Spark capital power utilities sector update march 2012

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Spark capital power utilities sector update march 2012

  1. 1. Indian Ports Initiating CoverageIn the build-out phase Sector Outlook Positive Indian Power Utilities Sector Update March 2012 1
  2. 2. Power UtilitiesWith ‘no power’ comes great responsibility Sector view PositiveIndian power sector (particularly generation utilites) has gone through a complete metamorphosis, with almost Date Mar 09, 2012all aspects taking a turn for the worse, over the last 18 months. With the Government showing signs ofintervention, the extent of relief that will be felt by our coverage companies will depend on the nature of Market Datameasures adopted and the totality of such measures. Now, on to our reality checks on potential reforms: SENSEX 17120• Domestic Coal – Domestic coal supply will continue to be short of demand for power sector (~100MT in FY12E to increase to ~184MT by FY15E). Hence Coal India (CIL) likely to be compelled to make available a greater quantity of BSE Power 2165 coal to power plants with linkages and sign FSAs with a minimum guaranteed commitment of ~80% for the eligible LoAs Market Performance (%)• Imported coal and coal price pooling – Given that CIL can ramp-up production at not more than ~5% CAGR over the next few years it will be forced to consider costlier coal imports to meet the shortfall, in which case it will possibly resort 1m 3m 12m to price pooling to ensure that the incremental cost of imports is absorbed Sensex -3% 1% -6%• Domestic Gas - With gas production at KG-D6 expected to drop further even from the ~36mmscmd in Jan’12, PLFs of second-generation gas-based power plants are expected to stay adverse. With increased allocation of APM gas to the BSEPowr 2% 7% -16% power sector not materializing, the completed power projects awaiting gas allocation are unlikely to commence operations over FY13-14 BSE Power vs Sensex - Relative performance• Tariff reforms – Considering the large scale ramifications, the Government has been wary to take-up tariff reforms 15% 10% aggressively or to back the interests of private developers. Nevertheless PPA reforms (hiking tariffs) to allow a 5% reasonable pass-through of fuel costs which will go hand-in hand with consumer-level tariff is a key theme, we expect, 0% -5% will play out over the next year - the single largest reason for our positive view on power utilities as a space Closing price -10% -15%• Unlike the fossil fuel-based gencos, the hydel utilities face negligible operational risk. However the key adverse variable -20% -25% for these utilities remains project delays for multitude of reasons. PGCIL on the other hand, we believe, will increase -30% -35% capex over FY13-14, driving transmission capex May-11 Nov-11 Jul-11 Mar-11 Mar-12 Jan-12 Sep-11• Given the high importance of power sector (~30% of 11th Plan infrastructure spend and 8% of bank credit), we believe the aforesaid measures will be taken. However, we are currently unsure of the totality of these measures and time that BSE Power Sensex will be taken. Hence, in the interim, we recommend a portfolio approach to investing in utilitiesOur top Buys are Lanco, CESC and GIPCL as we believe that the current stock prices does not factor-in Vijaykumar Bupathyimprovement in business fundamentals, which we think is misplaced. While Lanco will be a focused play on vijaykumar@sparkcapital.insector fundamentals improving, the latter two names will serve as portfolio shock absorbers in case the reform +91 44 4344 0036measures are indefinitely delayed. We also turn positive on PGCIL given the low operational risk involved andimproved growth prospects. Our top shorts are Adani Power and GMR - while on Adani Power, the reason for our Bharanidhar Vijayakumar bharanidhar@sparkcapital.innegative call is because of being exposed on fuel and tied to low-priced PPAs, our view on GMR is largely on +91 44 4344 0038account of stress from non-utility assets (chiefly airports vertical). Find Spark research on Bloomberg (SPAK <go>), Thomson First Call, Reuters Knowledge and Factset 2
