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Utilities India October 2010
Same problem, new execution risks

Its an old story with a new twist. India is on the cusp of adding huge amounts of new supply in a bid to meet ever-growing demand we forecast 53GW over the next three years, or c33% of existing capacity. In the past, project execution has been the major problem but this has improved due to regulatory changes and increasing private sector participation. Now new hurdles have emerged particularly coal and water supply problems that could push up costs, and counterparty risk. We identify the companies that are best placed to navigate the new terrain. We assume coverage of the Indian power sector with Overweight ratings on PTC India, Tata Power and CESC. We upgrade NTPC to Neutral and downgrade BHEL to Underweight.
By Arun Kumar
Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Utilities India 4 October 2010
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Contents
Investment Summary Capacity addition accelerating Fuel concerns Water availability Power prices Financial health of state owned T&D companies? 1 11 17 22 24 Appendix 1: Price determination 28 Appendix 2: Valuation methodology Disclosure appendix Disclaimer 94 100 104 91 Company updates
BHEL- Deceleration in growth CESC- Doubling capacity NTPC - Capacity addition? PTC trade growth, investment unlocking Tata Power- Ultra mega
31
32 44 56 68 79
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Investment Summary
Power utilities to add 33% of existing capacity (53GW) in FY11-13 led by private utilities (48%), driving earnings CAGR of 25%; however, this wont solve the supply deficit or bring down prices. The market has been cautious on utilities due to poor execution. We expect the focus to shift to operational challenges like fuel supply, water availability, power pricing and counterparty risk. We prefer utilities which can capture growth with risk mitigation measures in place. We are OW on PTC India, Tata Power and CESC. Upgrade NTPC to Neutral and downgrade BHEL to UW
Overview: Same problem, new execution risks

Its an old story with a new twist. India is on the cusp of adding huge amounts of new supply in a bid to meet ever-growing demand we forecast 53GW over the next three years, or c33% of existing capacity. In the past, project execution has been the major problem but this has improved due to regulatory changes and increasing private sector participation. Now new hurdles have emerged particularly coal and water supply problems that could push up costs, and counterparty risk. We identify the companies that are best placed to navigate the new terrain. We assume coverage of the Indian power sector with Overweight ratings on PTC India, Tata Power and CESC. We upgrade NTPC to Neutral and downgrade BHEL to Underweight. To illustrate the size of the problem, consider this: India, population 1.2bn, generates around 20% of the amount of electricity produced by China, population 1.3bn. We expect India to add c72GW of new capacity between FY08 and FY13. This is about 92% of the amount proposed in the 11th five-year plan (2007-12), with a lag of 12 months. While this represents substantial progress, we expect peak demand deficit to only moderate from 12% today to 10% by FY12 and to 9% by FY17. However, we believe the gap is much wider as the reported deficit does not take into account latent demand from scheduled power cuts and non-electrified rural areas. We believe the poor track record of project implementation is reflected in the muted performance of utility stocks down c5% relative to the BSE Utilities Index in last the 12 months. However, changes in policy that allow the private sector to participle in generation projects should see improvements on many fronts over the next three years. These companies are likely to add 35GW during FY08-FY13 some 50% of the total in the period to reach a total of 52GW. Note that private sector capacity was only 17GW at the end of FY07.
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We expect private utilities with better project management and equipment procurement skills to make up for the expected state sector short fall. As a result, we expect a sector income CAGR of 25% during FY11-13. However, all this capacity addition over the next three years will shift the earnings risk and the scope for negative surprises from implementation (still the core issue for government owned companies like NTPC) to operational issues like fuel supply, water availability, power prices and counterparty risk (payment delays and/or defaults). We discuss these risks in detail in this report and highlight companies which in our opinion can deliver the highest value against this risk reward backdrop. We note that project implementation issues have been considerably reduced due to the emergence of new power equipment suppliers, both domestic and international. Investment in the power sector in the last few years has supported earnings growth for these equipment suppliers. While we expect high growth for FY11-12, earnings should then reach a mature level implying a deceleration in growth for the likes of BHEL from 25% to single digits.
Sector positives
1, Sector earnings: Earnings should see a CAGR of c25% in the next two years on the back of increasing investment. 2, Margin improvement: Theres ample room for margin improvement as the sector moves away from the regulated cost plus regime to a price based market system. Margin improvement should also come from cost savings driven by timely project execution, efficient supply chain management and high operational efficiency. Tata Power and CESC stand to benefit most on improving execution capability and operational efficiency. BHEL, on the other hand, should see its margins pressured after FY12 as it enters a low-growth phase and capacity utilisation falls. 3, Power prices: Dont expect a major correction in bulk power prices. We believe the extraordinarily high prices charged by merchant power providers operators that sell on the open market driven by supply shortages and transmission bottlenecks, will not be sustainable beyond FY12 due to improvements in the power market. We also forecast the cost/prices for long distance power sale will come down by cINR0.2-0.3 due to the introduction of a new transmission regime. Therefore, we prefer companies which have obtained long term commitments for at least 70-80% of their generation capacity through power purchase agreements (PPAs). In this context all three utilities under our coverage NTPC, Tata Power and CESC are well placed as far as price risk is concerned.
Sector negatives
1, The scarcity of domestic coal: Some 85% of the new capacity is not only thermal but also pre-dominantly coal based (gas availability is limited and is not increasing). Slow supply growth (6.1% pa) from Coal India and the lack of captive coal mines allotted to power companies are critical issues for the power players. A number of Indian companies have recently acquired coal mines abroad, but we believe these imports face bottlenecks in terms of port capacity and shortage of rail wagons for delivery to the power plants. This will also add to cost pressures on power plants since imported coal is expensive, although companies operating on a regulated ROE regime will suffer least. We believe NTPC and Tata Power remain best positioned as far as coal risk is concerned, followed by CESC.
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Sensitivity analysis - coal and water related risk

