Lower merchant power rates and higher coal prices would ensure sustained pressure on profitability of non-integrated companies
The performance of Indian companies with large exposure to merchant power sales could remain under pressure, with a likely decline in earnings as a result of lower merchant power tariffs and rising coal prices. This especially holds true for non-integrated players. Thermal coal — a key input for power generation — has become costly in the global markets in the recent months (see chart). Additionally, India’s largest coal producer, Coal India, also recently increased the price of coal by 30 per cent for non-regulated (spot sales) power generation companies. Further, industry estimates suggest that demand from China and India could drive coal prices towards $150 a tonne. In the long run, given the nuclear crisis in Japan, any increase in preference towards coal-based power plants would only lead to further pressure on coal prices.
In this scenario, the cost of power generated could increase to as much as Rs 5 per unit. On the other hand, the average merchant rates have averaged at around Rs 4 per unit in the recent times, as against Rs 5-6 per units in the comparable period a year ago. The financial implication of these events, however, will be lower for merchant power producers that have assured low-cost coal supplies.
The situation could have been better, had the supply of domestic coal (which costs less) been sufficient. Due to environmental concerns, India’s annual thermal coal production growth is also slowing — to 1-2 per cent now from 6-7 per cent earlier. Recently, Coal India lowered its production growth to 3 per cent.
“Considering the input price pressure and lower merchant power rates, the impact will be seen on most of the IPPs (independent power producers) like Adani Power, Lanco, Nava Bharat Venture, JSW Energy, among others,” says Rabindra Nath Nayak, senior analyst at SBI Cap Securities.
Most of these concerns, however, are already reflecting in the sharp decline in stock valuations in the recent months. Experts have been advising to be selective in buying such stocks and prefer well-diversified (revenues mix) and integrated players.
Adani Power
Analysts have cut down their 2011-13 earnings estimates by 16-18 per cent for the company, given the increase in coal prices along with the impact of proposed 20 per cent MAT on SEZ. About 75 per cent of its capacity is based on power purchase agreements (PPAs), wherein rates largely cover the costs and return on capital. However, worries erupt as remaining capacity is for merchant sales and estimated to account for a large part of the profits. At Rs 113 (down 18 per cent in the last six months), the stock is trading at 13 times 2011-12 estimated earnings. Given that analysts value the stock at Rs 120-140, there are limited gains from current levels.
Jindal Steel & Power (JSPL)
JSPL, which has presence in metals and power, currently earns 33 per cent of its revenue and 60 per cent of its operating profits from the power business. While analysts see risk to their earnings estimates for JSPL due to its very large exposure to merchant power business, the company still makes strong profits and returns on equity, given its fully-integrated power plants. Thus, the impact on its financials will largely be influenced by movement in merchant power tariffs, rather than costs (like coal prices). Not surprisingly, the stock is among the least affected in this pack, down under four per cent since September 2010. Analysts value the stock at Rs 700-750, against its current price of Rs 663, which translates into 12 times its 2011-12 estimated earnings.
JSW Energy
Among the top power producers, JSW Energy’s earnings and stock valuations are highly sensitive to availability of coal and its prices, given that about 46 per cent of its planned capacity, about 11,390 Mw, is dependent on imported coal. For now, almost 60 per cent of its current capacity caters to merchant power sales. These concerns reflect in its stock, which has fallen nearly 44 per cent since beginning of September 2010 (versus a per cent rise in Sensex) and trades at 7 times 2011-12 estimated earnings. Till coal prices soften or merchant power rates rise, stock is likely to remain subdued, at least in the near term.
Lanco Infra
The company sources as much as 30 per cent of its coal requirement through imports and more than 45 per cent of its existing capacity (produce) is sold as merchant power. Considering the current scenario and project profile of the company, analysts have reduced their earnings estimates marginally for the company. At Rs 36, the stock is trading at 7 times 2011-12 estimated earnings. Given the prospects of its power and other businesses, analysts have valued the stock at Rs 45.
