3043 3252 [email protected]

Deepesh Agarwal +91 3043 3275 [email protected]

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Sensex JSWE on RHS

JSW Energy


Stellar operational performance but is this sustainable? JSWE’s PLF stronger than India’s average PLF JSWE’s average PLFs were higher than India’s average PLF in FY14. The company’s average PLF declined from 89% in FY13 to 76% in FY14, as the Ratnagiri plant’s PLF declined from 88% in FY13 to 71% in FY14 due to lower demand from MSEDCL. The average PLF for Vijayanagar and Barmer also declined marginally to 95% in FY14 (from 101% in FY13) and to 68% in FY14 (from 74% in FY13) respectively. However, Barmer’s operational performance significantly improved, with Barmer reporting a PAT of `1.4bn in FY14 vs a profit of `85mn in FY13.

Exhibit 1: JSWE’s average PLF has been consistently strong as compared to India’s average PLF

Source: Company, CEA, Ambit Capital research

Exhibit 2: Vijayanagar reported strong PLFs; Barmer’s and Ratnagiri’s PLF were impacted by outages (figures represent % PLF)


Robust margin performance JSWE’s EBITDA margin expanded by 610bps YoY in FY14 led by gross margin expansion of 590bps (which in turn was supported by a 7% increase in average realisation and 21% decline in average fuel cost). The reduction in fuel cost was led by softening prices of imported coal. Both Indonesian 4,200 Kcal Eco Coal and the South African 6,000 Kcal Coal Reference indices have declined by 9% and 11% in USD terms respectively due to lower demand from China and due to the US turning into a net exporter of coal.

Exhibit 3: JSWE’s EBITDA margin improved 610bps YoY in FY14…


Exhibit 4: …led by higher average realisation and falling fuel cost


60

70

80

90

100

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

JSW's PLF (%) India's average PLF (%)

40 50 60 70 80 90

100 110

Ratnagiri Vijaynagar Barmer

FY10 FY11 FY12 FY13 FY14

20%

25%

30%

35%

40%

FY11

FY12

FY13

FY14

EBITDA margin (%)

610bps YoY improvement

1.7

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2.7

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4.0

4.1

4.2

4.3

4.4

4.5

4.6

4.7

FY10

FY11

FY12

FY13

FY14

Realisations (Rs/unit) on LHS Fuel cost (Rs/unit)

JSWE’s average PLF in FY14 was at 76% vs India’s average PLF of 66%

JSWE’s FY14 EBITDA margin expanded by 610bps YoY led by 7% increase in realisation and 21% decline in fuel cost

JSW Energy


Exhibit 5: Indonesian 4,200 kcal and South African 6,000 kcal indices declined 9% and 11% (in USD terms) in FY14


But is this performance sustainable? Higher merchant tariff in south India to decline post integration of Southern Grid with the National Grid

We believe merchant tariffs in south India (59% of JSWE’s merchant portfolio), which have been quoting at a premium to the rest of India, could correct. As per the Indian Energy Exchange (IEX) website, merchant tariffs in south India have been on average (FY12-14) been quoting 91% higher than the rest of India.

Exhibit 6: Merchant tariff in south India increased significantly over FY12-14 (line represents merchant tariff in ̀ per unit)…

Source: IEX, Ambit Capital research

Exhibit 7: …given the higher peak deficit in the south (line represents % peak deficit)


With the synchronisation of the 2.1GW transmission line between Sholapur in Maharashtra and Raichur in Karnataka in FY15, the transmission capacity from the National Grid to the Southern Grid would increase to 3.6GW in FY15. Further, the Southern Grid is likely to be fully integrated with the National Grid by FY16, with synchronisation of transmission of: (a) 500MW between Kolhapur in Maharashtra and Narendra in Karnataka in FY16; and (b) 500MW between Angul in Odisha and Srikakulam in Andhra Pradesh in FY16.

This can virtually bring down south India’s peak power deficit of 3.0GW or 7.6% in FY14 to NIL. Consequently, the merchant tariffs in south India could correct along with JSWE’s profitability (as 59% of JSWE’s merchant portfolio is in south India).

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JSW Energy


Imported coal prices seem to have bottomed out

Whilst imported coal prices have corrected by 10% in the last one year, we believe prices are unlikely to decline significantly from hereon. Our discussions with miners in Indonesia suggest that capital expenditure for new mine capacities in Australia and Indonesia has reduced significantly, which may lead to tight supply in CY16 and CY17. If demand recovers by then, assuming a modest recovery in industrial demand in India and China, prices of imported coal could shoot up. Further, prevailing prices are very close to the production cost. Bumi, which is Indonesia’s largest miner, is at a risk of default on bond repayments, as it does not have enough cash to meet more than US$1bn of obligations that are due in the next 18 months.

JSW Energy


Fails to capitalise on balance sheet strength Unlike several of its listed peers that became very aggressive in adding capacities and in the process took on a lot of debt on their balance sheets (due to allowed leverage of 3x vs invested equity), JSWE choose to go slow on capacity expansion. In hindsight, this has proven to be a blessing in disguise, as several of its private sector peers that became aggressive in adding capacities are now left with stranded projects and over-leveraged balance sheets.

Exhibit 8: JSWE’s leverage has been the lowest amidst its peers….

