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Tata Power: Why so?

Mar 17, 2004

India's largest power player, Tata Power has under performed its peer Reliance Energy on the bourses in the last 3 months. The 3-month share price graph shows that Rs 100 invested in Tata Power would have fetched Rs 113, as compared to Rs 140 by Reliance Energy. Let us take a re-look at the company in detail.

Tata Power is the largest private player in the power sector, with a generation capacity of 2,278 MW (megawatt). This is 52% of the total power generation capacity of private sector in the country. Out of this installed capacity, 79% of capacity is used for supplying power to the Mumbai region. Over the past five years, the company has expanded its reach beyond the Mumbai circle, and this has aided much in the growth of its revenues during this period. As a matter of fact, the company has increased its revenues at a CAGR of 13% over the last five years.

However, with the recent Electricity Act 2003, things are bound to change for the company. The open excess policy, as mandated in the new Act, would allow distribution companies to use the transmission lines and import power from cheaper sources. Taking advantage of this clause, Reliance Energy is planning to import power from other players like NTPC. The landed cost of power purchased from Tata Power is higher by around 35% because in order to comply with the environmental norms, Tata Power has to use naphtha (a costly substitute of coal) for 60% of its power generation.

Now, if Reliance Energy is able to do that, i.e., import power from NTPC, Tata Power is likely to land up in trouble. This is due to the fact that, currently, Reliance Energy buys around 500 MW power from Tata Power and once it changes its vendor, revenue growth of Tata Power might be affected. In such a scenario, either Tata Power will have to look for another buyer or rationalize the tariffs for Reliance Energy, which can then take a toll on the company's operating margins over next two years.

Now, the problem for Tata Power does not stop here. If the Dhabol power plant were to become operational, the entire power scenario in the region would be in a state of flux. Then, who buys out the Enron asset, or at what rate the power generated is sold, would be of importance and can have an impact on the earnings of Tata Power.

Since power is a cash generating business, Tata Power has been used as the diversification arm of the Tata Group. Tata Power has invested in unrelated business like petroleum exploration, telecommunication and broadband infrastructure. Though the company has exited from broadband business and is looking to sell off its petro business (Tata Petrodyne), its intentions to invest in 'adjacent infrastructure businesses', as mentioned in its 2003 annual report (no clarity regarding the same), raises concerns once again. As a result, inspite being in the power business for the last 85 years, Tata Power has been able to grow its capacity just to 2,300 MW. This is in sharp contradiction to Reliance Energy (1,000 MW capacity) that has declared plans to install a 3,500 MW gas based power plant in UP and plans do a capex of around Rs 200 bn over the next five years.

At the current price of Rs 365, the stock trades at P/E multiple of 13.1x our FY04 earnings estimates. The emerging opportunities in the power sector and the likely divestment of Petrodyne remain positive triggers in the long and the medium term, respectively. However, the likelihood of a decline in realisations (prices at which it sells power in the Mumbai area) continues to be a major negative for the company. This is due to the fact that the Mumbai region accounts for around 80% of the company's total revenues. The company has increased its five-year capex plans to Rs 120 bn. However, the stock can witness an upside only when company indicates some clarity over the utilisation of this money. Investors, in that respect, must practice utmost caution.

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