Adani Power: Buy

In December 2010, Adani Power became the first Indian power company to commence a super-critical power project. Adoption of efficient super-critical technology for all the upcoming projects, with the good execution capabilities demonstrated by it, positions Adani Power as the best stock to own in the power space.

The load factors of Adani Power's current projects are high compared to other newly commissioned projects, thanks to definitive and relatively low cost coal supplies from the parent company (Adani Enterprises). Adani Enterprises' recent investments in coal assets abroad (Australia) would also benefit Adani Power, as it gives fuel security to it's upcoming projects . Given this backdrop, fresh investments can be considered in the stock of Adani Power with a two-three year time horizon. This time period will coincide with commercialisation of the chunk of generation capacity from which Adani Power will benefit immensely. .

At the current price of Rs 122, the stock trades at 11 times its estimated FY12 earnings and discounts its estimated FY12 book value by three times. Given that the stock may enjoy exceptional internal rate of returns on its projects during the initial years and with a significant jump in the capacity, the stock's price-book value multiple is justified. In P/BV terms, the stock trades at a justifiable premium to most utility stocks. .

Business overview

Adani Power, which is currently operating 1980 MW at Mundra, is all set to add another 4620 MW by end of April-September 2012; a 233 per cent growth from the current levels. By last quarter of FY-14, the company may have 9240 MW and the management targets 15000 MW additions by 2015. The company has achieved financial closure for 13200 MW capacity, with the equity funding expected to be made available from internal accruals. This gives more clarity on the execution of the projects.

Adani Power has judiciously arranged its power purchase agreement (PPA) and has mitigated fuel risk even though it depends on imported fuel. It has long-term fuel supply contract with its parent company for the supply of fuel for the Mundra project at $36 per tonne with marginal escalation in costs every year. Adani Power has already got fuel linkages for Thiroda (1980 MW project). It is also waiting for domestic linkages in the case of rest of the 1320 MW Thiroda project, part of Mundra project and 1320 MW Kawai project. At many of its projects, Adani Power has consciously maintained a time lag between commissioning and kicking off the long-term PPA, which gives the company leeway to take advantage of merchant tariffs during this period. By realising higher tariffs during the interim period, the payback period of the project can be shrunk. For instance, the on-time execution of the 660 MW units 1 of Mundra Phase III and expectation of another 660 MW Unit-2 to get commissioned by June 2011 will allow the company to sell power generated from these projects at merchant rates until February 2012 when the PPA with Gujarat Urja Vikas Nigam Limited takes effect. Same is the case with most of its projects.

Apart from this, the management plans to sell 23 per cent of 9240 MW through merchant route. However, these strategies may work only if the merchant rates stay firm.

Operations

For the nine months ended December 2010, Adani Power recorded profits of Rs 350 crore with improved plant load factors (PLFs). PLFs improved from 80 per cent in the first quarter of FY11 to 85 per cent in the third quarter. However, the average realisation steadily fell from Rs 3.3 per unit to Rs 2.93 per unit, thanks to the steep fall in short-term tariffs. With merchant tariffs once again firming up, average realisation may improve. Adani Power managed to get carbon credits for its Mundra Phase III supercritical project for a 10-year period, starting February 2011. As all other projects are super-critical, the company may get more carbon credits.

Risks

Fuel risk may emanate from Coal India not providing coal linkages to the company. In that case, Adani Power may rely fully on imported coal, increasing the variable cost component of the company.

Rising interest rates are another concern. However, the company has managed to get the commissioned project of Mundra Phase 1 and 2 re-financed at a lower cost. Similar moves in the upcoming projects may protect the company to some extent.

The equity contribution of financing may come from the internal accruals. However, any delay in implementation of the upcoming projects or lower realisations on tariffs may affect the profitability which, in turn, will have an effect on the equity contribution.

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