Stiff valuations

IPO REVIEW

Reliance Power's valuations are higher than its peers, which already have operational capacities, healthy cash flows and robust growth plans.

The Reliance Power IPO has created ripples in the market, even before it has opened for subscription. For one reason at least, which relates to valuations--- the market already seemed to have had a hint about its aggressive pricing, which is partly responsible for the re-rating of the power generation stocks in the recent months.

For now though, there are different views emerging with respect to its pricing. "Either the existing power generation companies are trading at low valuations or the initial public offering (IPO) of the Reliance Power is over valued". This is how most analysts reacted when asked about Reliance Power's valuation.

"Considering traditional investment principals, one may not expect too much upside from a near-term perspective due to various concerns mentioned in the RHP. However, listing gains could accrue to applicants based on the market scenario at the time of listing," says Deepak Jasani, head of retail research, HDFC Securities.

"We are neutral on the issue considering stiff valuations of about seven times its book value. However, at the same time we also believe that the execution of its projects should not be a problem and the group has never disappointed the share holders," says Lalit Thakkar, head of research, Angel Broking.

On the other side, says Jigar Shah, head of research, KIM ENG, a Singapore-based foreign investor, "It is difficult to put any valuation parameter for the company, which is having huge projects and significant growth opportunities in the power sector. If these projects are executed in time and efficiently, it will create significant value for shareholders." Some others are also positive due to factors like aggressive management, backing of the ADAG group and emphasis on inorganic growth. 
 

PROJECTED CAPACITIES
Year	Capacity  (MW)	Total
2009	NA	NA
2010	4300	4300
2011	2500	6800
2012	NA	6800
2013	7540	14340
2014	5060	19400
2015	4200	23600
2016	4500	28100

Some concerns
While there are few doubts about the growth prospects in the sector and, hence, opportunities for companies like Reliance Power, there is a flip side too, including concerns regarding the long gestation of projects, supply of equipment and availability of fuel.

For Reliance Power, which is setting up various power projects over the next seven to eight years, timely execution will be a challenging task. 
 

POWER ON
Project	Capacity (MW)	Procurement status	Fuel supply status	Offtake status	Cost   (Rs Cr)	Commissioning by
Rosa Ph. I, UP	600	EPC signed	Agreement signed	Long term (LT) PPA signed with UPPCL	2,702	Dec 2009 / Mar 10
Rosa Ph. II, UP	600	EPC signed	Applied to coal min.	300 MW LT PPA proposed to UPPCL 300 MW MoU with Rel Energy Trad	2,460	June 2010 / Sep 10
Butibori, Mah.	300	Bids invited	Applied to coal min.	LT PPA with captive consumers	1,405	Mar 2010 / Jun 10
Sasan, MP	3,960	In progress	Captive mines allocated	LT PPA signed	18,342	May 2013 / April 16
Shahapur Coal, Mah.	1,200	Bids invited	Coal sourcing  MoU with RNRL	LT PPA to be arranged	4,800	Sep 2011 / Dec 11
Urthing Sobla,  Uttarakand	400	Awaiting DPR submission	N/A	LT or ST PPA to be arranged	2,080	Mar-14

Its Butibori project, now scheduled to complete in June 2010, is already delayed and the government has stated that no additional extensions would be granted. Another project of 1,200 MW capacity in Shahpur, which is in the early planning stage, has also been delayed.

The other issue relates to fuel linkages. Three of the six projects, equivalent to nearly 30 per cent of the planned 7,060 MW capacity (commissioning scheduled between December 09 and April 16) and being part-financed through the IPO, are yet to achieve fuel linkages (two projects have applied for linkages but are yet to receive confirmation).

With regard to coal, the company is optimistic and expects the same to be addressed, including through tie-ups with global coal companies in the near future. However, availability as well as higher global coal prices remain a cause of concern.

Of the other seven projects under development, which are scheduled for commissioning between 2010 and 2016 (combined capacity of 21,140 MW), three of them with a combined capacity of 14,280 MW are yet to achieve fuel linkages.

Within these, for the gas-based projects of about 10,280 mw, the company has tied up with RNRL, a group company. Here too, the outcome of the dispute with Reliance Industries with regard to the supply of gas, will have a bearing on the company's plans. Simply because, as against the agreed price of $2.34 per mmbtu for gas, the current global price hovers around $8 per mmbtu.

On the positive side, a part of the power generated is planned to be sold on a free-pricing (merchant power) basis, which should help generate higher blended ROE of about 16-18 per cent, compared to the fixed ROE of 14 per cent. But, that will happen only from 2010-11, the first full year of operations. 
 

FUTURE SHOW
Estimates for 2012	Valuation Matrix
	NTPC	Tata  Power	Reliance Power
Current installed capacity (MW)	27904	2368	NA
New capacity (MW)	22096	7763	7060
Projected capacity (MW)	50000	10131	7060
Cost of new capacity (Rs cr)	88384	31052	31789
Debt required (Rs cr)	29384	24000	22836
Internal accruals (Rs cr)	59000	7052	0
Market capitalisation (Rs cr)	218422	32510	101700
M-Cap / Total Cap. at end-2012 (Rs cr)	4.37	3.21	14.41
Notes:  * New capacity cost assumed Rs 4 crore per  MW; Reliance Power's cost is taken from the RHP  * Debt required for NTPC and Tata Power is based on internal accruals, while for RPL it taken from RHP  * M-Cap to capacity at end-2012 reflects market value in Rs crore per megawatt * In NTPC's case, internal accruals based on cash profit of Rs 10,000 crore and is assumed to grow at 8% annually, a little lower than new capacity growth * Tata Power is estimated to generate total cash profits of over Rs 7,000 crore till 2012 * Tata Power and NTPC had cash/investments worth Rs 8,000 crore and Rs 29,000 crore respectively as on March 2007, excluding which, valuations are cheaper * M-cap of RPL is based on listing price of Rs 450 /share.

Conclusion
At the offer price of Rs 385-430 for retail investors (considering the discount of Rs 20), Reliance Power is valued at about seven times its post-IPO book value, compared with four times for players like NTPC and Tata Power. While some premium may be considered, assuming the potential for the higher blended ROE, the valuations still look stiff.

Even in terms of the market value per megawatt, the valuation looks expensive. If one deducts the investments and cash balance of Rs 29,000 crore for NTPC and Rs 8,000 crore for Tata Power (as on March 2007), the valuations only turn dearer.

Interestingly, by the time Reliance Power's six power projects (combined capacity of 7,060 MW) go on stream by 2012, NTPC would be having in excess of 50,000 MW of capacity operational, and would be generating Rs 15,000-20,000 crore of cash profit annually--more than sufficient to fund future projects of the company.

By then, Tata Power would be at over 10,000 MW. And by 2016-17, when Reliance Power's entire 28,200 MW capacity goes on stream, NTPC's capacity would be over 75,000 MW. In these circumstances, it makes sense to stick to the larger, established players in the business.

Issue opens: January 15, 2008
Issue closes: January 18, 2008