Net Debt:Equity FY13 FY14 FY15E NTPC 0.5 0.5 0.6 Torrent Power 0.8 1.2 1.1 JSW Energy 1.5 1.3 0.9 Reliance Power 1.2 1.4 1.5 CESC 1.4 1.6 1.5 Indiabulls Power 1.0 1.8 NA JP Power ventures 3.4 3.8 3.7 KSK Energy 3.4 4.6 4.3 Adani Power 8.4 6.0 4.6 Lanco Infratech 7.3 12.6 NA Average(x) 2.9 3.5 2.3

Source: Bloomberg, Company, Ambit Capital research

Exhibit 9: …given its conservative style of operations; pipeline is negligible given the high uncertainty in the sector

Commissioned Pipeline Pipeline as % of commissioned

JSW Energy 3,140 240 8%

CESC 1,525 4,220 277%

Reliance Power 5,100 20,432 301%

JP Power 2,860 6,560 229%

Adani Power 9,780 660 7%

Tata Power 8,613 4,875 57%

Indiabulls Power 810 1,890 233%

Average 159%

Source: Industry, Company, Ambit Capital research

One of the few companies which generates positive FCF Strong operational performance and minimal capex given a small pipeline of 240MW have meant that JSWE has been reporting a strong FCF. The FCF CAGR over the last three years has been strong at 215% led by low capex and negative cash conversion of 6 days. At present, the FCF yield (FY14 FCF/EV) was at 9.8%. Even NTPC, which is India’s largest utility, does not generate FCF, as its per annum capex of `130bn in the last five years is similar to its average CFO of `130bn during this period.

Given the strong FCF generation, JSWE is now well placed to acquire projects of ~2.0GW. The timing cannot be better due to the presence of a handful of buyers and many sellers. Also, valuation expectations are modest as reflected by the few deals that have happened over the last six months. As per NTPC’s management, about 50-60GW (all owned by the private sector) of projects are on the block, out of which 7-8GW are worth buying.

Exhibit 10: JSWE unlike its peers has been making positive FCF; a rarity in the sector

in ̀ mn FY14 FY15E FY16E

JSW Energy 20,733 26,867 35,450

NTPC 1,384 (3,047) 26,199

Torrent Power 1,052 8,585 16,933

CESC (13,102) (3,832) 12,837

Average 2,517 7,143 22,855

KSK Energy (23,130) (22,561) (9,453)

Reliance Power (26,496) (39,320) (31,383)

Indiabulls Power (27,176) (6,969) 14,427

Lanco Infratech (29,841) (17,246) 1,371

JP Power ventures (34,576) 20,806 20,177

Adani Power (44,220) 2,472 42,511


JSW Energy


However JSWE has failed to capitalise on this Clearly, JSWE’s FY14 net debt equity was strong vs 3.5x for its listed peers. However, JSWE has not been able to capitalise on this, as the management is sceptical about a recovery in domestic coal production and revival of power demand, given SEBs’ dismal financial health. Whilst the management’s scepticism is valid, there is a risk of good assets getting sold.

Recently, Lanco’s Udupi plant with 100% fuel pass-through was sold to Adani and JP’s hydro assets were sold to Reliance Power. During the recent results conference call, NTPC’s management had highlighted that they have received bids for ~55GW of power plants but their due diligence suggests that only 7-8GW of power plants are worth acquiring (with the others facing various challenges from no PPA to no FSA signed and pending environment clearances). Consequently, if JSWE does not act quickly, it may not be able to capitalise on its strong balance sheet.

Adani Power’s recent acquisition of Lanco’s Udupi project and Reliance Power’s acquisition of JP’s hydro portfolio are examples of JSWE missing out. Whilst Udupi was Lanco’s most profitable power plant, JP’s hydro assets earned a PAT of `3.3bn in FY13.

Exhibit 11: Udupi is the most profitable plant for Lanco

PAT in ` mn Capacity (MW) 1QFY13 2QFY13 3QFY13 4QFY13 FY13 1QFY14 2QFY14 3QFY14 4QFY14 FY14

Udupi 1,200 (329) 430 411 (92) 420 (261) (701) 17 2,186 1,241

Kondapalli 734 111 432 (82) (885) (424) -789 -686 -784 -729 (2,988)

Amarkantak 600 (199) (114) (874) 50 (1,137) -560 -502 -226 29 (1,259)

Tanjore 120 152 183 149 141 625 109 120 118 109 456

Anpara 1,200 (1,789) (1,289) (1,397) (1,873) (6,348) -958 -310 -30 -36 (1,334)

Budhil 70 0 (107) 182 (247) (172) NA

Total 3,924 (2,054) (465) (1,611) (2,906) (7,036) (2,459) (2,079) (905) 1,559 (3,884)


Exhibit 12: Recent transactions by foreign and Indian firms of acquiring stakes in Indian power projects

Company Project Consideration (̀ mn)

Stake bought MW Implied

P/B (x) Status of the project

Sembcorp Nellore, Andhra 8,480 45% 1,320 1.0 Fuel linkage and long-term PPA is still awaited

GDF Suez Krishnapatnam, Andhra 9,260 74% 1,000 1.0 PPA and fuel linkage is tied up for only 300MW out of 1,000MW

Adani Power Udupi plant, Lanco 60,000 100% 1,200 1.0 Imported coal-based power plant, with 90% PPA with Karnataka SEB

and 10% with Punjab SEB. Source: Ambit Capital research; Note: We have not included JP Power’s hydro project sale of 1,800MW to Reliance Power as the transaction is at an MOU stage

How much can JSWE acquire?

