Medium term profitability driven by commodity earnings

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1 Update SECTOR: UTILITIES BSE SENSEX S&P CNX 18,180 5,462 Bloomberg SHAREHOLDING PATTERN % (JUN-10) Others, 16.8 Foreign, 21.8 STOCK PERFORMANCE (1 YEAR) TPWR IN Promoter 31.9 Domestic Inst, 29.5 Rs1,255 Tata Power Neutral Reuters TTPW.BO Medium term profitability driven by commodity earnings Equity Shares (m) Consolidated profitability to be impacted given initial losses from Mundra UMPP project, Cutting estimates 52-Week Range (Rs) 1,519/1,193 1,6,12 Rel. Perf.(%) -5/-12/-20 M.Cap. (Rs b) M.Cap. (US$ b) 6.4 Y/E MARCH E 2012E Net Sales (Rsb) EBITDA (Rsb) NP* (Rsb) EPS (Rs)* EPS Gr. (%) BV/Share(Rs) P/E (x) P/BV (x) EV/EBITDA (x) EV/Sales (x) RoE (%) RoCE (%) * Consolidated; EPS calculated on fully diluted equity 1,600 1,450 1,300 1,150 1,000 Aug-09 Nov-09 Tata Pow er Sensex - Rebased Feb-10 May-10 Aug-10 Commodity earnings drive medium term profitability: Over FY10-12, we expect Tata Power's consolidated earnings to increase from Rs14.8b in FY10 to Rs25.1b in FY12 (CAGR of 30%). But a very meaningful part of the increase will be driven by commodity earnings, given that Tata Power is net long on coal by 16-18mt a year. The contribution of commodity earnings to consolidated profitability rose from 9% in FY08 to 44% in FY10 and we expect this to increase to 61% in FY12. Mundra UMPP commissioning to impact profitability from FY13 given possible losses: Given the competitive tariff bid and increased imported coal prices over past three years (from US$35-40/t in 2007 to US$70-75/t currently), we expect the Mundra UMPP to post meaningful losses. The initial unit is expected to be commissioned in September 2011 and the entire 4GW capacity by early FY14. Year one quoted tariffs are Rs1.9/unit and given permissible escalations, we calculate the applicable tariff at Rs2.15/unit, resulting in annual losses of Rs9.5b on full commissioning in FY14. After commissioning of the Mundra UMPP, the profitability of the chain (coal mining + Mundra UMPP) will fall from Rs15.7b in FY12 to Rs9.8b in FY14. But the ROE in the chain will continue to be robust at 18-21%, though lower than ~28% expected in FY12. Projects under construction largely have regulated/controlled returns; pipeline interesting: We expect TPWR to commission 5.5GW capacity until FY14, including the Mundra UMPP (4GW) and Maithon (1GW) where off-takes have been tied up. Merchant capacity for Tata Power is 220MW (already commissioned), which would be just 3% of the operational capacity by the end of FY14. Incremental project pipeline is 6.9GW, of which 1.3GW, is based on captive mines. For other capacities, fuel sourcing is yet to be tied up. Cutting estimates, maintain Neutral: We have downgraded our earnings estimate for TPWR to factor in lower other income, interest on excess debt to fund equity contribution etc. We now expect TPWR to post consolidated PAT of Rs19.7b in FY11 (a downgrade of 6%) and Rs25.4b in FY12 (a downgrade of 10%). We arrive at an SOTP-based price target of Rs1,267. We believe meaningful losses in Mundra UMPP project will impact TPWR's consolidated profit growth over FY13-15, given that the new project pipeline is in initial stages. Maintain Neutral. Satyam Agarwal (AgarwalS@MotilalOswal.com); Nalin Bhatt (NalinBhatt@MotilalOswal.com); / Vishal Periwal (Vishal.Periwal@MotilalOswal.com)