  3. 3. Power UtilitiesViews on StocksCompany View Rating • With ~2GW at Mundra and ~2.2GW of pipeline projects (Tiroda) not having a secured coal supply, fuel supply concerns outweigh SELL the positives of strong execution capabilities TP: Rs. 46 • Given that the production at Bunyu mine has been delayed significantly Adani Enterprises is supplying coal at a much higher rate CMP: Rs. 76Adani Power (~USD 90/ tonne) compared to the contracted rate of USD 36/ tonne, thereby eroding the near term profits. Also Adani Enterprises could hike transfer price of coal to Adani Power due to the recent change in Indonesian regulations • Company is not hedged for such unanticipated increases in fuel cost as all the PPAs are on fixed levelised tariffs • Moreover, stock trades at a significant premium to our DCF valuation of Rs. 46 per share, leading to our Sell rating • Scores high on fuel security with >50% of total annual coal requirement for the operational plants being supplied from the groups BUY captive mine (ICML); firm coal linkages exist with CIL for the additional requirement TP: Rs. 350 • Has a stable fixed-RoE based business model with a full pass through of fuel costs as well as operating costs; WBERC approved CMP: Rs. 265 new tariffs for the period 2011-14 with an average tariff hike of ~13% giving good revenue visibility for this periodCESC • Pipeline projects of 1,200MW are seeing swift execution, with 600MW at Haldia and 600MW at Chandrapur expected to be commissioned by FY14. As both plants have CIL linkages for coal, coal supply risk exists • Stock trades at a steep (~31%) discount to our DCF valuation of Rs. 373 per share leading to our bullish stance on the stock due to the fixed RoE model with the ability to pass-on fuel costs. Reiterate Buy • We like the Company’s fuel security as 500MW out of the total 810MW operational capacity have captive mines supplying lignite. BUY Companys pipeline project of 500MW is also based on lignite from the captive mines. TP: Rs. 88 • Though fuel security exists for gas based generation plants (310MW) through firm fuel supply commitments from GAIL & KG D6, CMP: Rs. 71 gas shortage has affected the company’s generation during FY12 and we continue to factor-in low PLFs going forwardGIPCL • Has an attractive fixed-return business model with assured power off take agreements for the entire operational capacity with GUVNL at tariffs set by GERC enabling cost-pass through. Stabilization of the 2nd unit of the power plant at Surat implies limited risks to earnings • Stock is currently trading at low valuations (<0.7x FY13E P/B) and with an expected dividend yield of 4% it is highly attractive in our view. Reiterate Buy 3
  4. 4. Power UtilitiesViews on StocksCompany View Rating • Company’s power segment faces multiple risks such as gas shortage to operational plants, gas allocation to the merchant plant at SELL Kakinada being cut, projects under construction without gas allocation and rigid PPA tariffs TP: Rs. 25 • Also the airports segment faces multiple headwinds such as imposition of a single till regulation at Hyderabad and persistent CMP: Rs. 28 delays in getting higher airport charges sanctioned at Delhi. As a result, the segment is making significant losses, largely onGMR account of Delhi Airport • Has a complex corporate structure with multiple / unrelated infrastructure assets comprising airports, roads, power plants and SEZs • Trades close to our revised DCF valuation of Rs. 25 which factors in realistic outcomes when several stocks are trading at steep discounts. Reiterate Sell • The power segment faces multiple risks such as gas shortage to operational plants and delays in development of the captive REDUCE mine which is to supply coal to the pipeline project TP: Rs. 17 • Airports segment faces key risks such as lack of regulatory clarity on airport vertical such as suspension of ADF collection at CMP: Rs. 18GVK Mumbai, imposition of single till at Bangalore and repeated delays in real estate monetization at Mumbai airport • Also the Company depends on a fund-raise at the airport holding company level to claw out of the debt trap necessitated by stake acquisitions in Mumbai and Bangalore airports • Trades at a premium to our DCF valuation of Rs. 17 per share. Reiterate Reduce • Power segment faces multiple risks such as coal shortage (at Amarkantak I, II and Anpara), gas shortage (at Kondapalli I, II), BUY merchant plants dependent on linkage coal / gas, capacity additions awaiting gas linkage (Kondapalli III), transmission lines not TP: Rs. 32 being ready to evacuate power (Udupi Unit 2) and rigid PPA tariffs (Amarkantak II) CMP: Rs. 20 • Has fuel cost pass-through for ~63% of total operating capacities inbuilt in the PPAs (Kondapalli I supplies to APTRANSCO at tariffs having a fuel cost component, similarly Aban’s PPA with TNEB and Udupi’s PPA with Karnataka have fuel cost passLanco throughs) hedging the company against fuel cost increases for these plantsInfratech • The 1.2GW at Anpara will be a direct beneficiary a of the recent directive from PMO obligating CIL sign FSAs for all plants that have turned operational by Dec’2011 • Has strong growth opportunity in the power segment which will grow to ~3.9GW of capacity by FY13 and eventually to ~9GW from 2.7GW now • Has strong EPC capabilities with timely project execution as well as exposure to a resource play in Griffin. Trades at a steep discount to our SoTP valuation of Rs. 32/ share and we believe the risks are more than priced into the CMP. Reiterate Buy 4
