>ADANI POWER (BNP PARIBAS)

The live wire

■ Plans to raise power-generation capacity 10-fold in next three years.
■ We assume higher coal costs and lower merchant tariffs.
■ Revenue growth of 132% and EPS growth of 127% over FY11-13E.

Initiate with BUY and a DCF-based TP of INR135.00.
At an inflexion point, in our view We initiate coverage of Adani Power (APL), an independent power producer (IPP), with a BUY rating. The company plans to expand its power-generation capacity 10-fold to 6.6 GW over the next three years and by another 6.6 GW. APL has a good mix (75:25) of long-term agreements to sell power and exposure to the spot market where tariffs are higher. This mix provides earnings visibility and high returns. We project APL’s ROE will peak at 41.9% in FY12.

Vertical integration, strong execution
APL is part of the vertically integrated Adani Group, which has interests in coal mining, shipping, special economic zone (SEZ) development, commodities trading (including coal and power), city gas distribution and oil & gas exploration. Listed group companies, namely, Adani Enterprises (ADE IN, CP: INR486.4, Not rated) and Mundra Ports and SEZ (MSEZ IN, CP: INR673.85, Not rated) have a track record of executing large infrastructure projects.

Conservative assumptions but still find upside
We estimate APL’s coal cost for its Mundra plant would increase only 7% if there is an increase in imported coal costs (we expect a 17-18% hike) from a change in the Indonesian mining laws. This is as APL will partly source cheaper coal from Coal India. We also assume conservative merchant tariffs, at INR3.50/kWh in FY11 and FY12, after which we model in a 6% increase. Based on our conservative assumptions, we estimate APL’s revenue will grow an average of 129% pa and EBITDA 141% pa in FY11-13, on the back of the planned10-fold rise in power-generation capacity.

Valuation
We value APL’s 6.6 GW of projects using a DCF model. We estimate project free cash flows for the next 15 years and then consolidate it to determine free cash flow to the firm. We assume a terminal growth rate of 3%. We use a WACC of 9.2%, a tax rate of 30%, a cost of equity of 15%, a cost of debt of 11% and a target D:E ratio of 80:20. APL trades at an FY12 EV/EBITDA of 6.4x versus the global peer group average of 6.6x on Bloomberg consensus estimates (Exhibit 10). At our TP, the stock would trade at an FY12E EV/EBITDA of 8.1x – a premium which we believe is justified given APL’s substantial growth prospects. Key risks stem from higher-than-expected coal costs, lower utilization, lower-than-expected merchant tariffs, non-allocation of captive coal blocks for Tiroda, protracted arbitration for reneging on its PPA with GUVNL, or a withdrawal of tax incentives.

To read the full report: ADANI POWER