Assuming no equity dilution and assuming that JSWE can lever its balance sheet to 3x FY14 net debt:equity, we believe JSWE can acquire ~2GW of coal based thermal capacity. We further assume that the total size of the acquisition would be ~`110bn (or at 1xP/B; in line with the recent acquisition multiple). Assuming 10% equity dilution (promoter stake is at 75%); the size of the acquisition can increase to 3.5GW compared to 2GW assuming no equity dilution.

JSWE has failed to capitalise on its strong balance sheet; we fear JSWE may run a risk of good assets getting sold

JSW Energy


Greenfield capex unlikely JSWE may also go slow on bidding for new projects, given the policy issues around lack of clarity on fuel cost pass-through for case 2 projects and banks’ unwillingness to fund projects based on the BOOT model.

Bankers resist the new BOOT model

Bankers have shown resistance in funding new projects on a BOOT basis wherein the developer has to transfer the assets to the utility after 30 years (which can be further extended by another 10 years). Such projects entail huge investments, which could impact their sustainability in the long term if developers are required to transfer them to the utilities. Whilst the BOOT model is being successfully implemented in several highway projects, this may not be suitable for the power sector given the size of the capital investment and the nature of the counterparty risk.

Lack of clarity on fuel pass-through for case 2 projects led to private sector shying away from making investments

Recently, the Odisha UMPP and Tamil Nadu UMPP lacked clarity on fuel pass-through, which resulted in developers refraining from bidding in the Request for Proposal (RFP) round.

Meeting the energy cost of 35paise/unit in Odisha UMPP - a tall task: Eight private sector players submitted bids in the recent pre-qualification bid for the Odisha UMPP; however, the financial bids have not been made, given the lack of clarity on the fuel cost pass-through. For the Odisha UMPP, where a captive coal block has been allocated with fuel cost being a pass through, the fuel cost has been capped at 35paise/unit in accordance with the provisions of Clause 26.2.2 of the draft PPA. A leading industry consultant highlighted that “meeting a production cost of 35 paise per unit is a tough task.”

In order to meet this energy charge, the mining cost has to be restricted to ~`700/MT, given the thumb rule of 0.5kg of coal required in generating 1KWH of power. This is a tall task, given that the cost of mining for Coal India, with far superior mines, is at `800-1,000/MT. Note that even countries like Indonesia (where the strip ratio is favourable) have a mining cost of `500-600/MT.

Tamil Nadu UMPP has no clarification on energy escalation cost: The RFQ document for the Cheyyur UMPP has not clarified the escalation allowed on the energy cost (to be quoted in US dollars) every year. The RFQ only mentions that the fuel charge to be offered by the bidder shall not exceed an amount that reflects ***% of the price of fuel computed with reference to the average API 4 Index (South Africa) for a period of 180 days immediately preceding the date of bid in accordance with clause 26.2.2 of the draft PPA forming part of the bidding document.

Our discussions with companies that had bid in the pre-qualification round suggest that unless the escalation is fully linked to the global indices, developers will not bid in the final round. This is because of the historical high volatility in Indonesian and South African coal prices (see Exhibit 13 below). Also, given the ill fate of incumbents like Adani Power and Tata Power, which have been making losses in projects based on imported coal, we fear that no developer will bid without opting for 100% escalation in energy cost.

Developers are unlikely to bid in the RFP for the Odisha UMPP unless clarity emerges on pass-through of energy cost

Cap of 35paise/unit implies maximum mining cost of `700/MT which is lower vs CIL’s `800-1000/MT

The RFQ document for the Cheyyur UMPP has not clarified the extent of escalation allowed on the energy cost

JSW Energy


Exhibit 13: Indonesian and South African coal prices have been extremely volatile


Exhibit 14: Capped mining cost for captive mine of Odisha UMPP at `700/tonne is 30% lower than Coal India’s average mining cost of `1000/tonne

Source: Industry, Company, Ambit Capital research

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JSW Energy


Share price factoring in near bull-case scenario JSWE’s share price is trading between our ‘base-case valuation of `66/share’ and ‘bull-case valuation of `84/share’, whilst ignoring the probability of our ‘bear case valuation scenario of `48/share’.

Our bull-case valuation of `84/share assumes: (a) JSWE acquires 2GW of coal-fired thermal-based CERC-regulated power plant, having 100% domestic coal linkage with Coal India, for an EV of `110bn/P/B multiple of 1.0x (in line with the recent acquisition multiple); (b) the acquired plant operates at 85% PLF and makes 15.5% RoE; and (c) the entire acquisition is funded using debt; implied net debt:equity of 3.1x on FY14’s equity with 12% cost of debt.

Our bear-case valuation of `48/share assumes: (a) JSWE’s average realisation declines to `3.9/unit in FY15 and `3.7/unit in FY16 (vs our base assumption of `4.2/unit in FY15 and `4.1/unit in FY16) as compared to an average realisation of `4.6/unit in FY14; and (b) the average fuel cost increases to `2.5/unit in FY15 and FY16 (vs our base assumption of `2.4/unit in FY15 and `2.3/unit in FY16) as compared to the average fuel cost of `2.3/unit in FY14.

