Investors can hold on to the stock of Tata Power, pending a final order from the Central Electricity Regulatory Commission (CERC) on higher tariffs for the company’s Mundra plant in Gujarat. The stock price which has fallen 28 per cent, year to date, will get a boost if the final order passed is in favour of Tata Power.

Tata Power, an integrated power company, has a large part of its operations based on an assured return model, as opposed to market-determined tariffs. Its performance has, however, been adversely affected by the loss-making Mundra ultra-mega power project. The plant (last unit commissioned in March 2013), which accounts for close to half of Tata Power’s capacity, has been the biggest drag on consolidated numbers.

The company reported net losses of Rs 1,088 crore and Rs 85 crore during 2011-12 and 2012-13 respectively. But its fortunes can reverse if a favourable final order is passed by the CERC.

While Tata Power has posted losses at the net level, its operating profit grew 16 per cent and 25 per cent during 2011-12 and 2012-13 respectively.

At the current market price of Rs 79, the stock discounts its estimated FY14 consolidated book value by 1.5 times. This is at the lower end of its valuation band over the last four years (1.4 to 3.7 times). There may be limited downside from current levels.

Tata Power is present in all segments of the power sector. About 40 per cent of its operations earn assured returns from regulated tariffs.

This includes its operations (generation, transmission and distribution) in Mumbai and that of its subsidiaries — Tata Power Delhi Distribution (TPDDL), Maithon Power and Powerlinks Transmission.

Assured returns

Tariffs approved by the State regulator allow for 16 per cent return on equity to TPDDL which handles the power distribution business in Delhi. The Maithon plant in Jharkhand currently operates on CERC notified tariffs, which ensure a return on equity of 15.5 per cent. Likewise, CERC regulations set the transmission service charges for Powerlinks Transmission which transmits surplus power from eastern to northern India.

Despite this, Tata Power posted losses in 2011-12 and 2012-13. Unremunerative tariffs at the Mundra plant and the fixed costs from the upcoming Maithon and Mundra projects resulted in losses.

The Maithon plant was fully commissioned in 2012-13 and has since reported an improvement in operational performance. The half-year ending September 2013 has seen a turnaround, with the project posting net profit of Rs 46 crore.

The fuel supply for the plant is largely tied up with domestic sources. Sale of 900 MW (out of 1,050 MW) is done through long-term power purchase agreements with State utilities. Besides, the company is pursuing long-term customers for the remaining output of 150 MW. All this puts the plant on a sound footing for the future.

The loss-making Mundra plant, however, has continued to remain a worry. The plant which runs on imported coal became unviable following a change in Indonesian laws, which raised the cost of imported coal by linking it to market prices. The power purchase agreements entered into with the distribution companies for the sale of power allow Tata Power only a partial pass-through of fuel cost.

Following Tata Power’s petition, the CERC ordered a compensation package in April this year. Later, the Deepak Parekh panel, which was set up to work out the right tariff, recommended a hike of 45-55 paise per unit in August.

The tariff hike now requires a final order from CERC, which has sought the views of the power purchasing states. This has been delayed due to opposition from Punjab and Haryana. A favourable decision on this matter will be a big positive for the business.

Apart from the power business, Tata Power holds a 30 per cent stake in two Indonesian companies and in 2012-13, acquired a 26 per cent stake in yet another one.

These investments are meant to provide the company a partial hedge against coal price volatility. Coal supply for the Mundra plant has been secured through a long-term agreement with the Kaltim Prima Coal mines in Indonesia. Tata Power also entered into a coal supply agreement with PT Antang Gunung Meratus last year.

However, recent revenue from the coal business (27 per cent of consolidated revenues) has been impacted by many factors including a fall in global coal prices. Segment profits from the coal business almost halved in 2012-13. For the quarter ended September 2013, the business made a loss (before interest and tax) of about Rs 4 crore in contrast with a profit of Rs 287 crore in the year-ago period.

CONCERNS

According to forecasts, coal prices which have been weighed down by excess supplies and weak demand from large consumers such as China and India are expected to remain so in the near future.

This will impact Tata Power’s revenue from the coal business. The consolidated debt equity ratio for Tata Power has risen to 3.3 times as on March 2013, up from 1.9 times in 2010-11. During the same period, the interest coverage ratio has deteriorated from 4.6 times to 1.8 times.

A ramp-up in revenues and cash flows from Maithon and a decline in interest rates over a 2-3 year time-frame may alleviate the situation. A favourable tariff order on Mundra however will be the most significant trigger for the stock.

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