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Tata Power: Operating blues - Views on News from Equitymaster
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Tata Power: Operating blues
Aug 4, 2005

Performance summary
Private sector power major, Tata Power (Research), had recently announced results for the first quarter of FY06. The topline has almost been flat despite a 7% increase in volume sales and improvement in realisations. Bottomline, however, has been aided by lower tax outgo. Operating margins remain under pressure and have contracted by almost 10% over the corresponding quarter of the previous fiscal.

Financial performance: A snapshot
(Rs m) 1QFY05 1QFY06 Change
Sales 10,869 10,988 1.1%
Expenditure 7,345 8,577 16.8%
Operating profit (EBDITA) 3,523 2,410 -31.6%
Operating profit margin (%) 32.4% 21.9%  
Other income 175 315 80.4%
Interest 597 379 -36.6%
Depreciation 1,209 656 -45.7%
Profit before tax 1,892 1,691 -10.6%
Extraordinary income/(expense)      
Tax 875 507 -42.1%
Profit after tax/(loss) 1,016 1,184 16.5%
Net profit margin (%) 9.4% 10.8%  
No. of shares 197.9 197.9  
Diluted earnings per share* (Rs) 20.5 23.9  
P/E ratio (x)   17.1  
(* annualised)      

What is the company’s business?
Tata Power (TPC) is the largest private player in the power sector with a generation capacity of 2,203 MW, which is around 18% of the total power generation capacity of the private sector in India. Out of this installed capacity, around 79% is used for supplying electricity to the Mumbai region. Power business contributes to around 96% of TPC’s revenues and almost the whole of PBIT. Apart from power generation, the company also has interest in areas like transmission and distribution and power trading.

What has driven performance in 1QFY06?
Power business, the saviour:  The marginal growth in TPC’s topline during 1QFY06 has wholly been a result of the over 1% YoY growth in power business revenues. Over 7% YoY increase in volume sales of electricity (to 3,617 million units, or MUs), combined with the pass through effect of rise in cost of inputs (mainly crude and coal), has helped TPC manage the small growth in revenues. The 10% YoY increase in sales to the Mumbai license area and higher sales volumes from the trading subsidiary – Tata Power Trading Company – has also aided the power business revenues. During the quarter, TPC generated 6% more electricity (3,751 MUs) than 1QFY05 (3,373 MUs). Investors should note that with the current installed capacity, TPC can produce around 4,820 MUs of electricity in a quarter.

Segment-wise performance…
  1QFY05 % of total 1QFY06 % of total Change
Power Business
Revenue 10,450 96.0% 10,598 96.3% 1.4%
PBIT 2,340 99.1% 1,789 101.0%  
PBIT margin 22.4%   16.9%    
Others
Revenue 434 4.0% 407 3.7% -6.1%
PBIT 22 0.9% (17) -1.0%  
PBIT margin 5.0%   -4.2%    
Total*
Revenue 10,883   11,005   1.1%
PBIT 2,362   1,772   -25.0%
PBIT margin 21.7%   16.1%    
* Excluding inter-segment adjustments

TPC’s other business segments have reported a 6% decline in revenues during 1QFY06. The company sold its broadband business during the quarter and this is reflected in the decline in revenues from this segment during the quarter.

Higher fuel costs dent margins:  Apart from the effect of a lacklustre topline performance, the rise in fuel costs has added to margin pressure for TPC during 1QFY06. Fuel costs rose to 55% of sales in 1QFY06, from around 47% in 1QFY05. Spiraling global crude oil prices and short supply of coal in the Indian market has led to this rise in fuel costs.

Investors should note that TPC's cost of generating electricity has traditionally been on the higher side. This has been largely due to the company's use of the relatively expensive liquid fuel like LSHS (low sulphur heavy stock), the price of which is dependent on the movement of global crude prices. It must be noted that strict pollution control norms in Mumbai especially, have led to Tata Power relying on oil as opposed to coal. Now with the company receiving permission to increase coal firing from 2,940 tonnes per day to 5,800 tonnes per day, we expect the cost of generation to reduce going forward, which might aid operating profitability.

Lower expenses, higher other income props bottomline:  Despite the drop in operating margins and the consequent decline in operating profits, TPC has managed to grow its net profits by over 16% YoY. This has been a result of reduced costs of interest, depreciation and tax. Other income has also grown strongly by 80% and this has further propped the bottomline growth.

Performance in the recent past…
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06
Sales growth (YoY, %) 0.5 (11.4) (11.0) (7.4) 1.1
Profits growth (YoY, %) 2.2 (17.1) (25.6) 213.8 16.5
Operating margins (%) 32.4 23.4 23.8 16.3 21.9

What to expect?
At the current price of Rs 410, the stock is trading at a price to earnings multiple of 18.5 times our estimated FY06 earnings. As reported by the management, work on the 120 MW Jojobera project is moving ahead of schedule with the final hydraulic testing and the first boiler firing completed successfully. The first synchronization is scheduled in 2QFY06. The board has also approved the signing of the shareholder agreement with the Damodar Valley Corporation (DVC) for a 74% equity stake in the 1,000 MW Maithon thermal power project. These initiatives, together with the fact that the company is in the process of shifting its focus from being a Mumbai centric player to having a national presence, augurs well for its growth in the future. Tata Power is among our preferred plays from the power sector from the long-term perspective.

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