The fuel cost in the bear case is on the assumption of imported coal price of US$75/MT for South African Richard Bay Coal of 6,000 kcal and US$55/MT for Indonesian coal of 4,200 kcal in FY15 and FY16 (vs our base assumption of US$68/MT for South African Richard Coal of 6,000 kcal in FY15 and FY16 and US$44/MT and US$41/MT for Indonesian coal of 4200 kcal in FY15 and FY16).

Exhibit 15: Sensitivity analysis

Bear Case Base Case Bull case

Acquisition assumption

No Acquisition No Acquisition

JSWE acquires regulated power plant of 2GW for `110bn (debt + equity) with coal linkage from CIL

Funding assumption Entire acquisition is funded by debt implying (net debt: equity of 3.1x on FY14's equity) at 12% cost of debt

Realisation assumption Average realisation at `3.7/unit in FY15 and ̀ 3.9/unit in FY16 (vs `4.6/unit in FY14)

Average realisation at `4.2/unit in FY15 and `4.1/unit in FY16 (vs ̀ 4.6/unit in FY14) Same as base case

Fuel cost assumption Fuel cost increases from `2.3/unit in FY14 to `2.5/unit in FY15 and FY16

Fuel cost increases from `2.3/unit in FY14 to `2.4/unit in FY15 and ̀ 2.3/unit in FY16

TP (̀ /share) 48 66 84


Ambit vs consensus Exhibit 16: Ambit vs consensus

Ambit Consensus Variation (%) Comments

Revenue (̀ mn)

Our EBITDA and PAT estimates are higher than consensus given our assumption of a modest increase in fuel cost of 4% in FY15.

FY15 87,731 92,881 -6%

FY16 86,717 94,286 -8%

FY17 87,135 95,508 -9%

EBITDA (̀ mn) FY15 34,284 32,463 6%

FY16 35,151 31,265 12%

FY17 35,653 29,163 22%

EPS (̀ ) FY15 7.5 7.1 6%

FY16 8.6 7.1 21%

FY17 9.5 6.8 41%


Our bull case assumes acquisition of 2GW coal-fired capacity at 1x P/B having 100% fuel pass-through and regulated RoE of 15.5%

Our bear case assumes average realisation falling to `3.9 in FY15 and `3.7 in FY16 vs our base case assumption of `4.2 and `4.1 respectively and fuel cost of US$75/tonne and US$55/tonne for Richard Bay and Indonesian Eco coal vs our earlier assumption of US$68 and US$44 respectively

JSW Energy


Key assumptions The key assumptions to our estimate of flat revenues over FY14-16 and EPS CAGR of 35% over FY14-16 have been mentioned in the exhibit below.

Exhibit 17: JSWE – key assumptions

Particulars FY13 FY14 FY15E FY16E Comments

Assumptions - Net Generation (mn kwh)

Vijayanagar 9,138 8,578 5,545 5,545 Assumed PLF of 80%

Ratnagiri I 8,448 6,770 7,174 7,174 Assumed PLF of 75%

RWPL 3,310 3,697 4,995 4,995 Assumed PLF of 60%

Total units sold 20,896 19,045 17,714 17,714 Key estimates (`mn unless specified)

Sales 89,343 87,054 87,731 86,717 Revenues to remain flat, in line with generation

Sales (YoY growth) 46% -3% 1% -1%

EBITDA 27,931 32,514 34,284 35,151 Expect EBITDA margin expansion of 320bps over FY14-16 given decline in Indonesian coal prices EBITDA margin (%) 31.3% 37.3% 39.1% 40.5%

EBITDA (YoY growth %) 93% 16% 5% 3%

Interest expense 9,628 12,059 12,199 10,955 Decline in interest expense given strong FCF

Depreciation expense 6,615 8,099 8,121 8,121 Likely to remain flat

PBT 11,857 10,602 15,512 17,839 PAT CAGR of 30% over FY14-16.

Tax rate 23% 27% 20% 20% Assumed tax rate of 20%

PAT 9,124 7,768 12,350 14,204 PAT CAGR of 35% over FY14-16.

PAT (YoY growth) 435% -15% 59% 15%

CFO 17,698 22,691 26,970 35,352 High cash flow from operations owing to minimal investment in working capital

Capex 9,783 4,940 1,584 1,584 Maintenance capex

Free Cash Flow 7,809 20,733 26,939 35,538 JSW to generate strong free cash flows


JSW Energy


SOTP-based fair value of `66/share We have valued JSW Energy using a sum-of-the-parts (SOTP) valuation model based on the discounted free cash flow to equity for each project. Whilst calculating the net present value (NPV) for each project, we use FCFE and discount it assuming a cost of equity of 13%. We arrive at a fair value of `66/share (implied valuation of 1.2x FY16 P/B).