2 Medium term profitability driven by commodity earnings Over FY10-12, we expect Tata Power's consolidated earnings to increase from Rs14.8b in FY10 to Rs25.1b in FY12 (CAGR of 30%). But a very meaningful part of the increase will be driven by commodity earnings, given that Tata Power is net long on coal by 16-18mt a year. The contribution of commodity earnings to consolidated profitability rose from 9% in FY08 to 44% in FY10 and we expect this to increase to 61% in FY12. CONSOLIDATED PROFITABILITY DRIVEN BY COAL EARNINGS (RS B) Contribution of commodity Utility Commodity Others (coal) earnings increased from 9% in FY08 to 44% in FY10 and we estimate this will be 61% in FY FY08 FY09 FY10 FY11 FY12 Source: Company/MOSL HIGHER EARNINGS FOR KPC/ARUTMIN MINES DRIVEN BY KPC/ARUTMIN MINES: MEANINGFUL IMPROVEMENT IMPROVED ECONOMICS IN PROFITABILITY (US$ M) 80 Sales (m ton) Realization (USD/t) 1, Expect meaningful improvement in reported profitability E 2011E E 2011E Source: Bumi Resources/Company/MOSL TATA POWER IS NET LONG ON COAL TPWR TOTAL PASS THROUGH NET LONG PRODUCTION SHARE # REQUIRE- BASED ON EXPOSED * POSITION MENT* CERC INDEX ON COAL Earnings are leveraged to coal prices; as TPWR is net long on coal to the tune of tons (A) (B) FY FY FY FY FY FY FY * Requirement for Mundra UMPP (4GW) and Trombay (100MW) # TPWR share at 30% till CY09; at 25.5% thereafter (after the stake sale to Olympus) Source: Bumi Resources/Company/MOSL 25 August

3 Mundra UMPP commissioning to impact profitability given possible losses Given the competitive tariff bid and increased imported coal prices over past three years (from US$35-40/t in 2007 to US$70-75/t currently), we expect the Mundra UMPP to post meaningful losses. The initial unit is expected to be commissioned in September 2011 and the entire 4GW capacity by early FY14. Year one quoted tariffs are Rs1.9/unit and given permissible escalations, we calculate the applicable tariff at Rs2.15/unit, resulting in annual losses of Rs9.5b on full commissioning in FY14. After commissioning of the Mundra UMPP, the profitability of the chain (coal mining + Mundra UMPP) will fall from Rs15.7b in FY12 to Rs9.8b in FY14. But the ROE in the chain will continue to be robust at 18-21%, though lower than ~28% expected in FY12. MUNDRA UMPP LOSSES CALCULATED AT RS9B-9.5B+ A YEAR FROM FY14 ONWARDS 0.0 FY12 FY13 FY14 FY15 FY16 FY Meaningful losses in Mundra UMPP would lead to possibly stagnant/decline in consolidated earnings for Tata Power in FY14 and FY Rs / unit Rs M Source: MOSL HOWEVER, PROFITABILITY IN THE CHAIN IS ROBUST (EQUITY INVESTMENT/ADVANCES, RS B, ROE, %) RoE in the chain including earnings from mining SPVs and losses on Mundra UMPP is expected at 18-24% Mining SPVs Mundra UMPP RoE (%) Decline in RoE given losses of Mundra UMPP 30% 27% 24% 21% 18% 0 FY10 FY11 FY12 FY13 FY14 FY15 15% Source: MOSL 25 August

4 Projects under construction largely have regulated/controlled returns, pipeline interesting We expect TPWR to commission 5.5GW capacity until FY14, including the Mundra UMPP (4GW) and Maithon (1GW) where off-takes have been tied up. Merchant capacity for Tata Power is 220MW (already commissioned), which would be just 3% of the operational capacity by the end of FY14. Incremental project pipeline is 6.9GW, of which 1.3GW, is based on captive mines. For other capacities, fuel sourcing is yet to be tied up. MAITHON, MUNDRA UMPP HAVE LARGE PART OF OFF-TAKE TIED-UP (MW) We expect TPWR to commission 5.5GW capacity until FY14, including Mundra UMPP (4GW) and Maithon (1GW) where offtakes have been tied up 9,000 6,750 4,500 2,250 Mumbai TISCO CPP Maithon Mundra UMPP Others 0 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E Source: Company/MOSL MERCHANT CONTRIBUTES JUST 2.7% OF THE CAPACITY TO BE OPERATIONAL BY FY14 (MW) OFFTAKE AGREEMENT TOTAL REGULATED CASE 1/2 MERCHANT REMARKS Merchant capacity for Tata Power is 220MW (already commissioned); Besides, there is possibility of an additional MW merchant capacity in the interim period from Mumbai license area CAPACITY RETURNS BIDS Mumbai region 2,027 1, Merchant based on imported coal; possibility of incremental MW on merchant basis TISCO CPP Long term PPA with Tata Steel Bellari IPP Based on fuel oil, PPA with Karnataka Power Corp valid until 2012 Wind Power Largely tied-up under LT PPA Haldia IPP MW on a merchant basis, based on industrial gases Maithon project 1,050 1, JV with DVC, regulated returns Mundra UMPP 4,000-4,000 - Case 2 bid Total 8,147 3,927 4, Source: Company/MOSL PROJECT PIPELINE INTERESTING, BUT IN INITIAL STAGES (MW) TOTAL FUEL SOURCE CAPACITY IMPORTED LINKAGE CAPTIVE MINE OTHERS REMARKS 1.3GW of a 6.9GW pipeline based on captive mines, fuel sources not tied up for most projects Coastal Maharashtra 2,400 2, Fuel source yet to be identified Naraj Marthapur 1, Mines to be operational from mid 2014* TiruldihIPP / CPP 1, , Mines to be operational in 2013* Corus (Tata Steel) Fuel is production gases Tama Koshi, Nepal Hydro power Total 6,905 2,400 1,860 1,320 1,325 *subject to timely land acquisition, clearances Source: Company/MOSL 25 August