Coal related risk Key assumption: Substitution from imported coal Earnings (NP) Impact NTPC Tata Power CESC Sector* Water related risk Key assumption: Probablity of water shortage Earnings (NP) Impact NTPC Tata Power CESC Sector*
10% FY13e 0.4% 0.5% 1.5% 2.5% FY11-13e CAGR 0.2% 0.2% 0.7% N/A
30% FY13e 1.2% 1.4% 4.0% 6.8% FY11-13e CAGR 0.4% 0.6% 2.0% N/A
50% FY13e 1.8% 2.1% 6.1% 10.4% FY11-13e CAGR 0.7% 0.9% 3.1% N/A
10% FY13e 0.7% 0.0% 0.8% 0.8% FY11-13e CAGR 0.3% 0.0% 0.4% N/A
30% FY13e 2.2% 0.1% 2.5% 2.5% FY11-13e CAGR 0.8% 0.0% 1.2% N/A
50% FY13e 3.7% 0.1% 4.1% 4.2% FY11-13e CAGR 1.4% 0.1% 2.1% N/A
*Sector includes all major listed power sector companies in India, such as Adani Power, CESC, GMR, GVK, Jindal Power, JPVL, JSW, KSK, Lanco, NTPC, Reliance Power, R-infra, Tata Power Torrent and NHPC Source: Company data, HSBC estimates
2, Water supply: This has an impact on the bottom line. The best example is the recent closure of the 2GW Chandrapur power project of Mahagenco for three months due to the unavailability of water. Power plants in regions with water shortages are most at risk. At the sector level, this could erode FY13 earnings by as much as 5%. Tata Power, in our opinion, largely remains immune to this risk as none of its plants are in water deficit areas. Some future projects may be affected but this doesnt impact our current earnings estimates. NTPC and CESC, on the other hand, remain prone to this risk. We have done a scenario analysis on earnings based on coal and water risks. Our analysis suggests the impact for FY13e ranges from about 3% to 15% (see table above). 3, Financial health of State Electricity Boards (SEBs): This involves distribution and transmission companies and the resulting counterparty risk for the power players. Cash losses booked by various state distribution companies have increased significantly over the last few years, posing a risk of payment delays and/or defaults to the power producers. Investors find comfort in the fact that in several states, a significant portion of the SEB loans are backed by guarantees by the state governments. However, the fiscal health of several states is questionable so guarantees may prove inadequate in the event of a crisis. Within our coverage universe, NTPC is exposed to this risk as it sells power to nearly every state in the country. Tata Power currently has minimal exposure to this risk but this may change once it starts selling power to the state of Jharkhand. CESC is best placed in our universe as it has the largest exposure is to Maharashtra, a relatively wealthy state. We highlight the positions of the companies under our coverage with respect to the positives and the negatives discussed above in the table on the next page.
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Risk reward benchmarking

Positives Capacity addition Power price outlook outlook Fuel (coal) risk Negatives Water risk
Company NTPC Tata Power CESC PTC BHEL Sector
Counterparty risk
Source: HSBC estimates, Key Positives = Darker colour indicates positively placed; Negatives: the lighter the colour, the better placed
Assuming coverage
We assume coverage of five companies in this report from Suman Guliani: three power utilities (NTPC, Tata Power and CESC), a power trader (PTC) and an equipment manufacturer (BHEL). We prefer companies which have a robust capacity expansion outlook with PPAs in place, an optimal mix of merchant capacity, a track record of timely execution and adequate fuel linkage to minimise fuel supply and cost risks. We remain cautious on companies which have disappointed on project execution and may continue to do so going forward.
Fair value summary coverage universe

Company PTC India CMP (INR) 115 HSBC Rating Overweight (V) 12m TP (INR) 161 Potential return 41% 12m target (FV) P/E 19.9 Valuation Methodology SOTP Key Assumptions Comments WACC of 11.8%, Trading Business - INR66 based on DCF COE=13.0%, Investments deployed - INR43 based on COD=11.0%, g=3% 1.5x book value Investments and others - INR52 based on 1x book value WACC of 10.1%, COE=11.5%, COD=9.8%, g=5% Parent company - INR564 based on DCF Plants under const. 5.2GW - INR301 based on DCF Plants under dev. 4.4GW - INR85 based on DCF @ 50% probability Coal business - INR318 based on DCF NDPL,Power links - INR61 based on 2.5x book value Investments and others - INR236
Tata Power
1,355
Overweight
1,565
16%
16.4
SOTP
CESC
385
Overweight
475
25%
9.9
SOTP
NTPC
217
Neutral
225
6%
17.1
DCF
BHEL
2,479
Underweight
2,300
-6%
15.7
EVA
WACC of 11.0%, West Bengal Licence Area 1.2GW COE=14.0%, INR268 based on DCF COD=11.0%, g=4% Plants under const. 1.2GW - INR140 based on DCF Investments and others - INR57 based on DCF and 1x book value Based on DCF and investments at 1x book WACC of 10.3%, value COE=10.9%, COD=8.7%, g=4% Assuming a Competitive Advantage Period Target Sales of 10%, Target Margin (CAP) of 10 years of 18.5%, WACC of 10.6%
Source: HSBC estimates *Prices as at close of 30 September 2010
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HSBC versus Consensus

HSBC estimates NTPC Tata Power CESC PTC BHEL Sector Average** FY11e Sales (INRm) FY12e FY13e 596,083 219,396 38,884 119,642 499,613 667,828 255,239 49,904 168,272 538,422 FY11e EBITDA (INRm) FY12e FY13e 174,001 51,719 9,285 1,551 102,685 339,241 204,700 65,392 14,384 2,554 105,796 392,826 FY11e 11.3 83.6 37.4 4.6 114.6 251.6 EPS (INR) FY12e FY13e 12.3 84.8 37.7 6.0 146.3 287.1 13.9 105.8 58.2 10.1 147.5 335.6
518,049 201,743 36,156 86,671 408,315
155,237 47,531 9,047 955 80,651 293,422
1,250,934 1,473,618 1,679,665 Sales (INRm) FY12e FY13e
Consenus estimates NTPC Tata Power CESC PTC BHEL Sector Average**
FY11e
FY11e
EBITDA (INRm) FY12e FY13e 196,694 51,034 10,372 1,481 95,655 355,236 EBITDA FY12e -11.5% 1.3% -10.5% 4.7% 7.3% -4.5% 235,194 69,656 11,413 2,893 108,223 427,379
FY11e 12.0 75.8 38.0 4.3 114.0 244.1
EPS (INR) FY12e FY13e 13.5 89.0 40.5 5.7 139.6 288.2 EPS FY12e -8.5% -4.6% -7.0% 4.6% 4.8% -0.4% 14.5 103.8 47.3 7.9 156.3 329.8
542,063 619,831 678,977 184,136 211,029 266,097 37,765 40,528 42,882 98,362 128,892 160,732 414,706 504,531 578,007 1,277,031 1,504,810 1,726,695 Sales FY12e -3.8% 4.0% -4.1% -7.2% -1.0% -2.1%
164,320 41,201 9,684 956 78,714 294,875
Divergence % NTPC Tata Power CESC PTC BHEL Sector Average**
FY11e -4.4% 9.6% -4.3% -11.9% -1.5% -2.0%
FY13e -1.6% -4.1% 16.4% 4.7% -6.8% -2.7%
FY11e -5.5% 15.4% -6.6% -0.1% 2.5% -0.5%
FY13e -13.0% -6.1% 26.0% -11.7% -2.2% -8.1%
FY11e -5.4% 10.4% -1.6% 6.3% 0.5% 3.1%
FY13e -4.1% 2.0% 23.0% 28.8% -5.7% 1.7%
Source: HSBC estimates, Bloomberg for consensus, CESC estimates are standalone figures
We reiterate OW on Tata Power and CESC, upgrade PTC to OW(V) from N(V) and NTPC to Neutral from UW, and downgrade BHEL to UW from OW. The table below summarises our ratings, target process, company comments and valuation methodologies. We are marginally below consensus on our FY12e sales estimates as we have only included those projects in our earnings estimates where substantial on-ground progress has been reported. Given that most of these new projects are higher margin projects (due to better pricing), our conservative approach makes us c5% below consensus on FY12e EBITDA and c8% below consensus on FY13e EBITDA. The table above shows how we compare with consensus, while a valuation and performance summary of the sector appears on the next page. We now discuss our investment case for each of the companies and summarise changes in our estimates.
PTC: OW(V), TP INR161

