Stock Review: TATA Power

Considering Tata Power's execution record, secured fuel supplies and stable financials, investors can buy this stock at the current levels

    TATA Power's presence across all the facets of the power value-chain makes its business model very unique. The upcoming projects and the ramp-up in coal business will drive the future growth of the company. Considering, Tata Power's execution record, secured fuel supplies and stable financials make it one of the top picks in the power sector. Investors can consider buying this scrip at the current levels.

BUSINESS: Tata Power is an integrated utility company, mainly involved in the business of power generation, transmission, supply and distribution of electricity and coal mining. It is the largest private sector power company in India with a capacity of 2,976 MW. Its major upcoming projects include Maithon (1,050 MW) and Mundra (4,000 MW).

    In the transmission business, it has a 51% stake in Power Links, a joint venture with Power Grid, and carries power from Bhutan to Delhi. In the distribution business, it holds 49% in North Delhi Power, a power distribution company. Tata Power also has distribution business in Mumbai. To secure fuel supply for its upcoming projects, it has undertaken backward integration. It has acquired 30% in each of the three Indonesian coal mining companies —KPC, Bumi Resources and Arutmin.

GROWTH DRIVERS: Tata Power's Maithon thermal power project, which is a JV with Damodar Valley Corporation, is nearing completion. Its first unit of 1,050 MW is expected to be operational from the fourth quarter of FY11. Once operational, it will contribute around 1,400 crore to its revenues. Its first ultra mega power project, Mundra UMPP is 65% complete and is expected to commence in FY13. Once fully commenced, it will generate revenue of over 4,000 crore. Its stake in Bumi resources secures fuel supply for its Mundra UMPP. It also provides a natural hedge against rising coal prices. Bumi's plans to double its production in the next one year will also help improve earnings for Tata Power on robust coal demand from China, India and Japan. Recently, Tata Power's stake divestment in KPC/Arutmin did not take off. This again increases its net long-position in coal. In Mumbai, the state government has asked Tata Power to supply power to Reliance Infra till March 2011. Reliance Infra's licence is due for expiry in August 2011. Bids have been invited for the same, and thus increasing the chances for Tata Power to expand its distribution business in Mumbai.

FINANCIALS: Tata Power's sales have increased at a CAGR of 30% in the past five years. Its net profit has also rose at a CAGR of 30%. We expect net sales to grow at the annual rate of 10% till FY13. In the first half of FY11, sales stood at 9,950 crore, 4% higher than the corresponding period in FY10. We expect this to be around 10,300 crore in the second half. In the first half, net profit rose by 7.8%. The company's operating margins are expected to be in the range of 24-25%. It would need a capital expenditure of around 18,000 crore for funding its future plans till FY13. We expect this to be done using a mix of debt and equity. In the first half, Tata Power raised 5,000 crore via debentures. The remaining portion can be funded through internal accruals.

VALUATIONS: Tata Power's stock trades at an estimated pricebook value multiple of 2.3, 2 and 1.8 for FY11, FY12 and FY13, respectively. The stock has a low beta of 0.7, which reflects lesser volatility in its price compared with the fluctuations in the broader stock market. Downside to the net profit is limited since the company works on a fixed return on equity. Given these factors, the stock looks attractive with limited risk.