Take a power break

IPO REVIEW

Jaiprakash's plant location may be worth a visit, not its stock.

The gurgling Baspa river in Sangla valley surrounded by pine and oak forests is one of the most alluring attractions in the Himalayas.

Besides, Baspa is home to rainbow deer and brown trout - thanks to the country's first trout breeding farm that came up in the valley in the 1920s. All that is well known. What is less known is that the river also feeds the power plant set up by Jaiprakash Hydro Power in the Kinnour district in Himachal Pradesh.

The story of Jaiprakash is obviously not as beautiful as the Baspa river. This power generation company is out in the market with a public offer of 18 crore shares at a price band of Rs 27-32. Not to ask for money to expand its business but to let its promoters sell a part of their holdings when the stock market are going strong.

The entire issue of Rs 575 crore which amounts to 36.66 per cent of the company's paid-up capital (at the higher end of the issue price) is an offer for sale by the promoter company Jaiprakash Associates. The company has no institutional interest.

Jaiprakash operates a 300 mw hydro-power plant in Himachal Pradesh and has a power purchase pact to sell all its output to the Himachal Pradesh State Electricity Board (HPSEB). The plant can produce electrical energy upto 1213.18 mu per annum.

The company's business model is simple: it produces and sells power to just one entity - HPSEB. Of the total power generated, 12 per cent is supplied free to the Himachal Pradesh government. On the rest, the company receives a tariff based on a 16 per cent assured return on capital. But there are at least three worries.

Firstly, HPSEB and the state government have approved a capital cost of only Rs 1,550 crore whereas the company has actually spent Rs 1,624.72 crore in buildings its power plant (the Central Electricity Authority (CEA) is yet to give a final decision on the capital cost). This means that the company will earn tariffs based on the return assured only on the capital cost approved by the government.

Secondly, the company has got a tariff of Rs 2.09 per unit for FY04 and Rs 2.25 for six months ended September 30, 2004, significantly lower than the price (Rs 2.95) agreed upon under the power purchase agreement (PPA).

A final decision on the tariff will be taken by the State Electricity Regulatory Commission. For now the company has accumulated arrears close to Rs 33 crore and if this money does not come through, it would have to write off the amount which would impact profitability.

Thirdly, it has a single customer - HPSEB - which has been in the red for the past five years. The company had debtors of Rs 127 crore as on September 30, 2004.

One plus is that the company will not suffer for non-availability of water. According to its purchase agreement, the company will get paid even if it does not produce power for want of water for seven years since the start of the project. The company will get paid for its actual output only if the plant produces less than 90 per cent of its capacity for any other reason.

For the first half of FY05, the company clocked sales of Rs 198.33 crore compared to Rs 296.61 crore for FY04 (May 2003-March 2004). It's margins are on the higher side - 35 per cent - compared to other power companies which typically have margins between 25 and 30 per cent (since most of them are coal- or liquid fuel-based). Net profits for the periods mentioned above stand at Rs 64.02 crore and Rs 57.91 crore.

Since the company is engaged in a regulated industry which works on an assured-return basis, the downside to earnings is limited. However, the issue seems to be priced aggressively.

Says Urmik Chayya, analyst, Anand Rathi, "The company will earn a return on capital of 16 per cent. Assuming the issue gets priced at the higher end of the band at Rs 32, the yield for investors will work out to 5 per cent which is not a great return by any standard." Also, the company's future prospects in terms of projects and expansion is not clear.

Based on an annualised EPS of Rs 2.5 for the year (based on HY05), the issue is priced at a P/E of 12.8 times. The only power company that can probably be compared is Gujarat Industrial Power which operates a 555 mw power plant.

At the current market price of Rs 72, Gujarat Industrial Power trades at 5.8x its trailing 12-month earnings and quotes at much lower earning multiples. The company commands a market-cap of Rs 800 crore. Jaiprakash with a market-cap of Rs 576 crore for a 300 mw power plant looks expensive.

You may consider a holiday to the Sangla valley instead.

RESEARCH CALLS

BAJAJ ELECTRICALS (BUY, TARGET Rs 360)
Sharekhan has put a buy on Bajaj Electricals at Rs 270 with a price target of Rs 360, citing increasing infrastructure spend and rising consumerism trends.

There has been a turnaround in its galvanising segment which is expected to grow at a healthy rate with the plant utilisation reaching its peak. Bajaj Electricals' strategy of outsourcing products instead of manufacturing in-house makes its model scalable.

NICHOLAS PIRAMAL (MARKET OUTPERFORMER, TARGET Rs 344 +)
Refco has given Nicholas Piramal a 'market outperformer' with a price target of Rs 344+. The full impact of CRAMS (contract research and manufacturing services) is expected to be visible by 2007 which has been discounted.

Valuations are expected to expand as investors start focusing on the high-margin annuity-based CRAMS business. The company's business is expected to undergo a transformation with higher exports. Higher CRAMS revenues will be the main growth driver.

MAHINDRA UGINE (BUY, TARGET Rs 150)
Motilal Oswal has put a buy on Mahindra Ugine Steel at a price of Rs 82, with a price target of Rs 150. Mahindra Ugine's recent capex of Rs 18 crore would lead to an increase of Rs 4,500 crore plus in its annual turnover in three years.

The company's inclusion in parent M&M's in-house auto ancillary programme would open the doors for it to supply alloy steel to M&M. Also, the industries that Mahindra Ugine caters to like automobiles, engineering and capital goods are in for an upturn.

ZEE TELEFILMS (SELL)
Citigroup's Smith Barney has maintained a sell on Zee Telefilms despite it underperforming the Sensex by 31 per cent over last six months. It has cut EPS estimates for FY05-FY07 between 2.7 and 10 per cent.

Zee would need to improve content ratings to benefit in a major way, given that competition is getting aggressive and the market is getting fragmented. Pressure on ad revenue growth, protracted litigation on cricket rights and a slow DTH rollout plague the company.