  5. 5. Power UtilitiesViews on StocksCompany View Rating • Has fuel security from Singareni Collieries for the plants in Andhra Pradesh and the projects under construction (64MW at Orissa BUY and 150MW at Paloncha). Risks exist for the existing 64MW at Orissa on fuel shortage from CIL and the tariff hike sought with TP: Rs. 247 OERC not being approved CMP: Rs. 195 • Has tied-up merchant contracts at attractive rates of Rs. 4.7 levels for the period Jan-May 2012 and >Rs. 4 thereafter. AllNava Bharat merchant sales are through intermediaries in the short term market where NBVL does not take up receivable riskVentures • At Maamba, high-grade coal sales will commence from April 2012 and the company expects to sell ~0.4mn tons, 0.6mn tons and 1.0mn tons in FY13E, FY14E and FY15E respectively, thereby driving >20% consol profits by FY15E • Will transform itself into a diversified infra player with operations across Africa, India and South East Asia. Consolidated profits expected to grow to Rs. 3.4bn in FY14 (45% CAGR over FY12-14E), with a high RoE profile. Trades inexpensive at P/E of ~7x and ~0.7x of book value (FY13E). Reiterate Buy • Faces consistent delays in commissioning of expansion projects due to various external / other factors; only ~150MW expected to REDUCE be commissioned in FY12 (of the initial target of ~560MW) and ~700MW during FY13 TP: Rs. 22 • ~1.2GW of capacity is at risk of being transferred to Jammu & Kashmir CMP: Rs. 21NHPC • High proportion of capital stuck in CWIP leading to low capital efficiencies; Actual RoE is only ~8% as compared to the regulated RoE of 15.5% • Situation of high CWIP and low RoE unlikely to reverse until FY14, leading to our negative outlook on the company’s financials • Trades at rich valuations with FY13E P/E of ~11x and P/B ratio at ~0.9x, for a below-par RoE. Reiterate Reduce • Although we like the Company’s captive lignite mining capabilities scores poorly on execution track record and growth potential REDUCE with a visible pipeline of only ~500MW at TPS-2 TP: Rs. 84 • Faces continued delays (due to technical reasons) in the commissioning / stable operations of the new plants (totaling 750MW CMP: Rs. 87 including TPS-2) representing a serious risk to the profitability of the company, particularly during FY13ENLC • Has to part with 26% of its mining profits (~80% of company level profits) assuming the Mining Bill is passed, representing a significant risk to the company’s profitability • Given these risks to near term profitability, we remain negative on the stock and value the stock at 1.1x FY13E P/BV. Reiterate Reduce 5
  6. 6. Power UtilitiesViews on StocksCompany View Rating • Has achieved ~88% of the Rs. 550bn target capex additions in the 11th plan despite the expected yoy fall in capex in FY12E. ADD Robust growth outlook exists as the management has guided for a 12th Plan target spend of Rs. 1tn, which will represent a >80% TP: Rs. 124 jump vs. the corresponding 11th plan target CMP: Rs. 108 • Backlog of orders awarded in the last two years which has to be commissioned stands at ~Rs. 250bn which we expect to bePGCIL commissioned over the next two years, driving capitalization, revenues and profitability. Hence, compared to the 9% yoy earnings growth expected during FY12E, earnings is expected to grow at a high 14% CAGR over FY12-14E • Coupled with the improved earnings growth outlook it has negligible operational risks with a fixed-RoE model, availability based revenue model, and limited receivable risks. Upgrade to Add from Sell with a target price of Rs. 124/ share • Growth in trading volumes faltering as supply to TNEB has been stopped from Oct 2011. PTC is still supplying power to UP which REDUCE already has ~Rs. 3bn in dues and has stopped payment from 2QFY12. Supply-freeze to UP is also a possibility – hence further TP: Rs. 52 risk to volumes CMP: Rs. 57 • Flawed risk management practices evident as they allowed the TNEB receivables situation to worsen to the extent of Rs. 7bnPTC (~30% of net worth) • Outlook on the company’s long term volumes not encouraging as almost all the