Low on energy

POUND WISE

Reliance Energy's stock price reflects the ambiguity shrouding its ambitious plans to scale up its power generation capacity.

The Anil Ambani-owned Reliance Energy (REL) seems to be losing steam on the bourses. A leading private sector player in the power distribution business, REL announced plans to jack up its power generation capacity from less than 1,000 MW currently to over 13,500 MW by 2011.

Its Dadri project was to kick off in 2009. However, two years after the plans were announced, there is still no clarity on the time line for the projects.

Key issues like land acquisition, gas availability and pricing are still to be sorted out. Besides, the company is bidding for ultra mega power projects, which also will take time to materialise.

Thanks to the uncertainty, investors have shunned the stock. In the past twelve months, the stock has plunged 30 per cent even as the Sensex has gained 51 per cent.

At the current market price of Rs 446.20, the stock trades at a price-to-earnings multiple of 14.57. Based on earnings estimates for FY07 and FY08, REL is trading at 13.3x and 12.2x, respectively, while its competitor Tata Power is trading at higher multiples of 17.4x and 16.4x.

Is REL a value buy at the current levels? Analysts are divided on this. While some believe it is a good play on the future growth opportunities, others feel it may be premature to bet on the stock as revenue visibility for the next couple of years remains hazy.

"Though REL's engineering procurement and construction (EPC) arm and relatively new infrastructure segments are likely to do well, there seems to be no major progress in its power projects. I am not betting on the stock, at least until there is some earnings visibility in the power generation business," says Mehul Mukati, analyst, Emkay Share and Stock Brokers.

Core business
At present, REL derives a bulk of its revenues from its electrical energy business, which has delivered consistent growth.

In FY06, the segment contributed 79 per cent of the revenues against 70 per cent in the previous fiscal.

The distribution division supplies more than 5,000 MW of power to various areas of Mumbai, Delhi and Orissa. It has also applied to the Uttar Pradesh Electricity Regulatory Commission for distribution licences in Meerut, Ghaziabad and Noida.

REL's Dahanu Power Station, one of the top performing coal-based power stations in the country, maintained a good performance despite lower demand because of heavy floods in Mumbai. Its other power stations at Samalkot and Goa are also doing well.

In the next couple of years, earnings growth from the existing energy business is likely to be muted unless state regulatory boards take some major steps to privatise more distribution circles.

The other significant revenue constituent for REL is its EPC division, which chipped in with 21 per cent (Rs 880 crore) to the company's revenues in FY06.

The division takes up contracts for electrification, erection and operation of power plant equipment, grids, substations and transformers. It has bagged a rural electrification contract from the Uttar Pradesh Power Corporation (Rs 735 crore) and a power project order from Haryana Power Generation Company (Rs 2,097 crore).

Till March 2006, the EPC segment pocketed orders worth Rs 3,358 crore, to which in-house projects contributed 15 per cent. Considering the macro picture, the EPC business should help the company in boosting its growth prospects, believe analysts.

Promising future
At present, REL's 942 MW power generation business forms a small chunk of its revenues, but as and when the company's proposed gas, coal, wind and hydro-based power generation projects in Maharashtra, Uttar Pradesh, Arunachal Pradesh and Uttaranchal fructify, the picture is likely to change.

The 7,480 MW Dadri (Uttar Pradesh) and the 4,000 MW Shahapur (Maharashtra) gas-based power projects are potential goldmines for REL, but given the present pace of progress it could take a while before they could be factored in the business valuations.

These two projects are likely to commence operations in mid-2009 and 2011 respectively.

REL recently bagged the Urthing Sobla hydropower project (Uttaranchal) and plans to develop the two hydro projects in a joint venture with the Arunachal Pradesh government.

Dadri drama
The mega gas-based Dadri power project in Ghaziabad will, on completion, be the world's largest power generation plant at a single location. The project was announced in February 2004, but it is yet to attain financial closure.

According to the gas supply agreement signed by the Ambani brothers, post-split, Reliance Natural Resources (RNRL) would source gas from Reliance Industries (RIL) and supply it to REL's Dadri project at Rs 2.6 per kwh or $3.18 mmbtu.

However, the petroleum ministry has recently rejected the gas valuation formula citing that the price is significantly lower than the prevailing market price of around $8-10 per mmbtu.

Combined with this, RNRL's intention to pocket marketing margin for the gas procurement is likely to impact the cost of the project that plans to draw heavily on gas procured from RIL, according to analysts.

New avenues
The company is foraying into the transmission business and will participate in the construction of 300 km transmission line for the Parbati and Koldam hydropower projects in Himachal Pradesh.

Realising the potential in the higher margin infrastructure projects, REL is investing Rs 500 crore in two NHAI road development projects and Rs 2,360 crore in MRTS (mass rapid transit system) project in Mumbai, on a BOOT basis.

In FY06, REL's net sales fell a marginal 2.7 per cent to Rs 4,019.07 crore. However, both operating profit and net profit grew 25 per cent to Rs 737.27 crore and Rs 650.34 crore, respectively.

Analysts expect the FY07 and FY08 revenues to be Rs 4,370 crore and Rs 4,820 crore, respectively. Though, purely based on valuations, the stock looks attractive, there is no near-term trigger for it. However, the scrip may be an interesting addition for a long-term investor.

Motilal Oswal Securities recommends a buy at Rs 411 citing that the stock is largely a play on the future growth opportunities rather than on existing assured return businesses.

Enam Securities has put a "sector outperformer" rating at Rs 437 with a target of Rs 525. They believe earnings growth from the existing generation and distribution business would be muted. Clarity on the Dadri and Shahpur projects and success for its bids on ultra mega power projects would be the key triggers for the stock going ahead.