We believe PTC remains well placed in the medium term to benefit from strong and stable growth in the power trade business. The visibility of future growth has significantly improved lately, as the company has achieved both backward and forward linkages, through PSAs (c5,500MW), PPAs (c16,000MW) and several short-term power contracts from its traditional segments. The company has also made significant progress in addressing its supply side bottlenecks by expanding beyond its core Bhutan projects. In addition, we note that PTC holds cash and cash equivalents of cINR14bn (or c38% of market cap), which provides it capital for future investments.
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We forecast an earnings CAGR of c42% for FY11-13e, which makes its FY12e PE multiple of c19.3x (vs. sector average of c17.4) appear compelling. We also expect PTC to unlock significant value from its subsidiaries, particularly PFS, and associates as it has plans for an IPO in the coming years. We are bullish on PTC and upgrade to Overweight (V) from Neutral (V) with a target price of INR161 (INR122 previously), which offers 41% potential return.
Tata Power: OW, TP INR1,565

The business can be divided into three major segments the standalone business (c37% of the group), holdings in the coal mines of KPC and Arutmin (c30%) and the new and upcoming projects at Mundra and Maithon. While the generation and T&D segment in the standalone business should find support from the planned equity infusion of cINR4.5bn over the coming years, the growth in the distribution and the merchant power business may also surprise on the upside. In addition, the group earnings will get a strong boost from the completion of the 5GW Mundra and Maithon projects in the coming year. Tata Power also remains in a sweet spot from a supply side perspective. We believe that its investment in coal mines provides a strong natural hedge as it stands to benefit from any increase in coal prices (the current trend) but may not necessarily lose if the prices fall (as the coal can be used in house). Overall, we forecast an earnings CAGR of c23% for FY11-13e, notwithstanding margin squeeze from the rising fuel costs and increasing outlay on short term power procurement. The stock remains attractive on FY12e PB, trading at c2.1x vs. a sector average of c2.2x. We reiterate Overweight and raise our target price from INR1,525 to INR1,565, which offers 16% potential return.
CESC: OW, TP INR475

We believe CESC remains well positioned to continue to grow its regulated power business with a gradual expansion of its equity base. This in our opinion is driven largely by: 1) strong cash flow margin of 30-32% in the regulated business; 2) regional expansion of CESCs customer base after the completion of its Chandrapur and Haldia plants. We forecast FY11-13 earnings CAGR of c19% for power business.
Utilities sector Valuation summary

Company CMP EBITDA EPS mgns growth 16% 30% 24% 1% 46% 13% 47% 26% Div yield 1% 2% 1% 1% RoE FY11e EV/ Sales 1.8 3.9 2.5 0.2 FY12e EV/ EBITDA 11.0 13.1 10.7 19.1 P/E 16.4 19.2 16.2 25.0 P/B 1.0 2.6 2.5 1.5 EBITDA EPS mgns growth 15.7% 29.2% 23.6% 1.3% 18% 9% 1% 30% Div yield 1% 2% 1% 1% RoE 7% 14% 13% 7% EV/ Sales 1.9 3.6 2.3 0.2 EV/ EBITDA 12.1 12.3 10.0 12.4 P/E 13.9 17.6 15.9 19.3 P/B 1.0 2.4 2.1 1.4
CESC NTPC Tata Power PTC India
385 217 1,355 115
6% 14% 15% 6%
Other covered companies Reliance Infra GMR Infra Lanco Infra Average - simple Average - weighted Average - aggregated Other uncovered companies Adani Power JPVL NHPC Reliance Power JSW Energy KSK Energy 134 64 32 160 119 174 60% 90% 77% 48% 46% 57% 40% 39% 28% 412% -28% -22% -10% 60% 109% 59% 44% 20% 0% 0% 1% 0% 1% 0% 1% 1% 1% 15% 6% 7% 4% 24% 13% 11% 12% 11% 17.6 32.9 10.4 39.1 4.9 7.3 10.2 9.4 4.3 29.2 36.4 13.4 81.9 10.8 12.9 22.0 21.2 15.2 31.9 74.3 22.2 62.7 14.3 16.9 32.6 28.9 21.7 4.3 3.7 1.5 2.5 3.3 2.2 2.6 2.7 2.4 62% 73% 79% 56% 47% 55% 40% 39% 30% 215% 204% 15% 16% 62% 80% 50% 32% 25% 0% 0% 2% 0% 2% 0% 1% 1% 1% 34% 12% 8% 5% 29% 18% 14% 14% 13% 6.3 14.9 8.9 25.6 2.9 5.6 6.4 6.4 3.4 10.1 20.4 11.3 45.8 6.0 10.1 14.4 14.9 11.5 10.1 24.4 19.4 54.0 8.8 9.4 25.8 24.6 17.4 3.1 3.1 1.4 2.4 2.5 1.7 2.2 2.3 2.2 1,069 57 72 13% 36% 29% 21% 28% 24% 14% 41% 64% 36% 23% 20% 1% 0% 0% 1% 1% 1% 10% 3% 23% 11% 13% 12% 2.0 7.5 3.0 3.0 3.7 3.1 15.4 21.0 10.4 14.4 13.5 13.1 16.4 89.1 19.5 28.8 24.0 19.5 1.5 3.0 4.1 2.3 2.6 2.4 14% 37% 27% 21% 27% 23% 28% -18% -11% 8% 7% 9% 1% 0% 0% 1% 1% 1% 11% 3% 17% 10% 13% 12% 1.6 7.5 2.2 2.7 3.4 2.6 11.5 18.0 8.0 12.0 12.1 11.3 12.8 108.4 21.8 30.0 24.3 17.9 1.4 3.0 3.4 2.1 2.3 2.2
Total Average - simple Total Average - weighted Total Average - aggregated
Source: HSBC estimates, Reuters, Prices as at close of 30 September 2010
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We note that company also has a pipeline of c3.3 GW of new projects in Orissa, Jharkhand and Bihar, the upside from which is not included in our forecasts as it may materialise only after FY14. The performance of the retail business, Spencer, has been a drag on the group financials with losses peaking in FY09. However, according to the management, the Spencer business has now become profitable at the store level (after the group closed down c60 loss making stores) and we forecast the loss at the PAT level to fall from INR2.1bn in FY10 (c50% of income from power business) to around INR700m (c10% of income from power business) in FY13e. We forecast a group earnings CAGR of c50% during FY11-13e on the back of strong growth in the power business and falling losses in the retail business. On our FY12 estimates, the stock is trading at c1.0x PB and c13.9 PE vs. the sector average of c2.2x and c17.4x, respectively. We find the valuation discount (PE 20%, PB 56%) compelling given strong growth prospects and reiterate Overweight on CESC with a target price of INR475 (INR518 previously), which offers 25% potential return.
NTPC: Neutral, TP INR225