thermal plants with which PPAs have been signed will face execution delays due to either coal shortage/ uncertain coal linkage • Trades at a premium to our SoTP valuation of Rs. 52 per share. Upgrade to Reduce from Sell due to the recent stock correction • Well placed on gas supply for its operational plants (YTD PLF of >80%) but is exposed to gas shortage with respect to capacities REDUCE under construction (UnoSugen 382MW and D-Gen 1.2GW) TP: Rs. 200 • Earnings at risk if the recent directive from the MoPNG, asking the power ministry to stop supplying gas from KG D6 to power CMP: Rs. 217 plants selling power in the merchant market, is implemented. (>300MW of operational capacity is sold in the merchant marketTorrent Power from Sugen) • Also the risk of inadequate / delayed increases in consumer-level tariff persists • We fear that cash generation is being utilized towards potentially unrewarding projects. We value the company giving 1.5x multiple to our FY13E P/BV yielding a TP of Rs. 200 per share. Upgrade to Reduce from Sell due to the recent stock correction 6
  7. 7. Power UtilitiesEstimate Revisions FY12E, Rs. mn Revision, % FY13E, Rs. mn Revision, %EstimateRevisions Revenues EBITDA PAT Revenues EBITDA PAT Revenues EBITDA PAT Revenues EBITDA PATAdani Power 40,559 13,301 2,866 0% 0% 0% 100,138 35,774 5,392 0% 0% 0%CESC 60,174 7,787 2,697 0% 0% 0% 67,644 9,215 3,675 0% 0% 0%GIPCL 13,851 4,446 1,321 0% 0% 0% 15,258 4,625 1,608 0% 0% 0%GMR 57,614 20,010 (1,373) 0% 0% 0% 80,141 29,737 587 -24% -28% -87%GVK 18,678 5,520 1,448 0% 0% 0% 21,266 6,430 1,286 0% 0% 0%Lanco Infratech 94,250 18,661 (1,108) 0% 0% 0% 109,150 20,811 2,070 0% 0% 0%Nava Bharat 9,377 2,111 1,609 0% 0% 0% 13,351 3,655 2,563 0% 0% 0%NHPC 59,871 39,443 23,630 0% 0% 0% 65,566 42,944 24,876 0% 0% 0%NLC 46,254 15,069 10,763 0% 0% 0% 57,352 19,419 12,105 0% 0% 0%PGCIL 92,646 78,143 29,531 0% 0% 0% 111,924 94,641 33,736 0% -1% -5%PTC 84,913 1,406 1,062 0% 0% 0% 120,530 1,960 1,371 0% 0% 0%Torrent Power 73,640 18,012 10,779 0% 0% 0% 80,430 21,252 11,003 0% 0% 0% 7
  8. 8. Power UtilitiesValuation MatrixCompany Revenues, Rs.bn EBITDA, Rs.bn PAT, Rs.bn RoE FY11-14E CAGR FY10 FY11 FY12E FY13E FY10 FY11 FY12E FY13E FY10 FY11 FY12E FY13E FY10 FY11 FY12E FY13E Revs EBITDA PATAdani Power 4.3 21.4 40.6 100.1 2.4 12.2 13.3 35.8 2.4 5.1 2.9 5.4 6% 9% 5% 10% 22% 61% 44%CESC 42.8 51.0 60.2 67.6 5.3 8.7 7.8 9.2 1.6 3.1 2.7 3.7 3% 7% 5% 7% 6% 13% 12%GIPCL 9.5 10.9 13.9 15.3 2.3 3.1 4.4 4.6 1.1 1.6 1.3 1.6 9% 12% 9% 10% 10% 15% 3%GMR 51.2 57.7 57.6 80.1 13.6 15.6 20.0 29.7 2.3 (9.3) (1.4) 0.6 3% -7% -1% 0% 2% 33% NMGVK 17.9 19.1 18.7 21.3 4.7 5.1 5.5 6.4 1.6 1.5 1.4 1.3 5% 4% 3% 3% 8% 45% -14%Lanco 81.8 77.8 94.2 109.2 16.0 18.9 18.7 20.8 4.6 4.5 (1.1) 2.1 14% 11% -2% 4% 8% 15% -2%Nava Bharat 11.7 11.0 9.4 13.4 5.6 3.1 2.1 3.7 5.0 3.2 1.6 2.6 31% 19% 8% 11% 13% 20% 2%NHPC 51.6 51.4 59.9 65.6 41.3 36.3 39.4 42.9 21.8 23.2 23.6 24.9 8% 8% 8% 8% 8% 8% 3%NLC 41.3 39.5 46.3 57.4 13.6 12.9 15.1 19.4 12.4 13.0 10.8 12.1 13% 12% 9% 10% 9% 14% -2%PGCIL 71.3 83.9 92.6 111.9 58.7 70.5 78.1 94.6 20.4 27.0 29.5 33.7 13% 14% 13% 14% 6% 17% 12%PTC 77.9 90.0 84.9 120.5 0.8 1.4 1.4 2.0 0.9 1.4 1.1 1.4 6% 7% 5% 6% 10% 28% 18%Torrent Power 58.3 65.4 73.6 80.4 17.1 17.7 18.0 21.3 8.4 10.7 10.8 11.0 21% 22% 20% 17% 24% 29% 21%Company Net Debt to Equity (x) CMP Shares M.Cap P/E (x) Price / BV (x) Target Rating FY10 FY11 FY12E FY13E Rs. (mn) Rs. bn FY10 FY11 FY12E FY13E FY10 FY11 FY12E FY13E P/BVx Rs.Adani Power 2.3 3.2 3.7 4.1 76 2,180 165.5 70.3 32.2 57.7 30.7 3.0 2.8 2.7 2.4 SoTP 46 SellCESC 0.5 0.7 0.9 1.1 265 125 33.1 21.1 10.5 12.3 9.0 0.7 0.7 0.6 0.6 0.80 350 BuyGIPCL 0.9 0.7 0.6 0.4 71 151 10.8 10.1 6.6 8.2 6.7 0.9 0.8 0.7 0.6 0.80 88 BuyGMR 3.2 1.9 2.0 2.0 28 3,892 108.4 48.1 NM NM 184.6 2.0 0.9 0.8 0.8 SoTP 25 SellGVK 1.0 0.9 1.4 1.3 18 1,579 27.9 17.9 18.0 19.3 21.7 0.9 0.7 0.6 0.6 SoTP 17 ReduceLanco 2.2 3.1 4.2 4.5 20 2,408 47.6 10.4 10.7 NM 23.0 1.4 1.0 1.1 1.0 SoTP 32 BuyNava Bharat (0.2) 0.0 0.5 0.8 195 89 17.3 3.5 5.4 10.8 6.8 1.1 0.9 0.8 0.8 SoTP 247 BuyNHPC 0.4 0.5 0.4 0.4 21 12,301 257.1 11.8 11.1 10.9 10.3 1.0 1.0 0.9 0.9 0.90 22 ReduceNLC 0.3 0.3 0.2 0.2 87 1,678 146.1 11.7 11.3 13.6 12.1 1.4 1.3 1.2 1.1 1.10 84 ReducePGCIL 2.1 1.9 1.9 2.0 108 4,630 500.9 25.0 18.9 17.3 15.1 3.2 2.4 2.2 2.0 2.00 124 AddPTC (0.5) (0.3) (0.0) (0.1) 57 295 16.9 18.0 12.2 15.9 12.3 0.8 0.8 0.8 0.7 SoTP 52 ReduceTorrent Power 0.8 0.8 0.7 1.0 217 472 102.7 12.3 9.6 9.5 9.3 2.6 2.2 1.9 1.6 1.50 200 Reduce 8
  9. 9. Industry Scenario 9
