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Reliance Energy: Power play! - Views on News from Equitymaster
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Reliance Energy: Power play!
Oct 20, 2005

Performance Summary
Private sector power major, Reliance Energy (Research), has announced strong results for the second quarter and half year ended September 2005. While revenue growth has been strong in the second quarter, decline in volume sales, primarily in 1QFY06, has impacted topline growth for the first half. Profit growth has also been excellent on the back of improved profitability of the EPC business and higher other income.

Financial performance: A snapshot…
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Sales 7,917 10,429 31.7% 17,345 19,926 14.9%
Expenditure 6,292 8,395 33.4% 14,246 16,288 14.3%
Operating profit (EBDITA) 1,626 2,034 25.1% 3,099 3,638 17.4%
Operating profit margin (%) 20.5% 19.5%   17.9% 18.3%  
Other income 868 1,185 36.5% 1,637 2,532 54.7%
Interest 247 553 123.9% 553 974 76.1%
Depreciation 837 871 4.0% 1,648 1,688 2.4%
Profit before tax 1,410 1,796 27.4% 2,535 3,508 38.4%
Extraordinary income/(expense)   -     -  
Tax 127 200 57.3% 224 346 54.2%
Profit after tax/(loss) 1,283 1,596 24.4% 2,311 3,162 36.8%
Net profit margin (%) 16.2% 15.3%   13.3% 15.9%  
No. of shares 185.5 201.9   185.5 201.9  
Diluted earnings per share* (Rs) 25.4 31.6   22.9 31.3  
P/E ratio (x)         16.8  
(* 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. Reliance Energy also has a presence in the engineering, procurement and construction (EPC) business (20% of 1HFY06 sales), which has been a strong growth driver in the past few quarters.

What has driven performance in 2QFY06?
EPC business scores: Reliance Energy’s EPC business (20% of 1HFY06 revenues) has led the company’s topline growth during the quarter and the half-year. This business has grown by 170% YoY and 74% YoY during 2QFY06 and 1HFY06 respectively. In fact, this segment, which has benefited on account of the surge in domestic capital investments, has led the company’s growth in the past few quarters as well. The segment has reported an outstanding order backlog position of Rs 35 bn at the end of 2QFY06, almost 3 times the segment’s FY05 revenues.

Segment-wise performance…
  2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Electrical Energy  
Revenue 7,120 8,203 15.2% 15,221 16,112 5.9%
% share 88.8% 77.3%   86.7% 79.8%  
PBIT margin 11.1% 11.3%   12.4% 10.5%  
EPC and Contracts  
Revenue 895 2,408 168.9% 2,342 4,084 74.4%
% share 11.2% 22.7%   13.3% 20.2%  
PBIT margin 10.5% 18.4%   5.4% 14.3%  
Total*  
Revenue 8,016 10,611 32.4% 17,563 20,196 15.0%
PBIT margin 11.0% 12.9%   11.5% 11.3%  
* Excluding inter-segment adjustments            
* Excluding inter-segment adjustments

The power business, however, continues to grow at lacklustre pace, reporting 15% YoY and 6% YoY growth during the quarter and the first half respectively. During 1HFY06, the company sold 4,178 m units (MUs), recording a marginal decline of 1% YoY. This was owing to lower generation and sales at its Samalkot station owing to lower gas availability. As a matter of fact, Samalkot station (220 MW), which contributes to around 23% of the company’s total power generation capacity, operated at a low PLF (plant load factor or capacity utilisation) of 51% during the quarter, against 70% PLF in 2QFY05. As per recent reports, the company has indicated closing this plant in view of the inadequate gas supply. Notably, the company has only been allocated 64% of the gas requirement at this plant (1 MMSCMD) and now when even this supply is not being received, the plant is operating at a very low PLF of 51%.

Even the Dahanu plant operated at a lower PLF of 94% during the quarter (104% in 2QFY05). This was a result of a temporary shutdown of one of the units during the quarter. Of the total power supplied by Reliance Energy during first half, almost 52% (42% in 1HFY05) was purchased from external sources (including Tata Power). The company paid Rs 2.62 per unit purchased during the first half, representing a decline of over 12% YoY (Rs 2.99).

Investors 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 is reflected in the lower per unit purchase cost during 1HFY06.

Lower purchase and fuel costs aid margin expansion: Decline in fuel costs and cost of power purchased have led to the 100 basis points margin expansion for Reliance Energy during 2QFY06. However, the margins improvement would have been higher but for an 8% expansion (as % of sales) in EPC costs. Based on segments (as shown in the table above), while PBIT margins for the power segment have expanded by 20 basis points, those for the EPC division have improved almost 8% during 2QFY06. Strong growth in the EPC business has been the result of the robust expansion in margins for this segment.

It boils down to the bottomline: Apart from the expansion in operating margins, higher other income and very marginal increase in depreciation outgo, has aided Reliance Energy’s bottomline, which has surged by over 24% YoY and 36% YoY during 2QFY06 and 1HFY06 respectively.

What to expect?
At the current price of Rs 525, the stock is trading at a price to earnings multiple of 15.9 times our estimated FY08 EPS. At the current rate of growth, Reliance Energy is likely to outperform our FY06 estimates. As such, we shall soon take a re-look at our numbers.

During 2QFY06, the company has made a preferential offer of equity to Anil Dhirubhai Ambani Enterprises and some long-term investors, amounting to Rs 17.2 bn. This shall form party of the funds required by the company to fulfill its aggressive capacity addition plans in the years to come. 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 Rs 480 bn in a 12,000 MW coal-based project in Orissa. The plans are grand and when fulfilled, will catapult Reliance Energy into the league of the big players in the sector. However, considering the huge funding requirements, which would entail equity contribution of 30%, a large equity dilution is imminent in the future. 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.

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