NTPC is not only the biggest power generation company in India (c20% of national capacity and c30% of national generation) but also one of the best in class in terms of its plant utilisation, with an average PLF of c89% (the national average is c70%). NTPC also has a firm fuel supply agreement (FSA) with Coal India for c90% of its existing coal requirements (i.e. an annual supply of c110mt).
Capital goods sector Valuation summary

FY11e Company CMP EBITDA EPS mgns growth 19% 30% Div yield 1% RoE 31% EV/ Sales 2.6 EV/ EBITDA 13.4 P/E 21.6 P/B 6.1 EBITDA EPS mgns growth 20% 28% Div yield 2% FY12e RoE 32% EV/ Sales 2.1 EV/ EBITDA 10.2 P/E 16.9 P/B 4.9
BHEL
2,479
Other covered companies ABB India* KEC Kalpataru Power Jyoti Structures Larsen & Toubro Thermax Voltas IVRCL Infra HCC NCC Simplex Punj Lloyd IRB Infra GMR Infra Reliance Infra 921 500 179 136 2,053 801 241 160 59 157 474 127 260 57 1,069 9% 11% 10% 11% 11% 12% 9% 9% 13% 10% 10% 8% 36% 36% 13% 15% 16% 14% 8% 13% 32% 17% 25% 30% 10% 6% 28% 28% 26% -55% 19% 40% -4% 16% 24% 16% 0% 0% 1% 1% 1% 1% 1% 1% 1% 1% 0% 1% 1% 0% 1% 1% 1% 1% 15% 24% 21% 21% 20% 30% 30% 11% 8% 10% 14% 6% 21% 3% 10% 17% 22% 17% 2.7 0.7 0.7 0.5 2.7 1.9 1.2 1.0 1.3 0.7 0.7 0.6 3.9 7.2 1.3 1.8 2.7 2.2 32.0 6.9 6.5 4.9 24.1 16.4 12.7 10.5 9.7 7.8 6.8 7.4 10.8 20.1 10.1 11.2 17.1 15.4 51.1 12.4 10.2 10.2 33.5 26.7 21.3 19.1 28.9 16.5 15.3 20.9 18.9 89.1 16.4 24.1 29.6 24.7 7.1 2.6 1.9 1.9 6.1 7.4 5.8 2.1 2.3 1.6 2.0 1.3 3.6 3.0 1.5 3.3 5.2 4.1 10% 11% 10% 11% 11% 12% 9% 9% 13% 10% 10% 8% 33% 37% 14% 14% 17% 14% 49% 13% 28% 25% 32% 25% 12% 28% 35% 37% 37% 104% 22% -18% 28% 29% 27% 28% 0% 0% 1% 1% 1% 2% 1% 1% 1% 1% 1% 1% 1% 0% 1% 1% 1% 1% 19% 22% 22% 21% 22% 31% 27% 13% 10% 13% 16% 12% 21% 3% 11% 18% 23% 18% 2.2 0.6 0.5 0.5 2.0 1.5 1.0 0.8 1.1 0.6 0.6 0.5 3.3 7.3 1.0 1.6 2.2 1.8 22.0 6.0 5.3 4.2 18.1 13.0 11.0 8.7 8.6 6.6 5.7 5.9 10.0 20.0 7.6 9.4 13.3 12.3 34.3 10.9 8.0 8.1 25.5 21.3 18.9 14.9 21.4 12.0 11.2 10.3 15.4 108.4 12.8 21.1 25.4 19.2 6.0 2.1 1.6 1.6 5.2 6.1 4.7 1.9 2.1 1.5 1.7 1.1 3.1 3.0 1.4 2.8 4.4 3.5
Average - simple Average - weighted Average - aggregated Other uncovered companies Siemens 820 Crompton Greaves 313 Areva T&D 290 52 Suzlon Energy BGR Energy 759 739 Cummins India 1,743 Bharat Electronics 486 Blue Star 219 Gammon India 374 Patel Eng. 121 Jaiprakash Associat 47 GVK Power Total Average - simple Total Average - weighted Total Average - aggregated
13% 14% 10% 5% 11% 20% 20% 11% 9% 16% 27% 31% 15% 16% 14%
40% 9% -15% -61% 40% na na 12% 4% -4% -33% 44% 4% 4% 43%
1% 1% 1% 0% 1% 2% 1% 2% 0% 1% 1% 0% 1% 1% 1%
25% 31% 18% -7% 33% 32% 18% 38% 9% 14% 13% 6% 19% 20% 15%
2.8 2.0 2.0 0.9 1.4 3.9 3.2 1.5 0.8 1.3 3.6 5.8 2.4 2.8 2.2
21.5 14.2 20.1 19.2 12.3 20.1 15.9 13.4 8.7 8.0 13.2 18.9 16.7 18.6 15.7
35.5 22.3 42.5 (17.4) 19.5 25.1 16.0 19.7 17.6 12.9 22.4 31.7 23.0 26.7 26.4
7.7 6.3 7.0 1.4 5.9 7.7 2.8 6.7 1.3 1.7 2.7 2.1 4.6 5.3 4.0
12% 14% 11% 8% 11% 19% 20% 11% 9% 16% 28% 35% 16% 17% 14%
17% 16% 46% -192% 26% 24% 16% 18% 14% 20% 21% 54% 10% 15% 26%
1% 1% 1% 1% 1% 2% 1% 2% 0% 1% 1% 0% 1% 1% 1%
24% 28% 22% 4% 31% 32% 18% 36% 9% 14% 14% 8% 20% 21% 18%
2.3 1.7 1.7 0.7 1.1 3.2 2.9 1.3 0.7 1.2 3.2 5.7 2.1 2.4 1.8
18.3 11.9 15.3 8.9 9.8 16.2 14.4 11.4 8.1 7.3 11.5 16.4 13.2 14.8 12.5
30.3 19.3 29.2 18.8 15.5 20.2 13.8 16.6 15.4 10.8 18.5 20.6 20.2 22.6 19.8
6.4 4.9 5.9 1.4 4.5 6.2 2.4 5.3 1.3 1.5 2.4 1.9 3.8 4.4 3.5
Source: HSBC estimates, Reuters; prices as at close of 30 September 2010 Note: *ABB India estimates are based on Reuters
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Utilities sector Share price performance summary

