Blow for Tata Power, Adani Power; earnings under threat

SC disallowing compensatory tariff may make Mundra power plants unviable for the two companies

In an unexpected blow to Adani Power and Tata Power, with respect to their power projects at Mundra, the Supreme Court set aside the appeal for compensatory tariff filed by the companies with the Appellate Tribunal for Electricity (APTEL). Consequently, stocks of Tata Power and Adani Power plunged by 3.5 per cent and 16.6 per cent, respectively. Analysts say this was totally unexpected by the Street given that in December 2016, the Central Electricity Regulatory Commission (CERC) ruled that both companies were entitled to relief in the form of compensation for higher coal cost for power plants in Mundra. Even from the December quarter investor call hosted by the companies, the Street got the impression that the Supreme Court’s verdict pending on the matter would favour the companies. Tata Power was awarded a compensatory tariff at Rs 0.52 per unit and Adani Power at Rs 0.41 per unit, over the remaining life of the UMPPs.

While the details of the court's order are awaited, the compensatory order being set aside implies a huge earnings setback for Tata Power and Adani Power. Tata Power has been conservative in accounting for receivables under the compensatory tariff, while Adani Power has taken an aggressive stance. The latter's revenues already include the likely inflows of the compensatory tariff, estimated at about Rs 9,000 crore. Therefore, Adani Power faces a huge risk of earnings write off in the current quarter. Analysts point out that the provisional compensatory tariff accounted by Adani Power is almost equal to the company’s net worth as on September 30, 2016. For Tata Power, the risk is that of future earnings starting from FY18 facing a huge downgrade, as the Street was expecting that a favourable order from Supreme Court would start reflecting in its earnings from FY18 onwards. Analysts at JP Morgan say that a failure to obtain tariff relief for Mundra plant implies Rs 15 per share downside to its target price of Rs 90 for Tata Power. For Adani Power, they note that a full retrospective recovery of the compensatory tariff would be worth Rs 23 per share. “If this is used to repay debt, interest liability could come down by Rs 1,100 crore and net profit could increase to Rs 480 crore. These earnings assumptions would require significant reworking," said analysts. On Monday, Adani Power's stock closed at Rs 44.35 and Tata Power at Rs 84.05 on the Bombay Stock Exchange. To that extent, analysts say the stock price reaction is justified and there could be more as the fine print of the Supreme Court order is analysed.

Apart from earnings, the more important point is that the Mundra UMPP has a high probability of becoming unviable for both the companies. Tata Power’s Mundra plant has a capacity of 4,000 megawatts (Mw), while that of Adani Power is 1,980 Mw. Interestingly, analysts say that for both the companies, the project was unviable from the beginning, given the risk of dependence on coal from Indonesia and foreign exchange fluctuation. “But, investors were willing to discount these aspects only on the hope that the compensatory tariff order would be in favour of the two companies,” an analyst from a domestic brokerage highlights on conditions of anonymity.

So, what is the road ahead for these companies? For Tata Power, its exposure to renewable, mainly solar power should be some silver lining. Other projects such as its Delhi Power distribution unit, Maithon plant and its overseas coal subsidiary are seeing improvement in the capacity utilisation. While this may not adequately compensate for the downside in Mundra UMPP, they keep the revenue stream unsaturated. Additionally, even after the company has sold the stake in one of the Indonesian mines, there is an element of hedge from movement in coal prices. This also explains why Tata Power stock is down by 3.5 per cent only.

For Adani Power, while the business will continue, as usual, the focus would be on retiring the mounting debt estimated at Rs 47,600 crore. Promoters of the company have already infused equity capital by increasing their stake from 63.13 per cent in March 2016 to 68.08 per cent as on March 31, 2017. The stocks of Adani Port and Adani Transmission were also down by 4-10 per cent after the Supreme Court verdict.