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Reliance Energy: All’s well ‘if’ it ends well! - Views on News from Equitymaster
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  • Jul 19, 2005 - Reliance Energy: All’s well ‘if’ it ends well!

Reliance Energy: All’s well ‘if’ it ends well!
Jul 19, 2005

Performance summary
Private sector power major, Reliance Energy, has announced mixed results for the first quarter ended June 2005. While revenue growth has been subdued, profit growth has been excellent on the back of expansion in operating margins, low depreciation outgo and a higher other income component. Decline in realisations and lower volume sales in the electricity segment, has led to the poor performance of the topline in 1QFY06.

Financial performance: A snapshot…
(Rs m) 1QFY05 1QFY06 Change
Sales 9,428 9,497 0.7%
Expenditure 7,955 7,882 -0.9%
Operating profit (EBDITA) 1,473 1,615 9.6%
Operating profit margin (%) 15.6% 17.0%  
Other income 769 1,348 75.2%
Interest 306 433 41.4%
Depreciation 811 817 0.8%
Profit before tax 1,126 1,712 52.1%
Extraordinary income/(expense) 71 (0)  
Tax 97 146 50.2%
Profit after tax/(loss) 1,100 1,566 42.4%
Net profit margin (%) 11.7% 16.5%  
No. of shares 185.4 195.3  
Diluted earnings per share* (Rs) 22.5 32.1  
P/E ratio (x)   20.3  
(* annualised)      

What is the company’s business?
Reliance Energy is a leading private sector power company in the country and has presence in generation, transmission and distribution in the states of Maharashtra, Goa and Andhra Pradesh. The company has an installed generation capacity of 941 MW and boasts of a customer list of over 5 m. The company has envisioned increasing its generation capacity to 9,000 MW by 2012, and as a precursor towards achieving this target, has unfurled its plan of setting up a 7,480 MW gas based power plant in phases, in UP, involving a capex of over Rs 220 bn.

What has driven performance in 1QFY06?
It’s EPC for once more:  The marginal growth in Reliance Energy’s 1QFY06 topline has been a result only of the 16% YoY growth in the EPC (engineering, procurement and construction) division and contributed to around 18% of the total revenues of the quarter. In fact, this segment has led the company’s growth in the past few quarters as well and has benefited on account of the surge in domestic capital investments. Notably, the EPC segment has reported an outstanding order backlog position of Rs 35 bn at the end of 1QFY06, almost 3 times the segment’s revenues in the previous fiscal.

Segment-wise performance…
  1QFY05 % of total 1QFY06 % of total Change
Electrical Energy
Revenue 8,081 84.8% 7,909 82.5% -2.1%
Profit 1,078 97.1% 759 84.4%  
Profit margin 13.3%   9.6%    
EPC and Contracts
Revenue 1,447 15.2% 1,676 17.5% 15.9%
Profit 32 2.9% 140 15.6% 332.1%
Profit margin 2.2%   8.4%    
Total*
Revenue 9,528   9,585   0.6%
Profit 1,111   899   -19.1%
Profit margin 11.7%   9.4%    
* Excluding inter-segment adjustments

On the other hand, Reliance Energy’s bread and butter business of generating and supplying power has reported a 2% YoY decline in revenues during 1QFY06. This seems a result of the reduced realisations per unit for electricity sold and lower units sale. Readers should note that Reliance Energy buys a large part of its requirement from its peer, Tata Power, and that, as per the MERC order, the rate at which the latter supplies power to the former has been reduced from Rs 3.1 per unit to Rs 2.7 per unit. This reduction in purchasing cost of power might have been passed on to the consumers and this, we believe, is partially the reason for the near flat growth of the electricity segment in the quarter. Also, the company sold 2,161 m units of electricity in the quarter, lower by 1.3% over 2,190 m units sold in 1QFY05.

Lower power purchase costs aid margin expansion:  While expansion in PBIT margins of the EPC business (from 2.2% in 1QFY05 to 8.4% in 1QFY06) has helped the overall operating margin expansion, it has also been aided by the reduction in cost of electrical energy purchased during the quarter. Notably, the same has reduced from 31% of sales in 1QFY05 to 29% in the quarter under consideration. And the reason is, as indicated above, reduction in cost of power purchased from Tata Power due to MERC ruling.

It boils down to the bottomline:  Apart from the expansion in operating margins, significantly higher other income and lower depreciation outgo has aided Reliance Energy’s bottomline, which has surged by over 42% during 1QFY06.

What to expect?
At the current price of Rs 650, the stock is trading at a price to earnings multiple of 20.3 times its annualised 1QFY06 earnings and 20.2 times our estimated FY07 earnings. The board of the company has recommended a quarterly dividend of Rs 1.2 per share (dividend yield of 0.2%). The stock has witnessed much buoyancy in the past month, after the settlement of ownership issues within the Reliance Group. Another reason for the surge in the stock has been statements made by the management with regards to the large expansion plans envisaged in the next few years.

In fact, in June 2005, the board had proposed a preferential offer of equity to Anil Dhirubhai Ambani Enterprises, the holding company of Reliance Energy, whereby the latter will invest Rs 15 bn to fund the expansion activities. Apart from the 7,480 MW gas based project planned in UP, which would involve an investment of Rs 220 bn, the company plans to invest another 480 bn in a 12,000 MW coal-based project in Orissa. While the plans are grand and when fulfilled, will catapult Reliance Energy into the league of the big players in the sector, funding will remain an issue, especially after the separation of interest from the erstwhile parent, the Reliance Industries. Also, investors should note that large-scale projects like these will take several years for completion and, to that extent, there is uncertainty with regards to the return on funds employed.

  • We shall soon update our research report on the company.

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