  10. 10. Power UtilitiesIndustry Scenario – Reconciling promises and reality!Over the last 8 months (when we first downgraded the coal-based power utilities), the issues of tightness in coal supply, high imported coal prices as well asinadequate pass-through mechanisms in PPAs (Case 1 bids) have exacerbated alarmingly, resulting in escalation of the issues up to the level of the PMO. Giventhe importance of the power sector (~30% of 11th Plan infrastructure spend and 8% of bank credit), the PMO has reciprocated by promising a deadline-basedapproach to solving the power crisis even as they directed CIL to sign FSAs that assure 80% coal supply for power plants and to import coal to meet shortages.While the mentioned event has triggered a wave of positive sentiment towards the power generation sector, we got down to performing a reality check, the keyconclusions of which are as follows#1 – Scarcity of indigenous coal to continue - India’s indigenous coal production likely to remain a key concern, although efforts (increased impetus on execution andfaster clearances) are afoot to increase production at a CAGR of >10% over the next 3 years. However, we assume that CIL’s production will grow only at a CAGR of ~5%over FY12-15E, which will peg the total coal shortage for the power sector at >180MTPA by FY15E (from ~100MTPA currently). Thus, the pressure on CIL linkage willremain, resulting in ~40-60% supply from indigenous sources vis-à-vis actual linkage.#2 – Importing coal the only option and move towards coal price pooling a possibility – Given the tight coal supply conditions that are expected to prevail over themedium-long term, CIL is being forced to consider costlier coal imports to meet shortfall. Given that current prices of CIL coal would be at a significant discount (~30-40%) toimported coal of comparable quality, CIL will possibly resort to price pooling to ensure they absorb the incremental cost of imports.#3 – Increased gas allocation to power plants unlikely while supply issues could persist, depressing PLFs low – Consistent decline in production at KG-D6 (from60mmscmd in 2010 to ~36mmscmd recently) has significantly impacted the PLFs of second-generation gas-based power plants. With gas production at KG-D6 expected todrop further and the increased allocation of APM-gas not being sanctioned for the power sector, fundamentals of these plants are expected to stay adverse.#4 – Reforms in PPA tariffs to allow fuel cost pass through – PPA reforms to allow a reasonable pass-through of fuel costs is a key theme we expect will play out overthe next year, the single largest reason for our positive view on power utilities as a space. Such reforms will however, need to be backed up with regular increases inconsumer-level tariffs for sustainability.#5 – Merchant power still lucrative but will not drive investments as the fuel tap for these plants remain at risk – Although merchant tariffs have stabilized at levels>Rs. 4, coal / gas linkages to the merchant plants will come under increased scrutiny. For ensuring such plants remain operational, the utilities will need to demonstrate theexistence of short term / medium term contracts with state utilities. Thus we expect merchant tariffs to remain in a tight band of Rs. 4-4.5 for the foreseeable future.#6 – Despite delays in commissioning, operational risks to hydel assets and transmission assets remain low – Unlike the fossil fuel-based gencos, the hydel utilitiesas well as the transmission utilities face negligible operational risk. However the key adverse variable for these utilities remains project delays for multitude of reasons.#7 – Logistical bottlenecks will likely remain on the fronts of both railways as well as ports – We see little / no steps being taken to address the issues of wagonshortage (railways) and inadequate coal handling capacities at ports. Both issues pose operational risks to power plants in the long term, but as structural issues likefeedstock availability and viability of private power plants take centre stage we believe these concerns will be underplayed until the structural issues are resolved.#8 – Reduction in borrowing costs coupled with policy initiatives will drive investments into the sector – Coupled with some / all of the aforesaid positivedevelopments, lower borrowing costs (1yr forward spreads have moved into negative territory after more than a year), we expect, will lead to improved private sector interestin the power sector.Weighing these expectations in balance, we anticipate that power utilities will, by and large, benefit from the amelioration of sector fundamentals over the nextyear even as increased pressure may be mounted on CIL to absorb the incremental cost of coal imports, at least partly. 10