5 PROJECT PIPELINE: DEVELOPMENT STATUS CAP FUEL LIKELY COMMENTS (MW) COD Coastal Maharashtra 2,400 Imported FY15E High power committee approved land compensation (66% acquired as at coal March 2010), 100% land acquisition by end 2QFY11; first phase of 1.6GW (2*800MW) to be largely under regulated mechanism. Mandakini coal block 1,200 Domestic FY15E 2.5mtpa of proportionate share from coal block jointly allocated with coal others; mining plan approved, land acquisition for coal block by March 2012, mines to beexpected for operations by mid-2014 Tubed IPP 1,200 Domestic FY14/15 2.5mtpa of proportionate share from coal block jointly allocated with coal Hindalco; mining plan approved, land acquisition in early stages, mines to be expected for operations by FY13 Corus (Tata Steel) 525 Waste gases N.A. Capitve for Tata Steel, based on waste gas Tama Koshi (Nepal) 800 Hydro N.A. Techno-economic study in progress Projects 6,125 Given that several projects are in the initial stages of land acquisition, we expect meaningful commissioning to commence from FY15 Valuations fair, maintain Neutral We have downgraded our earnings estimate for TPWR to factor in lower other income, interest on excess debt to fund equity contribution etc. We now expect TPWR to post consolidated PAT of Rs19.7b in FY11 (a downgrade of 6%) and Rs25.4b in FY12 (a downgrade of 10%). We arrive at an SOTP-based price target of Rs1,267. We believe meaningful losses in Mundra UMPP project will impact TPWR's consolidated profit growth over FY13-15, given that the new project pipeline is in initial stages. Maintain Neutral. SOTP BASED PRICE TARGET OF RS1,267 RS M RS/SHARE BUSINESS SEGMENT METHOD Power business (Mumbai, IPPs, etc.) 134, Power utility DCF, WACC 9.5% Defense business 3, Defense EV/EBIDTA 15x FY12E Delhi distribution 17, Power distribution PER, 15x FY12E Tata BP Solar 3, Solar cells, etc PER, 20x FY12E Powerlinks Transmission 3, Power transmission, ROE 18-20%, 1.4x FY12 P/BV generation, etc India Energy Ltd 6, Power exchange 15x FY12E PER Investments - Tata Sons 11, Investment company Value of investment, discount of 20% to market value - Aftaab Investments 7, Investment company Value of investment, discount of 20% to market value - Telecom Investments 34, Investments in Tata Tele: At 3x EV/sales for FY09, discount of Tata Tele and VSNL 20% to market value for other investment Power projects under development - Mundra power project -91, Power project, DCF, project NPV, cost of equity at 13.5% coal mines - KPC/Arutmin mines 131, FCFE, cost of equity at 13.5% - Shipping subsidiary 5, Shipping BV of investment in FY10 - Maithon power project 11, Power generation DCF, project NPV, cost of equity at 13.5% Power projects pipeline Naraj Marthapur 17, Power generation DCF, project NPV, cost of equity at 15% Tubed IPP 17, Power generation DCF, project NPV, cost of equity at 15% Liquid investments/cash (net) Govt Bonds, MF, etc 16, Investments Book value of investment until March 2010 Cash in hand 12, Book value Less: debt 39, Excluding debt on existing regulatory business Total 303,316 1,267 Source: MOSL 25 August

6 Appendix TATA POWER PROJECT PORTFOLIO (MW) NR Dagachhu 114MW NER Mundra UMPP 4000MW Wind Gujarat50MW Trombay Existing 1330MW Trombay Unit-8 250MW Hydel 447MW Windpower 77MW Windpower Exp 95MW Windpower Exp 98MW Belgaum 81MW Tamil Nadu 99MW ER TICSO Unit 428MW TISCO Exp 120MW Jojobera Exp 120MW Haldia 120MW Maithon 1050MW SR Operational Projects (2997MW) Under Construction (5382MW) Source: Company 25 August

7 Financials and Valuation 25 August

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