Reliance Energy: ‘Expensive’ growth - Views on News from Equitymaster

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Reliance Energy: ‘Expensive’ growth

Oct 18, 2007

Performance summary
  • Topline grows by 10% YoY during 2QFY08, largely driven by 40% YoY growth in electricity sales as EPC revenues decline 43% YoY.
  • Substantially higher power purchase costs pressurise operating margins. Lower EPC costs almost make up for it. Overall, margins contract by 0.4% during the quarter.

  • Strong rise in other income, powered by higher interest income and forex gains, aid a bottomline growth of 34% YoY.

  • For 1HFY08, sales and net profits grow 24% YoY and 30% YoY respectively.

  • EPC orderbook at Rs 47 bn - 2.3 times the segment’s FY07 revenues.

Financial performance: A snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Sales 14,016 15,417 10.0% 25,505 31,657 24.1%
Expenditure 12,301 13,604 10.6% 22,417 28,757 28.3%
Operating profit (EBDITA) 1,715 1,813 5.7% 3,088 2,900 -6.1%
Operating profit margin (%) 12.2% 11.8%   12.1% 9.2%  
Other income 1,821 2,582 41.8% 3,494 5,470 56.6%
Interest 671 854 27.4% 1,130 1,547 36.9%
Depreciation 635 556 -12.5% 1,254 1,137 -9.3%
Profit before tax 2,230 2,985 33.8% 4,197 5,686 35.5%
Extraordinary income/(expense) - -   - -  
Tax 366 484 32.1% 567 969 70.9%
Profit after tax/(loss) 1,864 2,501 34.2% 3,630 4,717 29.9%
Net profit margin (%) 13.3% 16.2%   14.2% 14.9%  
No. of shares         228.5  
Diluted earnings per share (Rs)         39.8  
P/E ratio (x)         45.6  

What is the company’s business?
Reliance Energy (REL) 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. It also has a presence in the engineering, procurement and construction (EPC) business (20% of 1HFY08 revenues).

What has driven performance in 2QFY08?
Electricity sales lead topline growth: The 10% YoY growth in REL’s topline during 2QFY08 was largely a result of the 39% YoY rise in electricity sales, as revenues from EPC business declined by 43% YoY. The performance of the electricity business was marked by an 8% YoY rise in volume sales and 29% YoY improvement in tariffs (against a tariff of Rs 4.2 per unit in 2QFY07, REL sold electricity at Rs 5.4 per unit in 2QFY08). The rise in volume sales was largely a result of higher volumes of electricity purchased from external sources, as the company’s own generating stations witnessed stable to lower PLF (plant load factor, or capacity utilisation). As for the external purchases, REL bought 1,296 m units of electricity during 2QFY08, higher by 12% YoY.

As far as the company’s second business line of providing EPC services (engineering, procurement and construction) is concerned, topline were under pressure during the quarter. While the management has categorically mentioned nothing, the pressure seemed on account of the lumpy nature of industry, wherein project execution delays can impact revenues in a particular quarter. At the end of September 2007, REL’s EPC order backlog stood at Rs 47 bn, or 2.3 times the segment’s FY07 revenues.

Segment-wise performance
  2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Electrical Energy            
Revenue (Rs m) 9,160 12,760 39.3% 18,500 25,746 39.2%
% share 64.6% 81.6%   71.3% 80.4%  
PBIT margin 11.4% 11.9%   12.8% 9.3%  
EPC and Contracts            
Revenue (Rs m) 5,030 2,871 -42.9% 7,452 6,269 -15.9%
% share 35.4% 18.4%   28.7% 19.6%  
PBIT margin 4.6% 11.7%   5.2% 8.1%  

Higher power costs dent margins: REL purchased 1,296 m units of electricity from external sources (largely Tata Power), which was higher by 12% YoY. More importantly, this external power cost the company Rs 5 per unit against Rs 2.9 per unit that was paid for power purchased in 2QFY07. Such a sharp rise in power purchase costs have dented the company’s operating margins during 2QFY08, with the same contracting by 0.4%. But for the decline in EPC costs (as percentage of sales), the pressure on margins would have been higher (see adjacent chart).

Forex gains, lower depreciation aid bottomline: Despite the contraction in operating margins, REL managed to grow its bottomline by 34% YoY during 2QFY08, a rate much higher than the topline growth. 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.

What to expect?
At the current price of Rs 1,815, the stock is trading at a multiple of 37.4 times our estimated FY10 earnings and 3.5 times our estimated FY10 book value. The stock has risen by a whopping 163% since the declaration of the last quarter’s result analysis. This has been a result of the management’s announcement of de-merger of its generation arm, Reliance Power Ltd. (RPL), which has projects under execution totaling 24,000 MW.

Considering that RPL will be selling its 10.1% stake for raising nearly Rs 70 bn, the valuation of the entire 100% stake comes to around Rs 693 bn. Taking into account REL’s 45% stake in RPL, the investment value per share for the former will be nearly Rs 1,365 per share. This when added to REL’s core business value of Rs 861 (as per our discounted cash flow estimates for the company), shall value REL at Rs 2,226, which is 23% higher than the stock’s current market price.

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