  11. 11. Power UtilitiesIndustry Scenario – Focus charts #1 Coal shortage for power sector to become ~184MT in FY15E Coal price pooling the most logical solution - tariff impact <80paise by FY15 Particulars Unit FY12E FY13E FY14E FY15E Demand Supply (MT), FY12 Demand Supply (MT), FY15E Deficit Linkage Coal Supply (Proj.) MT 310.0 391.0 449.6 522.8 mainly met by Production avbl for power MT 323.2 339.4 355.6 374.2 105 imports 184 Import requirement MT 0.0 51.6 94.0 148.6 Realisation of linkage Rs. / tonne 1,225 1,274 1,325 1,378 520 653 415 Realisation of import Rs. / tonne 4,125 4,331 4,548 469 Incremental cost of imports Rs. bn 212.7 407.0 675.7 Price of linkage coal – Pooling Rs. / tonne 1,650 1,953 2,279 method Demand Supply Demand Supply Rs. / System level cost increase 376 628 901 tonne Source: CEA, Spark Capital Research Source: Spark Capital Research Gas supply to remain tight - bleak outlook for gas-based plants persists Outlook on SEB financials not encouraging either, unless tariffs increase Natural Gas, mmscmd FY10 FY11 FY12E FY13E FY14E FY15E All India State Distribution Utilities FY11 FY12E FY13E FY14E FY15E On-shore 23 23 23 23 23 23 Revenues, Rs. bn 1,893 2,087 2,293 2,517 2,763 Mumbai High 48 48 47 46 45 44 Total Expenditure, Rs. bn 2,498 2,724 2,960 3,213 3,489 KG - D6 42 56 43 28 24 40 Total Units Supplied, bn units 689 751 816 885 961 Adjustments (9) (7) (3) 1 5 10 T&D Loss, bn units 163 171 179 187 195 Total Indigenous Supply 105 120 110 98 97 117 T&D Loss, % 24% 23% 22% 21% 20% Power 57 62 62 60 65 68 Total Units Consumed, bn units 526 580 637 698 765 Fertilizers 38 40 39 40 43 53 Avg. Cost per Unit Sold 4.75 4.70 4.65 4.60 4.56 Refinery & Petchem 23 21 26 28 32 42 Avg. Realization per Unit 3.60 3.60 3.60 3.61 3.61 CGD 12 14 18 21 25 29 Others 8 17 12 6 7 9 GAP before subsidy*, Rs. /unit 1.15 1.10 1.05 1.00 0.95 Total Demand 137 154 157 155 172 201 Subsidies and Grants 327 361 395 430 469 Deficit 32 34 47 58 75 84 GAP after subsidy*, Rs. /unit 0.53 0.48 0.43 0.38 0.33 Source: Spark Capital Research *Assuming no Commercial Losses, Source: Shunglu Committee Report 11
  12. 12. Power UtilitiesIndustry Scenario – Focus charts #2 Merchant market realizations have stabilized at ~Rs. 4/ unit in a year PGCIL’s Capex to grow substantially till FY15 after a subdued year in FY12 8.0 200 7.0 6.2 5.7 5.6 6.0 150 5.0 4.9 4.7 4.7 4.8 4.5 Rs. /unit 5.0 4.2 4.2 4.3 4.2 4.0 3.9 4.0 4.0 Rs. bn 3.8 3.9 3.9 4.0 100 204 4.0 185 187 145 3.0 123 128 50 109 100 84 2.0 68 Nov-10 Dec-10 Nov-11 Dec-11 Apr-10 Oct-10 Apr-11 Oct-11 Feb-11 Mar-11 Jul-10 Jul-11 Jun-10 Aug-10 Sep-10 Jan-11 Jun-11 Aug-11 Sep-11 May-10 May-11 0 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E FY17E Rate in Bilateral trading market PGCIL capex Source: CERC Source: CERC Hydel power capacity in the country – State sector plays a major role Expect interest rates to dip over the next year Salient Developers MW 4% 2,559 , 3% NHPC 3,767 7% NHDC 1,520 2% 11,852 , 30% Satluj Jal Vidyut 1,500 1% Jaypee Karcham Wangtoo 1,000 0% Tata Power 447 -1% Jaiprakash Power Venture 400 -2% 24,438 , 63% Jaiprakash Hydro 300 -3% Allain Duhangan 192 -4% Dec-08 Dec-09 Dec-10 Dec-11 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Feb-09 Feb-10 Feb-11 Feb-12 Jun-09 Jun-10 Jun-11 Aug-09 Aug-10 Aug-11 Everest Power Company 100 Central State Private Malana Power Company 86 Spread between Overnight rate and 12m OIS rate Source: CEA Source: Bloomberg 12
  13. 13. Reality Checks 13
  14. 14. Power Utilities#1 – Indigenous coal shortage set to worsen over the next 3 years, driving increased dependence on coal imports India’s power capacity additions largely skewed towards coal Conservatively, coal-based capacities expected to grow at a CAGR of ~7% Coal - Private 127.8 Total, MW Coal, % 140 120.8 Sector, % 113.8 120 104.8 Current Capacity in India 187,550 56% 93.7 100 84.2 76.0 77.6 Capacity Addition in FY10 11,433 57% 65% 80 GW 60 Capacity Addition in FY11 15,791 60% 60% 40 20 Capacity Addition YTD FY12 12,361 90% 61% 0 FY08 FY09 FY10 FY11 YTD FY12 FY13E FY14E FY15E Capacity addition last 3 years 39,584 69% 62% Coal based Capacity in India Source: CEA Source: CEA, Spark Capital Research • 90% of capacity additions during Total Coal Supply/Demand, FY12 Coal shortage for power sector to become ~184MT in FY15E FY12 were coal based, with private Coking Coal Demand 69 players contributing nearly 2/3rd Demand Supply (MT), FY12 Demand Supply (MT), FY15E • CAGR of coal-based capacity Non-Coking Demand, Power 520 Deficit addition has been ~11% during mainly FY09-12 Non-Coking Demand, Others 125 met by 105 imports 184 • We expect CIL to ramp-up production Total Demand, MT 713 at a CAGR of 5% over FY12-15E, their long term average CIL Supply 441 653 • Based on the pipeline, coal-based 520 capacities will grow at >7% CAGR SCCL Supply 47 415 469 over the same period Captive Blocks and Others 96 • Coal shortage for power sector including captives (excluding Total Domestic Supply, MT 584 lignite plants) will likely scale Demand Supply Demand Supply 184MT by FY15E Total Shortage, MT 129 Source: CEA, Spark Capital Research 14
