Group’s move to acquire large coal assets is in the right direction, but it also means a significant rise in liabilities.
GVK Power and Infrastructure’s announcement last Friday (after market hours) on the group's acquisition of Hancock Prospecting’s coal blocks in Australia for $1.26 billion will benefit the company on the business front. However, the deal also needs to be looked from the point of view leverage or liability, which will increase significantly.
Not surprisingly, its stock, which has underperformed broader markets in the past one year, did not react positively on Monday; it was down 0.6 per cent Rs 16.90. “We see limited upsides due to already high debt levels and continuing overhang of a potential further increase in balance sheet stress due to the Hancock acquisition,” says Shirish Rane, analyst at IDFC Securities.
| SUM OF THE PARTS VALUATION | ||
| Value (Rs) | As % of total | |
| Power assets | 11.9 | 31.2 |
| Roads | 9.4 | 24.7 |
| Airports | 12 | 33.7 |
| Coal mines | 0.2 | 0.6 |
| Others (inc. cash) | 3.8 | 9.9 |
| Total value | 38 | 100 |
| Holding co.discount(%) | 20 | |
| Value per share (Rs ) | 30 | |
| Source: Religare Capital Markets | ||
| MARGIN GAINS | |||
| In Rs crore | FY11 | FY12E | FY13E |
| Sales | 1,915 | 1,983 | 2,569 |
| Operating margin (%) | 26.8 | 31.4 | 39.9 |
| Interest | 263 | 276 | 433 |
| Net profit | 155 | 207 | 225 |
| Debt-equity ratio (x) | 1.6 | 1.9 | 2 |
| EPS (Rs ) | 1 | 1.3 | 1.4 |
| RoE (%) | 4.6 | 5.8 | 6 |
| PE (x) | 17 | 13.1 | 12.1 |
| P/BV (x) | 0.8 | 0.8 | 0.7 |
| E: Estimates, Source: Motilal Oswal Securities | |||
While there are medium-term risks of high debt and execution, some of it is already priced into the stock, which is trading at reasonable valuations of 12 times the 2012-13 estimated earnings and 0.6 times its book value. Hence, only those investors with an appetite for risk may consider investing in the stock.
MORE LIABILITIES
GVK Power already has a consolidated debt of Rs 5,548 crore as against shareholders' funds of Rs 3,557 crore as on March 31 (with debt-equity rising to about two times at the end of 2011-12), indicating there is little room for taking further leverage. In 2011-12, the company is expected to pay almost half its operating profits towards interest costs due to the high debt in the books.
On the Hancock deal of $1.26 bn (Rs 5,670 crore), it will be financed through debt of $1 bn or Rs 4,750 crore. Of the remaining $260 million the group is investing in the form of equity, GVK Power will be paying about $30 mn for a 10 per cent stake in GVK Coal Developers, which would acquire the Australian assets. While the remaining 90 per cent stake is held by GVK Natural Resources, a group firm, GVK Power has an option to increase its holding to 49 per cent at a later date.
Through this way GVK Power has kept the debt outside its books in this manner, the liability will increase drastically. The company would provide a corporate guarantee to the extent of Rs 2,325 crore (49 per cent of total debt).
“Additionally, GVK Power will pledge the shares of GVK Energy and GVK Transportation to secure the equity requirements of the projects, including debt service requirements. In our view, this would be a key negative from GVK Power shareholders’ perspective,” says Parineeta Poddar, analyst at ICICI Securities. On the whole, though the guarantee will not reflect in its overall debt, it will exist in the form of contingent liabilities in the balance sheet, and prove to be an overhang for the stock.
HIGH COAL SECURITY
From the business point of view, the deal gives the company access to large coal reserves of high quality. Also, the deal is valued at $0.16 per tonne of estimated coal reserves, relatively at par with the recent deal of the Adani group at $0.146 per tonne. “It is a bold step towards becoming a major player in the global energy market and providing fuel security for GVK Energy’s power plant expansion,” says Vaibhav Jain, analyst at Religare Capital Markets.
Apart from power, GVK Power operates in real estate, oil and gas, construction and infrastructure (roads and two key airports, at Mumbai and Bangalore). However, power dominates with 90 per cent contribution in revenues and accounting for 30 per cent of its total stock valuation of Rs 30 per share. Its power assets are under the subsidiary, GVK Energy, which has operational capacity of 901 Mw. The company is aiming to increase its generation capacity five-fold to 4,400 Mw over the next few years.
The mines being acquired in Australia have total resources of 7.9 bn tonnes of coal. The production from these, which at full capacity could be around 84 mn tonnes per annum, would start from 2014, with initial output pegged at about 35 mt. To achieve this, GVK Power would need to make additional investments towards development of the mines and related rail and port infrastructure, for which it plans to bring in new investors, say analysts.
The other benefit for GVK Power is that the deal gives an option to enter into a long-term coal purchase agreement up to 20 million tonnes per annum, enough for 7,500 Mw of power generating capacity. This will help secure long-term fuel supplies for its subsidiary, GVK Energy, for a discount compared to the benchmark prices.
The additional coal from these mines will be sold in the market; the company has already signed supply agreements (or is in the process) to sell 45 million tonnes per annum to power companies in China, Japan, Korea, Taiwan and Vietnam. However, while this will mean gains for GVK Coal Developers, the gains for GVK Power will only accrue after it increases its stake in the holding company.