Absolute Performance (%) Company NTPC Tata Power CESC PTC Average - simple Average - weighted Other covered companies Lanco Infra GMR Infra Reliance Infra 72 57 1,070 6.8% -3.2% 1.0% 8.0% 1.8% 6.9% 6.7% -4.8% -10.9% 36.8% -9.7% 7.2% 49.3% -19.1% -12.4% 5.0% -4.8% -0.7% 1.3% -8.3% -3.3% 4.0% -13.5% -19.7% 32.0% -23.2% -6.4% 44.1% -35.4% -28.7% CMP 217 1,354 385 115 1 Week 4.6% 2.9% -3.8% -3.8% -0.1% 4.0% 1 mth 10.8% 10.6% 1.7% -3.6% 4.9% 10.3% 3 mths 8.9% 3.7% 2.3% 14.8% 7.4% 8.1% 6 mths 4.8% -1.3% 0.6% 2.9% 1.7% 3.8% 12 mths 1.5% 2.6% -1.2% 30.9% 8.5% 2.1% 1 Week 2.8% 1.1% -5.6% -5.6% -1.8% 2.2% Relative Performance (%)* 1 mth 4.1% 3.9% -5.0% -10.2% -1.8% 3.7% 3 mths 6.2% 1.0% -0.4% 12.1% 4.7% 5.4% 6 mths -0.1% -6.2% -4.2% -1.9% -3.1% -1.1% 12 mths -3.7% -2.5% -6.3% 25.7% 3.3% -3.1%
Other uncovered companies Jaiprakash Power Adani Power JSW Energy Reliance Power KSK Energy NHPC 64 134 119 160 174 32 -1.3% -1.8% -2.7% 1.6% -2.4% -0.6% -0.2% 2.0% 1.0% -1.4% -6.5% 5.4% 13.0% 4.4% 4.0% 6.8% -7.5% 6.1% -5.5% -6.4% 2.7% 1.1% 0.9% 3.0% -5.6% 15.7% 6.0% 7.3% -5.5% 4.1% 4.9% 5.4% -22.7% 31.6% 0.0% -4.4% -14.5% -8.1% 2.6% 1.4% -3.1% -3.6% -4.4% -0.2% -4.1% -2.4% -2.0% 0.2% -5.7% -8.0% -13.2% -1.3% 6.4% -2.2% -3.2% -0.2% -10.2% 3.4% -8.2% -9.1% -0.1% -1.6% -2.8% -0.4% -10.4% 10.8% 1.2% 2.5% -10.4% -0.7% -1.3% -0.4% -27.9% 26.4% -5.2% -9.6% -19.7% -13.3% -4.3% -5.0%
Total Average - simple Total Average - weighted
Source: Thomson Datastream; *relative to BSE Utilities Index; prices as at close of 30 September 2010
However, in order to further increase its average PLF and hence its earnings power, and improve the efficiency of its underperforming plants, NTPC will require additional stable supplies of coal, especially as the new generation capacity comes online. Although the company has been awarded several captive coal mines in the last five years, the development of these mines remains disappointing. In our opinion, this issue is a barrier to future growth. The progress on capacity addition has been disappointing historically and we have little confidence in the companys ability to meet its capacity addition target of 75GW by FY17 in a timely manner. Although the earnings outlook remains robust because of solid business and strong cash generation, we believe the scope for earnings growth remains limited due to poor execution. We expect NTPCs earnings to grow at a relatively modest rate of c11.6% during FY11-13e, driven largely by the expected efficiency gains (and hence margin improvement). The stock doesnt look particularly cheap on our FY12 estimates, trading at 2.4x PB and 17.6x PE vs. the sector average of c2.2x and c17.4x, respectively. We upgrade NTPC to Neutral from Underweight and raise our target price from INR185 to INR225, which implies a modest potential return of 6%.
BHEL: UW, TP INR2,300

We expect the run-rate of generation capacity addition to stabilise at c17GW per annum during the 12th 5-year plan. This, in our opinion, will depress the y-o-y growth in BHELs power equipment orders relative to the the last five years (order intake went up from c3.4GW in FY06 to c16.5GW in FY10). Hence, we believe the execution of its sizeable order book will remain key for BHEL to achieve the expected earnings growth in the near term.
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Capital goods sector Share price performance summary