  15. 15. Power Utilities#2 – CIL to be pushed to convert LoAs into valid FSAs driving the need to import and most possibly, price pooling Background CIL’s production to increase only by 60-70MT over the next 3 years In October 2007, the New Coal Distribution Policy (NCDP) introduced the concept 600 of “Letter of Assurance” (LoA), which assured supply of coal to developers, 511 provided they met stipulated time-critical milestones. 486 500 463 49 431 431 441 47 Once the milestones were met, the LoA holders were entitled to enter into Fuel 404 44 379 41 42 400 361 28 34 Supply Agreements (FSAs) with CIL for long-term supply of coal. 25 24 MT CIL had signed FSAs for 306MT (total of 370MT for all sectors) for power sector by 300 March 2009. Due to the lackadaisical ramp-up in production, CIL has signed only a 200 limited number of FSAs since. Of the 550 LoAs issued for a total of 378MT, FSAs have been signed for only 55MT, of which only ~19MT pertains to power. 100 Given recent PMO’s directive pushing CIL to sign FSAs (where required) and meet shortfall through imports, CIL will need to sign the pending FSAs (and supply) an 0 additional ~150MT for the power sector alone by FY15E even if we assume only 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E half of the power plants in pipeline meet the relevant milestones. Coking Coal Non-Coking Coal Source: CEA, Spark Capital Research CIL’s supply commitments, on the other hand, are daunting!!! Coal price pooling the most logical solution – tariff impact <80paise by FY15 Total FSAs and MoUs Before NCDP (March 2009) Quantity, MT Particulars Unit FY12E FY13E FY14E FY15E signed Power Sector 131 306 Linkage Coal Supply (Proj.) MT 310.0 391.0 449.6 522.8 Other Sectors 1,189 64 Production avbl for power MT 323.2 339.4 355.6 374.2 Import requirement MT 0.0 51.6 94.0 148.6 Total FSAs/ MoUs signed 1,320 370 # FSAs/ Realisation of linkage Rs. / tonne 1,225 1,274 1,325 1,378 After # LoAs Quantit, # FSAs Pending, MoUs Quantity, MT NCDP issued MT Pending MT signed Realisation of import Rs. / tonne 4,125 4,331 4,548 Power 133 312 21 19 112 293 Incremental cost of imports Rs. bn 212.7 407.0 675.7 Others 417 65 284 36 133 29 Price of linkage coal – Pooling Rs. / tonne 1,650 1,953 2,279 method Total 550 378 305 55 245 323 System level cost increase Rs. / tonne 376 628 901 Source: Ministry of Coal, Coal India Ltd., Spark Capital Research Source: Spark Capital Research 15
  16. 16. Power Utilities#3 – Gas supply likely to remain under severe pressure, adversely affecting the gas-based plants • Of the total gas requirement of ~66mmscmd for the existing power plants, KG- Gas for 75% PLF, Gas based plants MW Developer D6 alone has an allocated supply quantity of ~32mmscmd (50%) mmscmd Central Sector 6,253 - 25.01 • But the dwindling supplies from KG-D6 has been the biggest sore point. State Sector 3,932 - 15.73 Production fell to 36mmscmd in Jan’2012 with only ~18mmscmd being Vatwa CCPP 100 Torrent Power 0.40 supplied to power sector Trombay CCPP 180 Tata Power 0.72 • Our Oil & gas analyst believes that KG-D6 supplies will fall over the next two Rithala CCPP 108 North Delhi Power 0.43 years, before potential improvement in subsequent years Baroda CCPP 160 GIPCL 0.64 • Increased pressure on EGoM to cut gas allocation to plants selling to Essar CCPP 515 Essar 2.06 merchant market is a key risk to merchant gas-plants. GMR (235MW), Lanco Peguthan CCPP 655 GPEC 2.62 (670MW) and Torrent Power (300MW) are companies with exposure in Sugen CCPP 1,148 Torrent Power 4.59 this bucket Gautami CCPP 464 GVK Power & Infra 1.86 GMR Energy Ltd – Kakinada 220 GMR Infra 0.88 Natural Gas, mmscmd FY10 FY11 FY12E FY13E FY14E FY15E Godavari CCPP 208 0.83 Jegurupadu CCPP 455 GVK Power & Infra 1.82 On-shore 23 23 23 23 23 23 Konaseema CCPP 445 KGPL 1.78 Kondapalli CCPP 716 Lanco Infratech 2.86 Mumbai High 48 48 47 46 45 44 Peddapuram CCPP (Samalkot) 220 Reliance Power 0.88 KG - D6 42 56 43 28 24 40 