Exhibit 18: SOTP value of JSWE is ̀ 66/share

Projects PV of FCFE (̀ mn) `/share

JSWEL 260 14,661 9

JSWEL 600 30,662 19

JSWREL 1200 30,655 19

RWPL 1080 19,596 12

Cash 5,675 3

Current Investments 6,342 4

154,558 66


Cross-cycle valuation - Unjustified premium Exhibit 19: JSWE is trading at a 16% premium on its three-year one-year forward P/B


Exhibit 20: …and at an 11% premium on its three-year one-year forward P/E


Exhibit 21: We expect JSWE’s ROE to decline to decline 140bps in FY16 to 16.7% and PAT CAGR to slow down to 11% over FY14-16 v/s 87% over FY12-14


At CMP, JSWE is trading at 1.6x one-year forward P/B, at a 16% premium to its three-year one-year forward P/B. On comparing with the five-year one-year forward P/B, the stock is trading at an 18% discount. However, the five-year average is not comparable given the irrational valuation in the Utilities sector over 2009-2011 consequent to the attractive merchant tariffs. On comparing with three-year one-year forward P/E, JSWE is trading at a premium of 11%.

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JSW Energy


Relative valuation - Punchy premium of 32% to peers on FY16 P/B At CMP, JSWE is trading at 1.4x FY16 P/B. This is despite RoE falling to 17% in FY16 as compared to 18% in FY14 and EPS CAGR of 11% over FY14-16 vs 87% over FY12-14. When compared with peers like TPWR, NTPC and CESC, JSWE is trading at a marginal premium of 8%. Whilst JSWE’s FY16 RoE is superior to these peers’ 13%, there is no visibility on growth, given its minimal pipeline of 240MW. These peers, on the other hand, have a strong pipeline coupled with a strong balance sheet to fund this as and when the visibility on ramp up of domestic coal production improves and clarity emerges on fuel pass-through bids. Consequently, we believe there is limited scope for JSWE’s valuation multiple to re-rate from the current levels. Further, if merchant prices in south India start to correct and imported coal prices start to rise, then this will not augur well for JSWE’s profitability, as it is exposed on both tariff and fuel cost. Consequently, its valuation multiple will also get de-rated.

Exhibit 22: JSWE is trading at a 32% premium to its peers on FY16 P/B

Companies CMP Mcap 3m ADV P/B (x) EV/EBITDA (x) P/E (x) CAGR (%) (FY14-16) RoE (%)

INR US$ mn US$ mn FY15 FY16 FY15 FY16 FY15 FY16 Revenue EPS FY14 FY15 FY16

NTPC 141 19,208 5.4 1.3 1.2 8.8 8.2 11.7 11.3 1% -3% 13% 11% 11%

Reliance Power 77 3,567 14.9 1.1 1.0 15.8 9.8 20.4 15.9 40% 17% 5% 5% 6%

CESC 700 1,442 5.4 1.4 1.3 8.9 6.6 15.1 10.3 18% 26% 10% 9% 13%

JP Power ventures 15 714 5.6 0.6 0.6 10.0 7.0 10.9 6.6 61% 81% 3% 6% 10%

KSK Energy 93 634 0.4 1.0 1.0 15.4 6.3 N.A. 18.2 68% N.A. -6% -5% 6%

NHPC 22 3,996 4.6 0.8 0.8 8.2 7.9 10.4 9.5 10% 8% 7% 8% 8%

SJVN 14 355 2.3 0.9 0.8 16.8 9.8 N.A. N.A. 35% N.A. -4% -18% -16%

Adani Power 51 2,420 10.9 1.8 1.4 6.4 6.7 8.1 8.1 19% 121% 7% 24% 20%

Torrent Power 139 1,085 3.8 1.0 0.9 6.2 6.0 13.7 11.4 7% 131% 2% 7% 8%

TPWR 90 4,022 14.9 1.6 1.3 4.5 4.4 10.8 9.0 9% NA -2% 17% 16%

JSW Energy 79 2,086 3.4 1.6 1.4 6.2 6.0 10.3 8.9 0% 11% 18% 17% 17%

Average (excl. JSWE) 1.2 1.1 9.7 7.1 12.4 10.9 24% 49% 5% 7% 9%

Divergence (%) 39% 32% -36% -14% -15% -17% -2,400bps -3,800bps 1,300bps 1,000bps 800bps

Source: Bloomberg, Ambit Capital research, Note: Valuation as on 2 September 2014; NTPC, APL, TPWR, Torrent Power, JSWE are Ambit estimates and others are Bloomberg estimates

JSW Energy


Key catalysts Decline in merchant tariff post the successful integration of the National Grid with

the Southern Grid is a key risk. This is because the merchant realisation in south India was at `5.3/unit in FY14 (vs India’s average merchant realisation of `2.8/unit in FY14). Once the integration of the Southern Grid with the National Grid is completed successfully, we expect ~4GW of additional supply in the southern region as compared to peak deficit of ~3GW in FY14.

Increase in prices of imported coal is also a key risk, as ~51% of JSWE’s portfolio is sold in the merchant market which does not have a fuel pass-through. Indonesian coal prices as on date at US$40/tonne for 4,200Kcal coal are 37% below the peak prices in March 2011 and only 16% higher as compared to the all-time low prices of US$35/tonne.

Key risks Inorganic acquisition is the biggest upside risk to our SELL stance. Our sensitivity

analysis suggests an upside of `18/share to our SOTP valuation, assuming JSWE leverages its balance sheet to a net debt:equity ratio of 3x and buys a coal-based power plant with 100% fuel pass-through at a total consideration of `55mn/ MW. However, the CMP is only 7% lower than our bull-case target price of `84/share.

Increase in merchant tariff with an increase in power demand due to a pickup in industrial activity is also a risk. Note that power demand over FY12-14 in south India increased by a meagre 3% CAGR, given the weak IPP growth of 0.5% during the period. However, power demand in south India increased at CAGR of 8% over FY08-10 when IIP grew by 4%.

