We reiterate our ‘reduce’ rating on Adani Power despite raising our target price to Rs 47 (from R40 earlier) and earnings estimate.
However, we find significant downside from the current levels even after raising our target price by 17.5% to factor in Kawai and Tiroda II projects, which results in our EPS estimates going up for FY14 by 102.9% and FY15 by 5.3%. The estimated increase in FY14 is significant owing to spot sales of power from Tiroda II before its long-term contracts start.
We use the discounted cash-flow methodology to value 9.24 giga watts (GW) of power generation capacity (6.6GW earlier). We have assumed a cost of capital of 8.8% (9.8% earlier) for the first 10 years and 8.1% beyond the first 10 years.
We have assumed a terminal growth rate of 3%. In the unlikely case of renegotiation of power tariffs for all of Adani’s power plants to allow fuel pass-through, no spot sales and 15.5% ROE, our fair value would be R70 — only 2% upside from the current levels. We believe that coal price pooling will eventually come through, but it is difficult to put a finger on the timing as this proposal has been in the works for more than a year.
Adani Power has coal linkages of 6.4 million tonne for its Mundra project and 8.03 million tonne for the Tiroda project. We are currently assuming that Coal India will supply only 65% of the contracted capacity.
If pooling is implemented, we assume that Coal India will supply 80% of the contracted quantity at ~20% higher prices. This additional supply will reduce the quantum of significantly higher priced imported coal required to fuel Adani Power plants. Consequently, coal cost reduction could result in our valuation going up by 15% to Rs 54.
We are currently assuming that Adani Power’s 1,320 mega watts (MW) Kawai power plant will use imported coal as there are no domestic coal linkages. However, our valuation would be R91 (33% upside from current levels) if Kawai gets coal in 2015 from captive mines allocated to Rajasthan Rajya Vidyut Utpadan Nigam (RRUVNL). Progress on developing the coal mines is currently stuck due to litigation over forest clearances.