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Reliance Energy: Growth at a cost
Jul 19, 2007

Performance summary
  • Topline grows by 41% YoY, driven by 12% YoY higher volume sales of electricity and 26% YoY rise in tariffs.

  • Substantially higher power purchase costs pressurise operating margins that contract to 2.3%. Power purchases higher by 17% YoY in volume terms.

  • Strong rise in other income, powered by higher interest income and forex gains, protect the bottomline, which grew by 26%.

  • EPC order book at Rs 50 bn or 2.4 times the segment’s FY07 revenues.

Financial performance: A snapshot…
(Rs m) 1QFY07 1QFY08 Change
Sales 11,489 16,240 41.4%
Expenditure 10,214 15,864 55.3%
Operating profit (EBDITA) 1,274 376 -70.5%
Operating profit margin (%) 11.1% 2.3%  
Other income 1,771 3,599 103.2%
Interest 459 693 50.9%
Depreciation 619 581 -6.1%
Profit before tax 1,967 2,701 37.3%
Extraordinary income/(expense) - -  
Tax 201 485 141.4%
Profit after tax/(loss) 1,766 2,216 25.5%
Net profit margin (%) 15.4% 13.6%  
No. of shares   228.5  
Diluted earnings per share (Rs)   37.0  
P/E ratio (x)   18.6  

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 Mumbai, Delhi, Orissa and Goa. The company has an installed generation capacity of 941 MW. The company also has a presence in the engineering, procurement and construction (EPC) business (36% of FY07 revenues).

What has driven performance in 1QFY08?
‘Power’ful boost to topline: Against the last quarter and fiscal’s performance, when the EPC (engineering, procurement and construction) business led growth in topline for Reliance Energy, this quarter recorded strong performance by both the segments. While sales of electricity grew 39% YoY, income from the EPC business was up 40% YoY. However, the electricity segment, owing to its much larger share in total revenues, was more instrumental in driving the growth in topline.

This business recorded by a 12% YoY increase in volume of electricity sold, which stood at 2,489 m units (MUs) during the quarter. The rise in volumes was both a result of improved plant load factor (PLF, or capacity utilisation) and higher volumes of electricity purchased from external sources. For instance, the company’s generating station at Dahanu (500 MW) operated at 104.5% PLF during 1QFY08, slightly higher than 104.3% PLF recorded in 1QFY07. The stations at Samalkot (Andhra Pradesh) and Goa also operated at higher utilisation levels. As for the external purchases, Reliance Energy bought 1,337 MUs (54% of volumes sold) of electricity during 1QFY08, higher by 17% YoY.

Segment-wise performance…
  1QFY07 1QFY08 Change
Electrical Energy      
Revenue 9,340 12,986 39.0%
% share 79.4% 79.3%  
PBIT margin 14.2% 6.8%  
EPC and Contracts      
Revenue 2,422 3,398 40.3%
% share 20.6% 20.7%  
PBIT margin 6.2% 5.1%  
Total*      
Revenue 11,762 16,384 39.3%
PBIT margin 12.6% 6.5%  
* Excluding inter-segment adjustments

The EPC business recorded an order backlog of Rs 50 bn at the end of June 2007. This was over double the segment’s total sales in FY07 and provides visibility for future growth. As a matter of fact, the company had booked some large orders during the later half of FY07, the initial execution of which have perked up this business’ sales numbers during the last few quarters. The company had recently bagged a project in Hissar (Haryana) to set up a 1,200 MW coal-based power project on a turnkey basis for Rs 38 bn. As reported, the project will be implemented in a schedule of 35 to 38 months. It also won a 500 MW project in Pariccha (Uttar Pradesh) for the EPC business. On the road construction front, the company had recently won two BOT projects - development of Namakklal-Karur highway (a stretch of 80 km in Tamil Nadu for Rs 5 bn) and contract for developing the Trichy-Dindigul National Highway four-laning project (stretch of 88 km for Rs 6 bn).


Costly purchases dampen profitability: While electricity purchases increased by 17% YoY during 1QFY08, it was the higher per unit cost of these purchases that negatively impacted Reliance Energy’s profitability during the quarter. As a matter of fact, the unit cost of purchase increased by 84% YoY, from Rs 2.7 in 1QFY07 to Rs 5 in 1QFY08. This led to the increase in power purchase cost from 27% of sales in 1QFY07 to over 41% of sales in 1QFY08. However, lower cost of fuel (as percentage of sales) pared some of this impact on the operating margins.

Higher other income, lower depreciation save bottomline: Despite the sharp contraction in operating margins, Reliance Energy managed to grow its bottomline at a decent rate of 26% YoY during 1QFY08. This was brought about by the substantial increase in other income, which was a consequence of higher interest income and forex gains. Reduction in depreciation charges also helped the bottomline growth during the quarter. But for the increase in effective tax rate to 18% (10% in 1QFY07), the profit growth would have been higher.

What to expect?
At the current price of Rs 689, the stock is trading at a multiple of 14.3 times our estimated FY10 earnings. On a price to book value multiple, the stock is trading at 1.4 times our FY10 estimates. The 1QFY08 results have been a mixed bag considering that while the strong topline performance was a positive, the decline in profitability owing to higher power purchase costs was a dampener. We remain cautious on the company’s expansion plans, given the hiccups that it is facing in terms of fuel (gas) supply and pricing. However, the strong order backlog in the EPC business accompanied by execution of the same over the next two years shall help the overall growth prospects of the company.

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