Absolute Performance (%) Company BHEL Larsen Thermax ABB Punj GMR Infra Reliance Infra KEC International Kalpataru Jyoti Structures Voltas IVRCL HCC NCC Simplex IRB Average - simple Average - weighted Other uncovered companies Areva T&D Siemens BGR Energy Crompton Greaves Suzlon Bharat Electronics Blue Star Cummins Gammon India Patel Eng. GVK 290 820 759 313 52 1,743 486 739 219 374 47 -0.2% 4.3% -1.5% -1.3% -2.5% -1.7% 3.1% -1.0% -2.5% -2.4% -0.6% -1.0% 0.9% -0.5% 18.5% -4.0% 5.8% 13.0% 5.1% 14.5% 0.2% 4.5% 2.5% 3.2% 5.8% 7.8% 0.1% 11.6% 3.6% 21.1% -9.7% 0.2% 18.2% 24.0% 0.6% -12.5% 5.3% 1.0% 5.5% -4.8% 10.8% 41.3% 19.8% -27.3% -20.4% 33.8% 43.9% -7.3% -17.6% 3.8% 3.0% 10.9% -8.1% 47.2% 67.1% 74.4% -42.9% 13.9% 34.7% 111.5% 15.6% -24.2% 0.1% 12.5% 18.0% -1.9% 2.7% -3.1% -3.0% -4.2% -3.3% 1.4% -2.7% -4.1% -4.0% -2.3% -2.7% -0.8% -10.6% 8.4% -14.1% -4.4% 2.8% -5.1% 4.4% -9.9% -5.6% -7.7% -6.9% -4.3% -2.4% -8.7% 2.8% -5.1% 12.4% -18.4% -8.5% 9.4% 15.2% -8.1% -21.3% -3.4% -7.8% -3.3% -18.4% -2.8% 27.7% 6.2% -40.9% -34.0% 20.2% 30.3% -20.9% -31.2% -9.8% -10.6% -2.7% -24.3% 31.0% 50.8% 58.2% -59.2% -2.4% 18.4% 95.3% -0.6% -40.5% -16.2% -3.7% 1.7% CMP 2,484 2,045 797 921 127 57 1,070 498 180 136 241 160 59 156 473 260 1 Week 1.5% 2.3% 1.0% 5.5% -4.2% -3.2% 1.0% -3.6% -6.0% -0.5% 4.5% -5.4% -0.8% -5.9% 0.0% -7.9% -1.3% 1.1% 1 mth 3.1% 12.8% 5.4% 18.5% 20.2% 1.8% 6.9% 9.8% -8.8% 1.2% 19.6% 2.5% 4.8% 1.3% 1.0% -6.2% 5.9% 7.8% 3 mths 0.9% 13.3% 5.1% 6.8% -7.0% -4.8% -10.9% 4.5% -15.4% -11.1% 21.6% -14.3% -1.4% -17.0% -4.1% -2.2% -2.3% 4.1% 6 mths 4.1% 25.7% 17.0% 10.9% -28.6% -9.7% 7.2% -14.7% -13.7% -16.2% 35.8% -3.1% -11.9% -3.8% 4.5% 1.6% 0.3% 11.1% 12 mths 6.8% 21.5% 45.8% 17.4% -52.6% -19.1% -12.4% -11.4% 6.2% -12.6% 65.5% -18.2% -10.2% 4.7% -6.3% 23.6% 3.0% 10.7% 1 Week -0.2% 0.7% -0.6% 3.9% -5.8% -4.8% -0.7% -5.2% -7.7% -2.2% 2.9% -7.1% -2.4% -7.5% -1.6% -9.6% -3.0% -0.5% Relative Performance (%)* 1 mth -7.0% 2.7% -4.7% 8.4% 10.1% -8.3% -3.3% -0.4% -19.0% -8.9% 9.5% -7.7% -5.3% -8.8% -9.2% -16.3% -4.3% -2.4% 3 mths -7.8% 4.6% -3.7% -1.9% -15.7% -13.5% -19.7% -4.3% -24.1% -19.8% 12.8% -23.0% -10.1% -25.8% -12.9% -11.0% -11.0% -4.7% 6 mths -9.5% 12.1% 3.4% -2.7% -42.2% -23.2% -6.4% -28.3% -27.3% -29.8% 22.3% -16.7% -25.5% -17.4% -9.1% -12.0% -13.3% -2.5% 12 mths -9.5% 5.2% 29.5% 1.2% -68.9% -35.4% -28.7% -27.7% -10.1% -28.8% 49.3% -34.4% -26.5% -11.6% -22.6% 7.4% -13.2% -5.6%
Total Average - simple Total Average - weighted
Source: Thomson Datastream; *relative to BSE Capital Goods Index; prices as at close of 30 September 2010
Our FY11-12 estimates assume BHEL will ramp up its order execution rate to 12-13GW of BTG equipment over the next two years compared to c5.2GW commissioned in FY10. We are broadly in line with consensus on FY11, but are modestly ahead on FY12 (c5% on EPS), driven mainly by our more positive view on margin development in FY12. However, we remain cautious on execution during FY13e, where we are c6-7% below consensus on sales and EPS. This is because, historically, power capacity addition in any five-year plan has always been back-end loaded and we expect this trend to persist. For the subsequent five years post FY12, we believe that muted order execution in the initial years of 12th 5-year plan (FY13-17) and increase in competition will significantly impact BHELs earnings power/growth during FY13-17. Furthermore, we expect margins to come under pressure during this period as the delivery of imported supercritical equipment begins, putting further downward pressure on earnings. We forecast the EPS growth during FY13-17e to decelerate to c5% compared to c30% growth during FY07-12e. Hence, we believe the stock should de-rate compared to the average 12M forward PE of c22x commanded by the group during FY07-10. Moreover, BHEL is trading only at a slight discount to the sector on FY12e PE (c16.9x vs. sector average of c19.8x), whereas the group is expected to witness a much lower growth in its earnings (1% during
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FY13e compared to the sector average of c25%) Therefore, in our opinion, the stock remains expensive vs the rest of the sector on a growth adjusted basis. We downgrade BHEL to Underweight from Overweight and lower our target price from INR2,850 to INR2,300, which represents 6% downside. Our target price is derived from the EVA valuation methodology and is based on a target sales growth of 10%, target return on sales of 18.5% and WACC of 10.6%. Our price target implies a 12M forward target PE of c15.7x vs. 12M forward PE of c19.3x currently.
Summary: Change in earnings estimates INRm PTC New Old Change New Old Change New Old Change New Old Change New Old Change ______ Revenue_______ FY11e FY12e 86,671 75,343 15% 201,743 209,309 -4% 46,389 34,230 36% 518,049 543,585 -5% 408,315 420,828 -3% 119,642 118,785 1% 219,396 227,536 -4% 52,259 36,190 44% 596,083 625,959 -5% 499,613 540,877 -8% ______ EBITDA _______ ______EPS (INR) _____ Target price Rating FY11e FY12e FY11e FY12e (INR) 955 800 19% 47,531 46,099 3% 7,396 9,209 -20% 155,237 166,124 -7% 80,651 83,501 -3% 1,551 1,569 -1% 51,719 52,676 -2% 8,219 9,428 -13% 174,001 197,469 -12% 102,685 108,827 -6% 4.6 4.2 9% 83.6 74.9 12% 23.5 39.8 -41% 11.3 11.5 -1% 114.6 117.5 -2% 6.0 6.9 -13% 84.8 82.6 3% 27.8 40.7 -32% 12.3 12.9 -4% 146.3 153.7 -5% 161 Overweight (V) 122 N(V) 1,565 Overweight 1,525 OW 475 Overweight 518 OW 225 Neutral 185 UW 2,300 Underweight 2,850 OW
Tata Power
CESC
NTPC
BHEL
Source: Company data, HSBC estimates
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Capacity addition accelerating

We estimate additional capacity of c53GW by FY13e, 2.8x the
amount added over last three years

Run rate in capacity addition in 12 plan expected to almost
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double, with c17GW of capacity addition per annum

Private sector to contribute 29% capacity; thermal capacity to
constitute 85% of new capacity, increasing fuel and water supply concerns
Significant capacity addition over next three years

We estimate new power generation capacity of c53GW to come on stream in FY11, FY12 and FY13, excluding renewable energy (see chart). This is substantially above the 21GW achieved over FY02-07 (the 10th five-year plan) and the 19Gw added over last three years (FY08-10). Indias installed capacity should reach 193GW by end FY12e from 159GW in FY10, including renewable capacity (c4GW over FY11-12e) which are not part of five-year plans.
Power capacity addition to accelerate in 11th plan

80 70 60 50 40 30 20 10 0 10th Plan FY08-10 FY11-13e FY08-13e Capacity addition (GW)
Source: CEA, HSBC estimates
72 2.8x 53
21
19
suggests that things are improving

Installed capacity in India has grown from 1.3GW at the beginning of the 1st Five-Year Plan in 1951 to over c160GW as of July 2010. Success rates in hitting targets in the last three five-year plans have been disappointing (around 50%) but we expect to see an improvement owing to the following: Policy changes: These include de-licensing of thermal projects and the merchant power policy
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(MPP), which have helped to streamline large thermal projects. Historically, setting up a power plant was a sequential process; new policies now allow project development activities to move in parallel. They also allow a project to achieve financial closure, acquire land and order equipment before even signing a PPA. However this has also increased the risk for developers. We believe the changes have largely helped private developers set up power projects. Private sector dominance: Despite some expectations of a shortfall from state and central government sector projects, we expect the private sector to set up 29% of the new capacity on the back policy changes. We expect 21% of total capacity by the end of 11th plan will be owned by the private sector. Lumpiness in capacity: Historically most capacity planned under five-year plans becomes operational during the last two years and the first year of the next plan (spill over projects). We expect this trend to continue (see following chart) and in the next three years (FY11-13) we expect an additional capacity of c53Gw, including 23GW of spill over projects in FY13.
11th 5-year plan to achieve more than the last three plans (GW)
11 plan to add c49Gw: Our project level
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analysis suggests that India will add c49GW of capacity during the 11th Plan. This is significant given that it will entail a capacity addition of c30GW in the last two years of the plan period. The Ministry of Power, and the central government expects c62GW addition in the 11th Plan against an original target of 79GW. However, given the progress at various projects, we believe the revised estimate of 62GW is not achievable (chart below).
11th plan target: Probable target of 62GW versus original target of 78GW but we still expect 49GW
25 20 15 45% 10 25% 5 0 FY08 FY09 Target FY10 Actual 63% 58%
81%
90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
FY11e FY12e % Achieved
Transmission in excess of INR560bn during FY11-12