Another risk is the award of domestic coal linkages to imported coal-based power plants despite them selling power in the merchant market. Assuming the cost of domestic coal is lower by Re1/unit as compared to imported coal cost of `2.3/unit, JSWE’s FY14 PAT of `11.5bn could increase by 133% to `26.9bn.

Accounting analysis – Clean chit Exhibit 23: Accounting flags

Field Score Comments

Accounting GREEN In our accounting analysis of utilities, JSWE scores in the top quadrant given the superior capital employed turnover, CFO/ EBITDA and low percentage of non-operating expenses.

Predictability RED With only 39% fuel linkage and 52% offtake tie-up, the predictability for JSWE’s profitability is low. Further, over the last five quarters, the company has surprised consensus negatively with an average deviation of 17%.

Earnings momentum GREEN Over the last three months, consensus EPS estimates for FY15 have been revised upwards by ~17%.


JSW Energy


Balance Sheet

Year to March (̀ mn) FY13 FY14 FY15E FY16E FY17E

Cash 3,989 5,675 10,267 24,703 39,839

Debtors 18,487 11,976 15,353 15,320 15,249

Inventory 4,415 4,158 8,042 7,226 7,261

Loans & advances 18,316 19,266 19,266 19,266 19,266

Investments 9,549 8,877 8,877 8,877 8,877

Fixed assets 148,741 142,387 135,850 129,313 122,776

Miscellaneous 279 106 106 106 106

Total assets 203,776 192,444 197,761 204,811 213,373

Current liabilities & provisions 44,753 32,896 36,009 39,002 41,988

Debt 95,008 91,400 81,253 71,106 60,959

Other liabilities 1,976 2,436 2,436 2,436 2,436

Total liabilities 141,737 126,732 119,699 112,545 105,384

Shareholders' equity 16,401 16,401 16,401 16,401 16,401

Reserves & surpluses 45,638 49,311 61,662 75,866 91,589

Total networth 62,039 65,712 78,062 92,266 107,989

Net working capital (3,535) 2,504 6,651 2,809 -213

Net debt (cash) 91,019 85,726 70,986 46,403 21,121


Income statement


Operating income 89,343 87,054 87,731 86,717 87,135

% growth 46.0 (2.6) 0.8 (1.2) 0.5

Operating expenditure 61,412 54,540 53,447 51,565 51,482

EBITDA 27,931 32,514 34,284 35,151 35,653

% growth 92.9 16.4 5.4 2.5 1.4

Depreciation 6,615 8,099 8,121 8,121 8,121

EBIT 21,316 24,415 26,163 27,030 27,532

Interest expenditure 9,628 12,059 12,199 10,955 9,736

Non-operational income / Exceptional items 169 2,022 1,548 1,764 2,061

PBT 11,857 14,378 15,512 17,839 19,856

Tax 2,733 2,834 3,162 3,635 4,134

Reported PAT 9,124 11,544 12,350 14,204 15,723

Adjusted PAT 11,089 11,544 12,350 14,204 15,723

% growth 234.1 4.1 7.0 15.0 10.7


JSW Energy


Cash flow statement


PAT 11,857 8,012 12,350 14,204 15,723

Depreciation 6,615 8,746 8,121 8,121 8,121

Interest 9,627 12,059 12,199 10,955 9,736

Other Income (1,069) (1,100) (1,546) (1,761) (2,057)

(Incr) / decr in net working capital (6,873) (4,942) (4,148) 3,842 3,022

Others (2,459) (85) (6) (9) (12)

Cash flow from operating activities 17,698 22,691 26,970 35,352 34,533

(Incr) / decr in capital expenditure (9,783) (4,940) (1,584) (1,584) (1,584)

(Incr) / decr in investments (1,217) 1,048 - - -

Others 1,111 1,934 1,552 1,770 2,069

Cash flow from investing activities (9,889) (1,958) (31) 187 485

Issuance of equity - - - - -

Incr / (decr) in borrowings 3,819 (2,701) (10,147) (10,147) (10,147)

Others (10,662) (15,889) (12,199) (10,955) (9,736)

Cash flow from financing activities (6,843) (18,591) (22,346) (21,102) (19,883)