Vemagiri CCPP 370 GMR Infra 1.48 Karuppur CCPP (Aban) 120 Lanco Infratech 0.48 Adjustments (9) (7) (3) 1 5 10 P.Nallur CCPP 331 PPN Power 1.32 Total Private Sector 6,492 25.97 Total Indigenous Supply 105 120 110 98 97 117 Total 16,676 66.71 Bleak outlook for gas-based power plants persists Power 57 62 62 60 65 68 • Due to the structural deficit in domestic gas the need to import LNG is inevitable. Fertilizers 38 40 39 40 43 53 In the current system State EBs has to recommend use of RLNG by the power producers if domestic gas supply is not sufficient Refinery & Petchem 23 21 26 28 32 42 • RLNG is highly priced at >USD 12/MMBTU as compared to the USD 5.2/MMBTU CGD 12 14 18 21 25 29 pricing for KG-D6 gas and APM gas. Thus, we expect R-LNG to be used only during the summer months, to limit power outages Others 8 17 12 6 7 9 • Although power is considered as a priority sector, the EGoM has not increased allocation of APM gas to the power sector, citing the low quantum available as a Total Demand 137 154 157 155 172 201 key reason. Thus we expect the PLF scenario to remain bleak for gas-based Deficit 32 34 47 58 75 84 power plants over the next 2-3 years Source: CEA, Spark Capital Research 16
  17. 17. Power Utilities#4 – High losses and peaking subsidies forcing SEBs to hike tariffs; PPA reforms inevitable as well SEB financials have worsened substantially over the last 5 years Outlook on SEB financials not encouraging, unless consumer tariffs increase Rs. bn FY06 FY07 FY08 FY09 FY10 Total All India State Distribution Utilities FY11 FY12E FY13E FY14E FY15E Revenues 950 1,120 1,250 1,400 1,570 6,290 Revenues, Rs. bn 1,893 2,087 2,293 2,517 2,763 Total Expenditure/ ARR 1,120 1,350 1,560 1,910 2,140 8,080 Total Expenditure, Rs. bn 2,498 2,724 2,960 3,213 3,489 Loss before Subsidy (170) (230) (310) (510) (570) (1,790) Total Units Supplied, bn units 689 751 816 885 961 Subsidy 120 130 170 250 300 970 Loss after Subsidy (50) (100) (140) (260) (270) (820) T&D Loss, bn units 163 171 179 187 195 T&D Loss, % 24% 23% 22% 21% 20% • The Shunglu Committee report observes that the situation of the power sector Total Units Consumed, bn units 526 580 637 698 765 remains largely unresolved when compared to 2003 Avg. Cost per Unit Sold 4.75 4.70 4.65 4.60 4.56 • Accumulated losses are Rs. 820bn (after subsidy) for the period FY06-10 attributable to the gap of ~Rs. 0.60/ unit between average power cost and Avg. Realization per Unit 3.60 3.60 3.60 3.61 3.61 average realization. Apart from lack of tariff revisions the panel also holds the GAP before subsidy*, Rs. /unit 1.15 1.10 1.05 1.00 0.95 high AT&C losses (average ~26%) and operational inefficiencies of Subsidies and Grants 327 361 395 430 469 transmission utilities a major reason for this large gap GAP after subsidy*, Rs./ unit 0.53 0.48 0.43 0.38 0.33 *Assuming no Commercial Losses, Source: Shunglu Committee Report SEBs with highest cumulative losses – Many have resorted to tariff hikes Strong rationale for PPA reforms to pass-through coal cost, at least partly State Loss, Rs. mn Recent Tariff increases? Tariff Hike • Several private developers entered into Case 1 bids / Case 2 bids, which do Tamil Nadu (238,500) Yes Nov 2011 ~50- 150% proposed not allow fuel costs to be passed through. Given their weak finances, SEBs are Uttar Pradesh (194,750) No - - not open to renegotiating their PPA tariffs (mostly between Rs. 2.2 and 3.0) upwards Madhya Pradesh (89,690) Yes Jun, 2011 Upto ~6% • The Case 1 / Case 2 bids are likely to incorporate a ‘Force Majeure’ clause Rajasthan (77,250) Yes Sept, 2011 Upto ~28% protecting developers from factors beyond their control such as regulatory Punjab (51,420) Yes May, 2011 Upto ~12% changes in Indonesia and unavailability of domestic coal Haryana (45,200) No - - • Retrospective changes to PPAs allowing marginal tariff increases are, in our Bihar (44,730) Yes Jun, 2011 NA view, likely. Our view is based on four key reasons (1) CIL will be forced to Jharkhand (35,280) No - - import large volumes of coal to meet their FSAs and will most likely resort to coal price pooling, (2) PPA tariff increases are unlikely to increase by >25 Maharashtra (28,110) No - - paise immediately and by >75 paise even through to FY15, (3) lack of such Karnataka (16,790) No - - reasonable PPA tariff increases would make several power plants unviable and Others (3,570) - - - (4) tariff hikes at the end-consumer level will help soften the blow on SEB Total (825,290) - - - financials Source: Shunglu Committee Report, Spark Capital Research 17

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