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Tata Power: Long journey ahead!

May 30, 2006

Performance summary
India's largest private sector power generator, Tata Power, has announced mixed results for the fourth quarter and fiscal ended March 2006. On the back of higher generation and consequently increased volume sales, the company has reported a 16% YoY growth in topline during FY06. However, on account of a strong rise in cost of fuel, operating margins have taken a hit, contracting by 600 basis points. Subsequently, the net profit growth has underperformed growth in revenues. For the fourth quarter, while revenues have grown by 22% YoY, net profits have declined by 19% YoY, again on the back of lower operating margins. Substantially lower other income has also spoiled the 4QFY06 bottomline performance. On a consolidated basis, topline and bottomline have grown by 15% YoY and 26% YoY respectively.

Standalone financial performance: A snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Sales 9,623 11,711 21.7% 39,304 45,628 16.1%
Expenditure 8,054 10,138 25.9% 29,777 37,273 25.2%
Operating profit (EBDITA) 1,569 1,573 0.3% 9,527 8,355 -12.3%
Operating profit margin (%) 16.3% 13.4% 24.2% 18.3%
Other income 1,921 754 -60.7% 3,871 3,256 -15.9%
Interest 401 420 4.7% 1,914 1,653 -13.7%
Depreciation 1,029 734 -28.6% 3,596 2,783 -22.6%
Profit before tax 2,060 1,173 -43.0% 7,888 7,174 -9.0%
Extraordinary income/(expense) (300) 300 (300) 300
Tax 55 85 56.1% 2,074 1,369 -34.0%
Profit after tax/(loss) 1,706 1,388 -18.6% 5,514 6,105 10.7%
Net profit margin (%) 17.7% 11.9% 14.0% 13.4%
No. of shares 197.9 197.9 197.9 197.9
Diluted earnings per share (Rs) 27.9 30.9
P/E ratio (x) 16.6

What is the company's business?
Tata Power (TPC) is the largest private player in the power sector with a generation capacity of 2,324 MW, which is around 19% of the total power generation capacity of the private sector in India and a mere 2% of the country's total capacity. Out of this installed capacity, around 80% is used for supplying electricity to the Mumbai region. Power business contributes to around 95% of TPC's revenues. Apart from power generation, the company also has interests in areas like transmission and distribution and power trading.

What has driven performance in FY06?
Volume led growth: Growth in TPC's topline during FY06 was a result of combined growth in both volume sales and realisations per unit. While the former grew by 7.5% YoY, the latter were higher by 9.3% YoY. The company sold a net of 13,616 m units (MUs) during the fiscal, almost 2% higher than what we had estimated. The actual realisations were, however, 1% YoY lower than our FY06 estimated figure of Rs 3.22 per unit. Higher generation was aided by the commissioning of a 120 MW thermal plant at Jojobera and higher generation from the company's hydro power plants (on the back of good monsoons during the fiscal leading to improved water levels in the company's lakes). As a matter of fact, hydropower capacity forms around 20% of TPC's total power generation capacity and acts as a good source of meeting peak time electricity requirements by the company's Mumbai licensed area.

Segment-wise performance…
4QFY05 4QFY06 Change FY05 FY06 Change
Power Business
Revenue 8,633 11,143 29.1% 36,831 43,302 17.6%
% share 90.3% 95.1% 93.5% 94.8%
PBIT margin 3.5% 12.9% 17.0% 14.7%
Others
Revenue 932 570 -38.8% 2,579 2,369 -8.2%
% share 9.7% 4.9% 6.5% 5.2%
PBIT margin 5.2% 16.9% 4.3% 1.1%
Total*
Revenue 9,565 11,713 22.5% 39,410 45,671 15.9%
PBIT margin 3.7% 13.1% 16.2% 14.0%
* Excluding inter-segment adjustments

Higher fuel and power purchase costs dent margins: During FY06, TPC's operating margins were pressurized by higher fuel costs and cost of power purchased from external sources. As a matter of fact, TPC purchases around 300 MUs per annum from external sources to meet demand in the Mumbai licensed area. During FY06, cost of power purchased increased to 12.8% of sales, from 10.6% of sales in FY05. Secondly, fuel costs increased from 47.4% of FY05 sales to 52.5% of sales in FY06. Sustenance of high global crude oil prices and short supply of coal in the Indian market continue to impact the company's cost of fuel. This has consequently affected the company's profitability (see adjacent chart). Investors should note that the rise in fuel costs would have been higher but for the increased supply from hydro power plants, for the reason mentioned above.

It boils down to the bottomline: Apart from contraction in margins, lower other income has also had its impact on TPC's bottomline during FY06, which has grown at a lesser rate than the topline. Even lower interest, depreciation and tax charges and higher extraordinary income could not help the company buoy its net profits during the fiscal. In fact, during 4QFY06, net profits have declined by 19% YoY, due mainly to fall in operating margins and lower other income.

On an expansion drive…
TPC has lined up large expansion plans for the future. Currently, the following projects are under the execution phase:
  1. 250 MW coal fired unit at Trombay (scheduled to be commissioned by October 2008 – 3QFY09)

  2. 100 MW diesel generating sets to meet additional requirement in Mumbai in the interim (scheduled to be commissioned by May 2007 – 1QFY08)

  3. 1,000 MW coal based plant in coastal Maharashtra.

  4. 1,000 MW Maithon thermal project. TPC has acquired 74% stake from Damodar Valley Corporation (scheduled to be commissioned in FY11)

Apart from these projects, TPC has also submitted its interest in developing ultra mega power projects (4,000 MW each), which were announced as part of the Union Budget proposals in February 2006. The company is also looking at developing projects in Bangladesh and South Africa. These initiatives, together with the process of shifting focus from being a Mumbai centric player to having a national presence, augurs well for TPC's long-term growth. However, the gestation period is quite long and, as such, we have not included any of these expansions in our future estimates for the company.

What to expect?
At the current price of Rs 512, the stock is trading at a price to earnings multiple of 13.0 times our estimated FY08 earnings. The board has recommended a dividend of Rs 8.5 per share (dividend yield of 1.7%). While the topline performance has almost been in line with our estimates, we are concerned by the gradual decline in the company's profitability over the past few quarters. This has mainly been on the back of higher fuel and power purchase costs. These, we believe, shall continue to impact the company's performance in the near term, given the kind of resource (coal and gas) constraints that the entire power sector is facing.

Thus, the only way for TPC to improve upon its profitability, like its peers in the sector, is to rapidly increase its generation capacity. While the company has lined up large expansions plan for the future, which includes the entire spectrum of the power sector – from power generation to transmission and distribution – considering the long gestation period and regulatory hurdles involved (especially in distribution), we shall advise investors to practice caution with respect to the stock.

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