Net change in cash 966 2,143 4,593 14,436 15,135

Free Cash Flow 7,809 20,733 26,939 35,538 35,019


Ratio Analysis

Year to March (%) FY13 FY14 FY15E FY16E FY17E

EBITDA margin 31.3 37.3 39.1 40.5 40.9

EBIT margin 23.9 28.0 29.8 31.2 31.6

Net profit margin 10.2 13.3 14.1 16.4 18.0

Return on capital employed 13.9 15.5 16.5 16.8 16.6

Return on equity 15.3 18.1 17.2 16.7 15.7

Return on invested capital 17.3 17.5 17.9 17.7 17.5

Current ratio (x) 1.0 1.2 1.5 1.7 1.9


Valuation parameters

Year to March FY13 FY14 FY15E FY16E FY17E

EPS (`) 5.6 7.0 7.5 8.7 9.6

Book value per share (`) 37.8 40.1 47.6 56.3 65.8

P/E (x) 14.2 11.2 10.5 9.1 8.2

P/BV (x) 2.1 2.0 1.7 1.4 1.2

EV/EBITDA (x) 7.7 6.6 6.3 6.1 6.0

EV/Sales (x) 2.4 2.5 2.5 2.5 2.5


JSW Energy


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Geared for the next leg of growth Tata Power (TPWR) is the best-placed company on our competitive matrix (alongside NTPC), as more than 90% of its assets have fuel linkages and secured off-take. We expect TPWR’s RoE to improve from -2% in FY14 to 16% in FY16 due to lower losses in Mundra; we continue to assume that TPWR will receive the compensatory tariff hike. Moreover, TPWR’s net debt:equity may reduce to 1.0x by FY16 (vs 3.1x in FY14) if it is able to sell its stake in the Arutmin and KPC mines. This should provide enough ammunition to fund the next leg of growth as domestic coal production ramps up and clarity on fuel pass-through for case 2 bids.

Competitive position: STRONG Changes to this position: POSITIVE

Best placed on our competitive matrix

TPWR is best placed (alongside NTPC) on our competitive matrix which maps India’s top-11 power companies on off-take and fuel risk. We prefer TPWR over NTPC, as we estimate higher FY14-16 EBITDA CAGR of 16% for TPWR vs only 3% for NTPC (due to the CERC’s adverse tariff regulations). Further, if domestic coal production ramps up and clarity emerges on fuel pass-through, TPWR would be better positioned to add capacities (given its low base of 8GW vs NTPC’s 43GW). Strong balance sheet to fund the next level of growth

TPWR recently raised equity of `19.9bn through a rights issue, out of which `11.7bn will be used for repaying the debt. Consequently, the FY15 net debt:equity is likely to improve to 1.8x vs 3.1x in FY14. If TPWR is able to sell its stake in Arutmin and KPC for US$510mn and $250mn this year, the FY16 net debt:equity can reduce to 1.0x. This should position TPWR favourably to fund the next level of growth. Coastal Maharashtra (1.2GW), Mundra (1.6GW) and Maithon expansion (1.3GW) are already in the development stage. Supreme Court order negative but we remain optimistic on tariff hike

The Supreme Court (SC) recently stayed APTEL’s order on granting a prospective tariff hike to TPWR. The SC directed APTEL to pass the order expeditiously. Whilst this is negative (as it delays the receipt of the tariff hike), TPWR would likely get the hike, as the change in the Indonesian law has led to a higher-than-expected increase in coal cost, making the PPA at the agreed price unviable. The Mundra project was envisaged to be operated on imported coal, for which TPWR had purchased a 30% stake in Bumi’s mines.

Valuation: Attractively valued

At CMP, the stock is trading at FY16 P/B of 1.3x, a 34% premium to its peers. Given TPWR’s higher FY16 RoE of 16% (vs peers’ 9%) and with its EPS turning positive, we think the premium is justified. The premium may widen, as TPWR deleverages its balance sheet to fund the next leg of growth.

Tata Power BUY

COMPANY UPDATE TPWR IN EQUITY September 03, 2014

Key financials YE March (̀ mn) FY13 FY14 FY15E FY16E FY17E Operating income 330,254 356,487 401,116 426,971 431,519 EBITDA 66323 77065 101728 103048 97020 EBITDA (%) 20.1 21.6 25.4 24.1 22.5 Net profit 7,646 (2,600) 22,480 26,137 27,890 EPS (`) 3.2 (1.1) 8.3 9.7 10.3 RoE (%) 6.6 (2.3) 16.7 15.5 14.3 P/E (x) 27.9 NA 10.8 9.3 8.7 P/BV (x) 1.9 1.9 1.6 1.3 1.2


Utilities

Recommendation Mcap (bn): `243/US$4.0 6M ADV (mn): `177/US$3.3 CMP: `90 TP (12 mths): `111 Upside (%): 23

Flags Accounting: GREEN Predictability: RED Earnings Momentum: GREEN

Catalysts Favourable order from APTEL for

compensatory tariff hike

Arutmin and KPC stake sale transaction

Awarding distribution circle licences

Performance (%)


Analysts Details

Bhargav Buddhadev [email protected] +91 22 3043 3252

Deepesh Agarwal [email protected] +91 22 3043 3275

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Key assumptions The key assumptions to our estimates of 9% revenue CAGR and 16% PAT CAGR over FY14-16 have been mentioned in the exhibit below.

Exhibit 1: Tata Power – key assumptions

Assumptions FY13 FY14 FY15E FY16E Comments

Gross generation (mn kWh)

Mundra (4,000MW) 12,440 23,928 22,848 29,784 We model PLF of 63% in FY15 and expect this to ramp up to 82% in FY16.

Maithon (1,050MW) 4,587 6,328 7,818 7,818 We model ramp up in PLF to 85% in FY15 and FY16 vs 69% in FY13.

Trombay 9,424 7,083 11,654 11,654 We model ramp up in generation in FY15 and FY16, consequent to modernisation of Unit 6 (500MW).

Jojobera 3,067 2,832 3,187 3,187 We model ramp up in PLF to 85% in FY15 and FY16 vs 76% in FY14 and 82% in FY13.

IEL 1,705 1,694 1,787 1,787

Haldia 925 942 894 894

Key output (̀ mn)

Sales 330,254 356,487 401,116 426,971 Consequently, we expect revenue CAGR of 9% over FY14-16.