In our view, additional capacity addition will expedite the projected expenditure in the transmission sector which should witness capex in excess of INR560bn (cINR225bn from PGCIL alone) during FY11-12. Since the regulator has now increased the ROE from 14% to 15.5% post-tax, this along with increased equity base is likely to benefit the transmission companies. We expect this to help the transmission EPC companies in terms of order book as well as execution.
80 70 60 50 40 30 20 10 0
100% 75% 50% 25% 0% VIII IX Capacity planned % Achieved X XIe Capacity added
54%
47%
52%
62%
What can go wrong?

Shortfall and delays
Any further project execution delay beyond our current assumption of c6-12 month delays, will lead to a downward revision of earnings. Though
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we expect some state sector projects to experience delays we believe private sector projects will be completed earlier than scheduled, partially offsetting the delays from the state projects.
% Capacity addition against target: Private sector to lead the pack
Run rate to almost double in 12th plan

We expect the generation capacity addition momentum to continue in the 12th Plan (2013-17) with capacity addition of c16-18GW per annum almost doubling the capacity addition run rate of the 11th Plan (c9-10GW). We expect overall capacity addition of c83GW in the 12th plan period, up 70% over the current plan period (our estimate for 11th plan capacity addition is 49GW). We believe that this will be achieved given that: UMPPs (ultra mega power projects) are expected to be on stream in the 12th plan. We think four UMPPs will be operating by then (the Central Electricity Authority, or CEA, estimates there will be seven). These projects have been awarded to private companies which have signed firm PPAs and obtained various clearances, including acquisition of land, fuel linkage as well water access, which have been major reasons for slippages in the past. Developers also face harsh penalty clauses for non-completion of projects on time. Policy changes: We expect the policy changes discussed earlier to also facilitate land acquisition, fuel linkages/agreements, equipment ordering and financial closure during the 12th plan. Do not expect equipment supply constraints: We believe the increase of power equipment capacity by BHEL (to 20GW) and the entry of new private players such as L&T (4GW) and Thermax (3GW) will remove a major bottleneck for power capacity addition. This is in addition to various international suppliers from China and Korea who are able to compete in the Indian market. The lack of power equipment has been a major reason for project slippage in the past.
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% VIII Central
IX State
XIe Private
Adequate transmission capacity
Limited transmission capacity can be a dampener for new power projects expecting to sell power across regions. Currently inter-regional power transmission capacity is c22GW, which is expected to increase to c37GW by FY12. However, in our view this is grossly inadequate for the proper functioning of the power market and the discovery of best bulk prices for power. Although we expect cINR560bn in transmission capex during FY11-12, we believe if there is major shortfall in transmission capacity once the power projects become operational it will limit the operating efficiency of new projects.
Contracting margins
We believe margin pressures on variable components could dampen the upsurge in the earnings for some companies. This applies to increased fuel costs as well as lower than expected average realisation from the sale of power.
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Slippage projects to be commissioned in FY13: Slippage of about 30GW from the 11th plan which are now at advanced stages of implementation is likely to be commissioned early in the 12th plan. Project orders: Equipment orders have already been placed for c60GW of capacity addition in the 12th plan.
Strong capacity execution expected in 12th Plan (2013-17) Source In GW
(c623kWh) is also less than many underdeveloped countries.
Demand CAGR of 8.6% over next seven years

We expect demand to rise 8.6% pa over 2010-17, reaching c212GW in terms of peak demand and a total of c1,445bn units by 2017 in terms of base load. Our estimate is based on the combination of projected GDP growth rate, elasticity and growth in per capita consumption of electricity (see tables).
HSBC Electricity demand projections against other estimates (billion units) Source FY12e FY17e
Total benefit according to 12th Plan base paper (i) Target for 11th Plan (ii) Estimated Capacity addition in 11th Plan HSBC (iii) Capacity not executed in 11th Plan (iv=ii-iii) Execution expected in 12th plan (v=i+iv) Probabilistic target by CEA HSBC estimates % of probable target achieved
139 79 49 30 168 100 83 83%
We estimate Indias installed capacity will reach 293GW by end FY17e from 193GW in FY12e including renewable energy capacity addition (c16GW over FY13-17e) which are not part of five-year plans.
Electricity demand - 17th EPS Electricity demand (Integrated Electricity Policy) Electricity demand (National Electricity Policy 1000KwH per head) Average of various sources HSBC Average HSBC - based on GDP growth HSBC - based on per capita growth rate
969 1,008 1,038

1,005 977 979 974
1,392
1,392 1,445 1,438 1,453
Source: 17th Electric Power Survey; National Electricity Plan; HSBC estimates
Energy demand supply gap to remain

Despite an accelerated run rate in capacity addition in the remaining part of the 11th Plan (FY11-12e) and the 12th Plan period (FY13-17e), the demand supply gap will continue. The peak demand deficit in India is c13% which we expect to moderate to 10% by end FY12e and 9% by FY17e. However, we believe the actual gap is much wider as the reported deficit does not take into account latent demand from scheduled power cuts and non-electrified rural areas. Note also that India, with a population of 1.2bn, generated 747bn units in FY10 just 20% of that of China (population 1.3bn, 3,643bn units in CY09). Indias per capita electricity consumption
We assume a GDP growth rate of 8.8% for FY11e and 8.3% for FY12e and 8% thereafter (in line with our economists forecasts). Moreover we assume electricity elasticity at 1.0 (slightly higher than the 15-year average of 0.93). We assume per capita demand to grow from 710 units in FY10 to 805 in FY12e and 1,100 by FY17e, still below the current per capita consumption of 2,760 units in China in CY09.
Generation requirement for FY17 indicates our estimates (1,445 BU) are at the lower end of government projections GDP Growth rate GDP / Electricity Electricity generation required (BU)
8% 9% 10%
0.8 0.9 0.8 0.9 0.8 0.9
1,415 1,470 1,470 1,532 1,525 1,597
Source: Report of The Working Group on Power for 11th Plan, Feb 2007
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Demand supply deficit to narrow, but could be higher if we consider latent demand
300 250 200 150 100 50 0 FY02 FY03 FY04 Installed capacity (GW) Peak shortfall %
24% 20% 16% 12% 8% 4% 0% FY05 FY06 FY07 FY08 FY09 FY10 Peak demand (GW) Deficit considering latent demand % FY11e FY12e Peak met (GW) FY17e
Capacity addition exceeds demand growth over 2010-17, narrowing gap

