Tata Power: What should investors do?

With rising power demand and the Centre’s ambitious target of installing 500 GW of non-fossil fuel capacity by 2030, Tata Power has been a significant beneficiary. The necessary expansion of the transmission network to maintain grid stability further supports the company’s growth. Additionally, its dominant market share in the rooftop solar segment positions Tata Power well to capitalise on opportunities presented by the PM Surya Ghar Muft Bijli Yojana announced in Budget 2024.

The company derives benefits from regulatory-based earnings from a portion of its generation, transmission, and distribution (T&D) segments while the earnings from the renewable generation portfolio are based on fixed tariff. Its balance sheet has seen substantial strengthening as increased power generation has led to higher operational cash flows, resulting in a net debt/EBITDA ratio of 2.75 times, from 5.19 times five years ago.

Further, the company’s Mundra thermal plant (tariff-based) in Gujarat has benefitted extensively from the Section 11 invoked by the Government, which mandates imported-coal based (ICB) power plants to sustain full-capacity operations, thereby allowing the plant to sell power on a full cost pass-through basis. However, uncertainty still looms over its Mundra plant tariff as it has not yet secured any power purchase agreements (PPAs).

Overall on the business front there have been many positives in recent years. However this is also well reflected in stock which has surged over 100 per cent in the past year and around 600 per cent in the last five years. It is currently trading at 30 times its FY25 earnings, a premium of more than 50 per cent compared to its five-year average valuation of around 19 times.  Hence, given the current valuation, we recommend that investors book partial profits to lock in the gains. Given positives mentioned above and Tata Power being levered to the long term India growth story, we are not recommending a full book profit.

Business

The company being a comprehensive power utility operating across power business verticals, its business segments encompass generation from hydroelectric and thermal sources (55 per cent of revenue in FY24), renewables such as wind and solar (15 per cent), transmission and distribution (30 per cent).

As of March 2024, the company has an installed capacity of 14.7 GW, including 8.86 GW from thermal and 0.88 GW from hydro sources. A significant portion of this capacity is secured through long-term PPAs, ensuring revenue stability. The Mundra plant (4.2 GW) operates on imported coal from Indonesia and has faced challenges due to changes in Indonesian coal pricing laws under which all contracts were compulsorily linked to a benchmark market-determined coal price, thus nullifying all fixed-price agreements previously entered into by the company. The situation has improved with government interventions extending Section 11 regulations, most recently until October 15, 2024.

Tata Power’s transmission network spans 4,626 ckms, and its distribution network serves over 12.5 million customers across regions such as Mumbai, Delhi, Ajmer, and Odisha. The company has successfully reduced aggregate technical and commercial (AT&C) losses through technological investments, such as smart metering.

In 2022, Tata Power restructured its renewable business into a wholly-owned subsidiary, Tata Power Renewable Energy Ltd. This segment includes utility-scale projects, rooftop installations, solar EPC and manufacturing, solar pumps, and electric vehicle charging. The company has installed renewable capacity of 4.5 GW. Key clients for its solar EPC services include NTPC, NHPC, and SJVN. Recently, the company won Firm and Dispatchable Renewable Energy (FDRE) tenders for 460 MW and 200 MW PPA capacity from SJVN and NTPC, respectively. These FDRE tenders command higher tariffs than plain vanilla solar and wind sources and are preferred by distribution companies due to their ability to store and release power as needed, addressing intermittency issues.

Performance

The Plant Availability Factor (PAF) and Plant Load Factor (PLF) of Tata Power’s Mundra plant more than doubled from 29 per cent and 25 per cent in FY22 to 70 per cent and 56 per cent in FY24, respectively, aiding it to break even at the PAT level. While the captive coal mine profitability acts as a hedge for Mundra’s profitability, any unfavourable regulatory changes in Indonesia could increase the risk of the combined portfolio, according to India Ratings and Agency.

In the solar EPC business, Tata Power’s large utility-scale order book stands at 2.6 GW, valued at ₹13,400 crore. In the rooftop solar and group captive domain, the order book amounts to ₹2,867 crore as of March 2024. Additionally, in the transmission sector, the company has secured two orders totaling nearly ₹2,300 crore, allowing it to provide transmission services for 35 years.

Revenue increased by 12.5 per cent YoY to ₹61,994 crore in FY24, driven by higher execution of solar EPC projects, increased generation at the Mundra plant, and higher sales across Odisha discoms. The EBITDA margin expanded by over 400 basis points to around 18 per cent. The company reported a 14 per cent YoY growth in net profits to ₹3,701 crore, with the PAT margin remaining stable at around 6 per cent. The RoE has significantly improved from 6.2 per cent in FY20 to 11.3 per cent in FY24. During the year, net debt/EBITDA increased to 2.75 from 2.66 last year, due to higher capital expenditure (capex), which was partially offset by strong operational cash flow and the release of working capital.

Outlook

In March 2024, Tata Power’s renewable energy arm commenced commercial production of approximately 130 MW of solar modules, with peak capacity expected to reach 4.3 GW in the coming quarters. Initially, the domestically produced modules will be used to meet the company’s captive requirements, facilitating operational synergies.

Tata Power has fulfilled its FY24 capex commitment of ₹12,000 crore. The company is currently undertaking two brownfield pumped storage projects (PSPs) with a total capacity of 2,800 MW. These projects, requiring capex of ₹4,700 crore and ₹7,850 crore respectively, are expected to be completed by 2027 and 2028, and will generate 6,000 MWh and 10,800 MWh daily with the minimum annual revenue of ₹2,500 crore once operational, as per estimates given by JM Financial.

Looking ahead, the management has provided a capex guidance of ₹60,000 crore through FY27, with 42 per cent allocated to incremental renewable capacity, around 35 per cent to T&D projects, and 18 per cent to pumped hydro storage facility.. The company aims to add 1.5-2 GW of renewable energy annually to achieve 70 per cent of its installed capacity from renewables by FY30.

Over the last five years (FY2020-2024), Tata Power has more than doubled its earnings in absolute terms, while its stock has surged by over 600 per cent. Despite the solid fundamentals, given the substantial appreciation in the company’s valuation and the risk-reward being unfavourable, we recommend that investors consider booking partial profits to secure gains.

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