Tata Power - Not Powerful Enough

The power sector has been in the news quite often these days, especially coal prices and power tariffs which have grabbed television headlines and reams of newsprint. Macro issues like govt. policies, low tariff rates and the weak financial conditions of state electricity boards (SEBs) have seen the power sector index decline by as much as 34% on a year-to-date (YTD) basis compared to the 20% decline of the Sensex, indicating investor bearishness on the sector. In a scenario like this, Tata Power, a leading private sector player in the power industry, intends to ramp up its installed capacity by 2.7x between FY12 and FY13.

This is exactly the factor that has put the company and its stock on our radar. The scrip has corrected by almost 23% on an YTD basis. What prompts the management to go in for such a capacity expansion? Going forward, where is this company headed? Will it deliver decent returns to shareholders once the broader market sentiment improves? Here is a detailed analysis of the various factors, done after due discussions and deliberations with the company management which seeks to answer all of the above questions.

Company Background

Tata Power (TPC) has over the years firmly established itself across the entire value chain of the power business. From generation to transmission and distribution to trading, the company has a demonstrated capability in each of the segments. In addition to this, it also has a presence in a range of ancillary and synergistically well-aligned businesses to the power sector, including coal, fuel logistics, manufacture of solar photovoltaic cells, engineering and consulting.      

The business of TPC is categorised in three main segments: power, coal and other businesses. The company, as of Sept 2011, has a capacity to generate 3,701 MW of power, 80% of which is thermal, 12% is hydro and the balance 8% is from renewable resources. As for the other areas of business across the value chain of the power sector, the company operates transmission lines between Bhutan and India and distributes power in the metro cities of Mumbai and Delhi.

Future Expansion Plans

Through its various projects, the company is executing power projects which will culminate in a generation capacity of 5,351 MW. The 1,050 MW Maithon project is progressing well and its first unit of 525 MW has already been commissioned. TPC is also executing the 126 MW Dagachhu hydro-power project in Bhutan. This project is expected to be commissioned by FY13 and it has signed a power purchase agreement (PPA) with Tata Power Trading Company. The Mundra ultra mega power plant (UMPP), the biggest project of TPC, is also on the verge of completion. The total project cost of this UMPP is Rs 17,000 crore which is funded through a mix of debt and equity. This project is based on a 100% sourcing of Indonesian coal, with 25% at a fixed price and 75% at a benchmark price.

Recently, the Indonesian government asked its miners to sell all coal at benchmark prices due to which TPC will see about US$ 30-35 rise in the price of the fixed component of coal. As per management estimates, under the current tariff norms, this project will suffer a loss of about Rs 480 cr when it is fully commissioned. The TPC management is negotiating with the government for tariff hikes. It is also seeking possibilities of running the plant on low calorific value coal which is available at a cheaper cost in various countries. On the distribution front TPC has commissioned two distribution sub-stations, 50 consumer sub-stations and has added 105 CKm of cable network, taking the total length of its distribution network to 1,350 Ckm.

Its subsidiary, Strategic Electronic Division (SED), which is in the defence electronics business, has recently bagged Rs 1,094 cr worth of orders to modernise 30 air bases of the Indian Air Force (IAF). Revenues from this project will improve TPC’s margins and broaden its reach into the modernisation of airfield infrastructure which has become a priority for the IAF. We see more such orders in the future.

Financial Performance

On the financial front, the company has shown stable growth in its topline. For FY11 its revenues stood at Rs 19,861 cr, compared to Rs 19,574 cr in FY10. Its bottomline growth remained silent with net profit that was just 2% higher at Rs 2,181 cr. Its revenue from the power business has remained quite stable for the last 3 years. For FY11 its total forex outgo was Rs 1,241 cr compared to its forex earnings of Rs 117 cr. In the current scenario of a depreciating rupee, the mounting interest expenses would be a big concern for the company.


TPC entered the coal business by acquiring a 30% stake in the coal mines in Indonesia for around US$ 1.2 billion through a special purpose vehicle. This segment is contributing strongly towards the growth of the company. The acquisition was at first financed through bridge loans of US$ 950 million, and later refinanced with a non-recourse loan of US$ 590 million and a recourse facility of US$ 270 million. The remaining US$ 90 million was paid through a mix of short-term loans and surplus funds available with the company.

The parent companies owning these coal mines have raised US$ 450 million through a hybrid issue guaranteed by TPC, which was used to prepay the non-recourse loans. As of March 31, 2011 the outstanding debt stood at US$ 790 million. In the 2nd quarter of FY12, TPC has disappointed with a net loss of Rs 1,219 cr. This is primarily on account of a forex loss of Rs 638.96 cr and a provision for impairment of Rs 823 cr for its Mundra project. Though its revenues in the power business grew by 31% and those in the coal business increased by 47%, its Mundra project puts its earnings visibility into doubt.

Valuation And Investment Rationale

There are some good things about this company worth noting. First, the company has been in the power sector for almost 9 decades which underlines it long-term sustainability. Second, it is building large capacities which will take its total capacity to 8,527 MW by FY13. Third, the company has a secured coal supply for its projects in the pipeline. The reason why we believe TPC will do well in the long term is that the increasing volumes of coal will increase the share of its coal business which has a better realisation. Maithon, which is based on a regulated returns model, has started adding to the revenues. Compared to its peers, TPC is fairly well-equipped with fuel linkages and PPAs.

However in the shorter term there are some concerns. We expect the Mundra project to impact its bottomline in FY12 and FY13. Even though its Unit 1, which is expected to be commissioned in January 2012, has an inventory of coal for about 4-5 months, its other units are expected to be commissioned within an interval of 3-4 months in FY13 which will require coal that will have to be acquired at benchmark prices. In the current scenario, Mundra will incur losses as the tariffs are not yet revised upwards. Considering this, the company has already started making provisions for the impairments related to the Mundra project. Also, revenues from the other capacities may partially offset the losses from the Mundra project when they are commercially operational.

Having said that, we think the power tariffs are likely to be revised upwards. Recently some SEBs have hiked the tariffs which has created a positive environment. Despite the fact that the tariff hikes were not high enough, there is still dissatisfaction among the public about the hike. It should be noted that the prices of all the commodities have gone up but power tariff hasn’t gone substantially up for the last five years. A sudden hike has agitated the public and hence the government would take a stepwise approach. We therefore believe that there would be hikes in the next few years but political compulsions may restrict the quantum of these hikes.

On the valuations front, currently its EV/MW stands at Rs 12.81 cr, which looks quite expensive compared to that of the bigger players like NTPC which is at Rs 4.67 cr per MW. This looks bit on the higher side as the company is in a massive expansion mode, but once the expansion is completed and the projects go live the same would fall. Even after considering the expansion the same stands at Rs 5.24 cr per MW. We believe that the company may not report good numbers in the remaining 2 quarters of the current financial year and hence underperform the broader market. We would suggest our readers to stay away from the counter at the present moment.