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Mundra UMPP, valuations mar Tata Power's prospects

With Mundra incurring losses and resolution of higher costs not likely soon, stock could feel pressure

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The stock has underperformed broader markets in the current quarter, a trend likely to sustain, going ahead, due to concerns over its and stock valuations. Against a two per cent rise in the Sensex, Tata Power’s stock is down almost six per cent in the quarter so far.

The 4,000 Mw Mundra ultra mega power project (UMPP) (set up under Limited (CGPL) reported a net loss of Rs 165 crore in the June 2012 quarter, which was ahead of analysts’ estimates. This has only added to the concerns about the viability and recovery of investments (Rs 4,112 crore in equity) Tata Power has made in this flagship project. Though the management is trying to work out a solution, analysts remain worried about the continuity of losses and hence, ascribe a negative value to (which has accumulated losses of Rs 2,208 crore) while valuing the Tata Power stock. They are also concerned about the performance of the Indonesia-based coal business, which contributes significantly to Tata Power’s consolidated earnings, as a result of pressure on margins.

“Mundra UMPP losses are a reality now (cannot be undone without tariff hikes not mandated in PPA), coal ASPs (average selling prices) have been declining and cost of production has been increasing. As such, we downgrade the stock from Neutral to Sell,” says Venkatesh Balasubramaniam who tracks the company at Citi Research in his recent note on the company. Most analysts remain cautious as current valuations are not cheap either. At Rs 97, the stock is trading 24 times its earnings and 1.8 times book value based on FY14 estimates.
 

PROFITS UNDER PRESSURE
In Rs crore FY12 % chg Q1' FY13 % chg
Total revenue 25,869 33.7 7,353 26.7
Ebitda 5,193 15.6 1,510 7.6
Interest costs 1,527 76.3 548 108.4
Reported net profit -1,088

193 -61.6
Book value (Rs) 50 10.4
EPS (Rs) 2.9 -63.3
% change is year-on-year                        Source: Emkay Global Financial Services

Mundra concerns
The Mundra Project has operational capacity of 1,600 Mw (including 800 Mw commissioned last month) and is fuelled by imported coal from Indonesia-based KCP and (Tata Power owns 30 per cent stake in each). Though CGPL is getting coal supply, changes in Indonesian mining laws have led to an increase in the cost of coal. At the time of agreement, coal supply was fixed at about $36 per tonne but today prices are market driven and are hovering around $90-100 per tonne.

According to the (PPA), cost increase (escalation) is allowed for only 45 per cent of the fuel component. As a result of significant increase in costs, there is a shortfall (cost is higher than the selling price) leading to losses. The company had earlier quoted a 25-year levelised tariff of Rs 2.26 per unit. The management says that a 0.40 paisa per unit hike in tariff will help the project break-even, while a 0.65 paisa increase will ensure reasonable return. Under this situation, the other upcoming units of the project could also face problems when they become operational.

Nevertheless, if the situation continues, CGPL could continue to report a monthly loss of Rs 40 crore in FY13 leading to erosion in equity investments. Not surprisingly, analysts are according a negative value to the Mundra project. They believe that in the current environment not just the returns, but recovering costs will also be challenging.

Solutions being worked out
In the FY12 annual report, the company said, “Tata Power has offered to transfer 75 per cent of the dividend flow of coal SPV (which holds 30 per cent stake in the two Indonesian mines) to CGPL or any other alternate structure or method to support the debt service. Your company is in discussions with lenders to formalise a suitable structure.”

Such a move will help as these mines produce about 60 million tonnes of coal. Its 30 per cent stake gives it a share of about 18 million tonnes of coal. If about two million tonnes of this is supplied to Mundra UMPP, Tata Power will still make profit on the remaining 16 million tonnes. These mines produce coal at about $49 per tonne and sell the same at $90-100 per tonne making handsome profits. While this could solve the cash flow issue, those pertaining to fuel cost will still remain.

Meanwhile, the company has also approached the CERC for an increase in tariff and has sought to allow pass-through of the non-escalable part of the fuel component. However, this needs to be watched, considering that it is not part of the PPA and is also dependent on acceptability by respective states (power purchasers).

Operationally, too, it has taken initiatives. A company spokesperson says, “We are also exploring alternatives to mitigate the problems to the extent possible. The company has commenced blending and deploying alternate coal called eco-coal, which is equally environment friendly and low in sulphur content, but is cost competitive and thus helps to offset cost. Up to 70 per cent blending is being done to offset some of the cost impact due to the steep increase in international coal prices and we plan to maximise this to reduce the overall cost of fuel. However, this is not enough to achieve a break-even, and as mentioned, we would now await the outcome of CERC proceedings.”

Meanwhile, analysts have lowered their estimates for Tata Power. While they are expecting its revenues to grow led by power generation, transmission and distribution businesses as well as coal mining, analysts expect profits to remain under pressure over the next two years, mainly due to Mundra. k

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