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The Supreme Court's recent order to not allow the Compensatory Tariff to Coastal Gujarat Power (CGPL), a wholly owned subsidiary of Tata Power Company (TPCL: 'IND AA'/Stable), will result in continuous under-recoveries of fuel cost at CGPL of around INR10 billion for coal prices at USD60 MT (FoB), says India Ratings and Research (Ind-Ra). Ind-Ra believes that TPCL at a consolidated level has a natural hedge to an extent from the increase in coal prices due to its 30% stake in the Indonesian coal mines.
Ind-Ra highlighted that while an increase in international coal prices will adversely impact CGPL's profitability, it will help improve the profitability of TPCL's Indonesian coal mines. Thus, TPCL enjoys a commodity price hedge at the consolidated level, if not exactly as a cash flow hedge for the operating losses at CGPL.
Ind-Ra notes that post the sale of Arutmin mines, TPCL's 30% stake in Kaltim Prima Coal (KPC) with an annual production run rate of 55mmtpa, would be equivalent of effective 16.5mmtpa coal production per annum, which is higher than the annual coal requirement of 10.15mmtpa of CGPL for it to achieve a plant load factor of 73%. And thus, TPCL would still have net long positions on coal. Since Indonesian coal mining is subject to royalty payment of 13.5% on FoB value, as long as each dollar increase in realisation of coal price net of royalty is captured in improving gross profit of the mining business, TPCL profitability would be positively impacted at consolidated level (excluding the tax implication at Indonesian mine company).
Ind-Ra, notes that if 36% of each dollar increase in coal realisation is translated into higher mining gross profit, TPCL would be hedged to coal price increases at a consolidated level. In the 3QFY17 analyst presentation, TPCL reported USD11.86/MTqoq improvement in coal realisation, while the cost of goods sold increased by USD5.70/MT, and thus gross profit improved by USD 6.16/MT (52% of increase in realisation).
Ind-Ra had highlighted in February 2017 that Compensatory Tariff as announced by CERC, provides a cushion to CGPL's earnings. And thus, now there is limited headroom for TPCL's current rating of 'IND AA'. Thus Ind-Ra believes it is imperative for TPCL to deleverage, based on the other announced measures, such as the sale of non-core assets and other means of equity raising.
TPCL is exploring all possible options to reduce the under-recovery at its CGPL plant, including sourcing of competitive coal and use of low grade and blended coal options.
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