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Tata Power: Fuel worries!

Jul 31, 2006

Performance summary
India’s largest private sector power generator, Tata Power, has announced mixed set of numbers for the first quarter of FY07. For the quarter, revenues have grown by 25% YoY. However, on the back of higher fuel and power purchase costs, operating margins have taken a hit, contracting by 320 basis points (3.2%). The effect is seen on the bottomline, which has managed a mere 3% YoY growth.

Standalone financial performance: A snapshot
(Rs m) 1QFY06 1QFY07 Change
Sales 10,988 13,766 25.3%
Expenditure 8,577 11,185 30.4%
Operating profit (EBDITA) 2,410 2,581 7.1%
Operating profit margin (%) 21.9% 18.7%  
Other income 315 410 29.9%
Interest 379 524 38.5%
Depreciation 656 760 15.9%
Profit before tax 1,691 1,706 0.9%
Tax 507 488 -3.8%
Profit after tax/(loss) 1,184 1,219 2.9%
Net profit margin (%) 10.8% 8.9%  
No. of shares 197.9 197.9  
Diluted earnings per share (Rs)*   31.0  
P/E ratio (x)*   15.8  
* On a trailing 12-months basis

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 1QFY07?
Realisations and volumes combine: Higher electricity generation and much higher unit sales have aided Tata Power’s topline growth during 1QFY07. While generation grew by 2% YoY to 3,824 m units (MUs), volume sales recorded a growth of over 5% to 3,807 MUs. Higher generation was a result of better performance from the company’s Jojobera units, where units generated increased by 25% YoY and contributed to 19% of the total generation during the quarter. Further, growth in generation at Jojobera was aided by a 120 MW expansion undertaken during the second half of the last fiscal.

A part of the topline growth in 1QFY07 is also due to better realisations that, on an average, increased to Rs 3.5 per unit, from Rs 2.9 per unit in 1QFY06. In order to give a further boost to its performance, the company is currently working towards a 250 MW coal based unit at Trombay (currently at 1,330 MW). This expanded capacity is expected to get commissioned in FY09 and will cater to increasing energy requirements in the Mumbai region. The company is also in process of setting up 100 MW of diesel generating sets, also to cater to demand in Mumbai. Also, during 1QFY07, the company started work on a 120 MW captive unit for Tata Steel at Jamshedpur. This project is also likely to be commissioned in FY09. In our estimates, we have factored in just the 250 MW Trombay expansion and, as such, there is likely be an upside to our numbers post FY09.

Higher fuel and power purchase costs dent margins: Tata Power, in line with its peers, continues to face pressure on profitability due to rising fuel prices. The same was seen in 1QFY07 as well, when fuel costs increased to 59% of sales, from 55% in 1QFY06. Cost of power purchased also witnessed a rise, thus impairing the overall profitability further. As a matter of fact, TPC purchases some part of its requirements (for instance, purchases of 448 MW in FY06) from external sources like MSEB and Jindal to meet demand in the Mumbai licensed area. Also, the power purchase cost per unit is higher than cost of internal generation, thus having the ability of impacting margins adversely in case of higher purchases. These two costs formed around 72% of Tata Power’s total sales in 1QFY07. However, for FY07, we estimate these to form around 66% of sales, as generation from the company’s hydro stations is likely to increase in the next two quarters assuming normal rainfall in the Mumbai region and consequently greater supply of water at the company’s lakes at Bhira, Bhivpuri and Khopoli.

Margins impact bottomline: Contraction in operating margins has had its impact in Tata Power’s net profits, which have witnessed a lacklustre growth of 3% YoY during the quarter. Consequently, net profit margins have contracted by 190 basis points to 8.9%. Though we estimate the same to improve over the next few quarters, for reasons mentioned above, our estimate for FY07 net margins stand at 13.2%.

What to expect?
At the current price of Rs 490, the stock is trading at 15.2 times our estimated FY08 earnings and 1.7 times estimated FY08 book value. The effect of higher capacity was clearly seen in Tata Power’s topline performance during 1QFY07. However, we remain concerned about the general rise in raw material costs, which have dented the company’s profitability levels. Though we expect the situation to improve in the subsequent quarters, assuming higher offtake from hydro stations, the overall fuel situation still needs to be seen with utmost caution.

We had recently recommended a ‘Buy’ on the stock at Rs 476 with a target price of Rs 630 from a long-term perspective. Considering the strides that the company is taking towards expanding capacity, which will consequently define growth in the future, we maintain our view on the stock.

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