Sales (YoY growth) (%) 27% 8% 13% 6%

EBITDA 66,323 77,065 101,728 103,048 EBITDA margin to increase by 250bps YoY, consequent to compensatory tariff hike at Mundra. EBITDA margin (%) 20% 22% 25% 24%

EBITDA (YoY growth) (%) 25% 16% 32% 1%

Interest expense 26,355 34,399 35,239 32,608 Interest expense is likely to decline consequent to reduction in debt; TPWR plans to repay ̀ 6bn debt from the `19bn equity proceeds raised from the rights issue

Depreciation 20,517 27,296 26,829 27,222

PBT 21,267 9,751 41,490 49,246 Trickle-down impact of EBITDA.

Tax 55% 103% 36% 36% Tax rate would decline, as Mundra would break-even, consequent to compensatory tariff hike. Note that Tata Power was not able to set off Mundra's losses, as they are in CGPL (a 100% subsidiary).

APAT after minorities 7,646 -2,600 22,480 27,187 Consequently, APAT to turn positive.

PAT (YoY growth) (%) -110% NA NA 19%

CFO 32,796 64,831 64,523 63,325 Tata Power has been consistently generating positive cash flows from operations.

Capex 42,702 43,086 11,718 10,568 We model maintenance capex in FY15 and FY16.

Free cash flow -10,067 4,108 52,804 52,757 We expect FCF to increase to 13.0x in FY15 due to maintenance capex and Mundra tariff hike


We value Tata Power, using SOTP and DCF-based valuation, at `111/share.

Exhibit 2: Tata Power’s SOTP-based TP – ̀ 111/share

Project FCFE to shareholders (̀ mn) Value per share

Mundra 12,237 5

Maithon 18,724 7

Bumi 62,123 23

Powerlink 7,678 3

NDPL 16,229 6

Haldia 6,235 1

Jojobera 14,829 5

IEL unit 6 4,145 1

IEL unit 5 7,792 2

Mumbai Circle 99,234 37

Wind capacity 8,392 3

Investments 26,658 9

Cash 27,430 10

Total 311,707 111


Tata Power


Balance Sheet – Consolidated


Networth 113,427 113,238 155,638 182,825 212,399

Loans 366,465 366,767 394,741 385,343 369,196

Other liabilities 79,495 120,739 106,086 96,944 74,406

Sources of funds 559,387 600,745 656,465 665,112 656,001

Net block (incl. CWIP) 437,109 467,823 452,712 436,059 419,038

Net current assets 11,334 (18,159) 67,324 101,768 132,215

Investments 110,945 151,081 136,428 127,285 104,747

Application of funds 559,387 600,745 656,465 665,112 656,001


Profit and loss – Consolidated


Revenue 330,254 356,487 401,116 426,971 431,519

EBITDA 66,323 77,065 101,728 103,048 97,020

Depreciation 20,517 27,296 26,829 27,222 27,589

Interest expense 26,355 34,399 35,239 32,608 28,729

Other income 1,816 (5,619) 1,830 6,028 7,935

PBT 21,267 9,751 41,490 49,246 48,638

Provision for taxation 11,780 10,084 14,937 17,729 14,440

Consolidated adj PAT 7,646 (2,600) 22,480 27,187 29,574

EPS diluted (`) 3.2 (1.1) 8.3 10.1 10.9


Cash flow statement – Consolidated


PBT 21,267 9,751 41,490 49,246 48,638

WC changes (23,511) (226) 15,214 8,916 1,568

CFO 32,796 41,527 64,523 63,325 58,731

Net capex (42,702) (43,086) (11,718) (10,568) (10,568)

Net Investments (161) 5,667 - - -

CFI (42,863) (37,418) (11,718) (10,568) (10,568)

Proceeds from borrowings (5,867) (32,654) 32,380 (5,067) (11,523)

Issue of equity - - 19,764 - -

CFF (5,867) (32,654) 52,144 (5,067) (11,523)

FCF (10,067) 4,108 52,804 52,757 48,163


Ratio analysis / Valuation parameters

Year to March FY13 FY14 FY15E FY16E FY17E

Revenue growth (%) 27.0 7.9 12.5 6.4 1.1

EBITDA margin (%) 20.1 21.6 25.4 24.1 22.5

Net margin (%) 2.3 (0.7) 5.6 6.4 6.9

RoCE (%) 9.8 10.4 14.5 13.6 12.1

RoE (%) 6.6 (2.3) 16.7 16.1 15.0

Net debt / Equity (x) 3.1 3.1 1.8 1.2 0.8

P/E (x) 27.3 NA 10.8 9.0 8.2

P/B(x) 1.8 1.8 1.5 1.3 1.1

EV/EBITDA(x) 6.8 5.9 4.5 4.4 4.7

EPS diluted (`) 3.2 (1.1) 8.3 10.1 10.9


Tata Power


Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta Banking / Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Aditya Khemka Healthcare (022) 30433272 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 [email protected]

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Real Estate (022) 30433205 [email protected]

Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave Healthcare (022) 30433212 [email protected]

Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Retail (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Midcaps – Chemical / Retail (022) 30433242 [email protected]

Ritesh Vaidya Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Tanuj Mukhija, CFA E&C / Infra / Industrials (022) 30433203 [email protected]

Utsav Mehta Technology (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction

Tata Power


Explanation of Investment Rating Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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