As discussed earlier, we expect the capacity momentum to continue in the 12th plan, with an addition of 83GW. We also assume an improvement of 25bps in the effective plant load factor (over installed capacity), and a similar improvement in peak capacity available to meet peak demand. This will result in 9.2% CAGR over FY10-17e on the supply side, outpacing the expected demand of 8.6% over the same period, which will narrow the peak demand supply gap to 9% by FY17e from 13% in FY10e.
the total power generation to c30% by the end of FY17e (see chart).
Private sector contribution as % to total installed capacity to increase substantially
In GW 100% 80% 60% 40% 20% 0% FY07 FY10 Central State FY12e Private FY17e 34% 32% 34% 32% 53% 50% 46% 132 13% 159 18% 193 21% 293 30%
37%
Private sector to dominate

Our analysis suggests private sector contribution to power generation will increase from c18% in FY10 to c21% in FY12e. We expect the private sector to add c14GW of generation capacity (i.e. c30% of the total capacity addition) under the current 11th fiveyear plan. This is significant given that the total installed capacity of private players at the end of the 10th plan was just c17GW. In the 12 plan, we expect the private sector to add another 35GW of generation capacity (i.e. c42% of the total estimated capacity addition in the 12th plan), taking private sector contribution to
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Thermal growth increases fuel concerns

Indias power sector is dominated by thermal based capacity, with coal being the key source of fuel for producing power. This is due to a lack of other fuel sources as well as cost sensitivity. We expect the share of thermal capacity to increase from 65% in FY10 to 66% by FY12e and 69% by FY17e. On our estimates of 11th Plan capacity addition of c49GW, almost c42GW (85% of 11th plan capacity addition) is expected to
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based on thermal. This is 3.5x times the capacity addition of the last three plan periods (12-13GW) as shown in the chart. We expect thermal capacity to double from 102GW in FY10 to 202GW by FY17e. Our analysis suggests that the coal based capacity will increase by 115% from c84GW in FY10 to c181GW by FY17e, implying a CAGR of c11.6%. We expect this to double coal demand from the power sector. We believe domestic coal production will not be able to keep pace with the acceleration in the generation capacity addition. Moreover, we believe that delays will be prevalent in the captive coal blocks allotted to power developers (28 blocks are in operation out of a total of 215 allotted). This deficit in domestic coal availability will have to be met by imports, which are expected to increase 4.9x from c68m tons in FY10 to c335mn tons in FY17e (a CAGR of 26%).
We discuss the fuel concerns in more detail in the following chapter.

Thermal based capacity as % to total capacity to dominate
In GW 100% 80% 60% 40% 20% 0%
132 6% 26%
159 10% 23%
193 10% 20%
293 12% 16%
65%
64%
66%
69%
FY07 Thermal
FY10 Hydro
FY12e Nuclear
FY17e RES
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Fuel concerns
Domestic coal shortage seems imminent; requirements likely to
accelerate at c12% CAGR during FY10-17e

Ramp up from Coal India and captive coal mines unlikely; imports
to increase at a CAGR of c26% during FY10-17e

Inadequate ports capacity and rail wagons availability could
restrict imports, putting margin pressure on power utilities
Coal demand to accelerate over next five years

India will continue to witness significant investment in power generation capacity. As the new capacity comes online, the availability of coal will become an increasing concern. We forecast Indias coal requirement to reach c1.26bn tons by FY17. This implies an increase in demand of c97m tons pa over FY11-17 (see table), significantly ahead of growth (c40m tons pa) in the last five years (FY05-10).
Around 88% of Indias power capacity addition will be coal based

Our analysis suggests India will add c97GW of coal based capacity over FY11-17 at a rate of c14GW pa. Even though our estimates assume delays of c6-12 months, this growth is unprecedented and almost 4x the annualised capacity addition of the last five years. This will require an average incremental coal supply of c74m tons pa, leading to additional coal demand of c516 tons between now and FY17 (see table).
India: Coal demand and supply model In MTs Demand Power Others Total Supply CIL SCCL Captive / Others Total -Imports/ Exports FY08 FY09 FY10p FY11e FY12e FY17e Incremental (FY10-17e) 888 375 1,263 651 54 222 927 -335 516 164 680 220 4 171 395 -267 FY10-17e (p.a) 74 23 97 31 1 24 56 -38 FY12-17e CAGR (p.a) (FY10-17e) 77 27 104 33 1 33 67 -37 13.2% 8.6% 11.7% 6.1% 1.1% 23.6% 8.3% 25.7%
332 172 504 379 41 37 457 -50
363 183 546 404 45 44 493 -59
372 211 582 431 50 50 532 -68
447 214 661 461 46 66 572 -89
500 240 740 487 47 58 592 -149
Demand from power sector Total 332 - Domestic - Imported
363 329 34
372 332 40
447 402 45
500 438 62
888 725 162
516 393 123
74 56 18
77 57 20
13.2% 11.8% 22.2%
Source: Ministry of Coal, HSBC estimates.*P=Provisional
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Coal based capacity: 62% by FY17 from 53% in FY10
Others sectors need coal too

64% 62% 60% 58% 56% 54% 52% 50% 48% 46%
200 180 160 140 120 100 80 60 40 20 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY17e
While we have estimated the demand for coal from the power industry, we use Ministry of Coal estimates to gauge the demand from other sectors such as steel and cement. According to these estimates, the demand for coal (ex-power) is expected to increase from c211m tons in FY10 to c375m tons in FY17, implying a CAGR of c9% (see chart below). This remains a touch higher than the 8% CAGR during FY06-10 and will increase total average incremental demand for all coal to 97 mt/annum. This implies an additional 680m tons of coal demand over FY11-17.
Demand from steel, cement and other sectors expected to increase at 9% CAGR over FY10-17e (MT)
Coal (GW)
% to total capacity
. c82% of coal based capacity is based on domestic coal

The majority (c82%) of the upcoming coal based capacity will use domestic coal as the primary fuel while only c18% (see chart below) will use imported coal. Over the next 5-7 years most of the incremental coal demand from the power sector is expected to be met domestically (assuming c75% PLF for domestic coal based power plants and an energy intensity of c3,000 Kcal/kg for domestic coal). This, in our opinion, will require an average incremental domestic coal supply of c56m tons per annum (total c393m tons) between now and 2017.
Imported coal based capacity to be 10% of expected total coal based capacity (GW)
400 300 200 100 0 FY07
CAGR of 9% over FY10-17e
FY08 FY09 FY10p FY11e FY12e FY17e Steel Cement Captive /Others
Source: CEA, MOC estimates
Domestic coal supply unlikely to catch up

Domestic coal supply, in our opinion, will significantly lag domestic coal demand. We expect Coal India, which meets c80% of coal demand in India, to add additional capacity of only c31m tons per annum over the next five years. This will leave a significant demand/supply gap (c66m tons per annum) which puts the onus on captive developers and/or imports (see chart below). Moreover, the quality of domestic coal supplied by Coal India has deteriorated because of overexploitation of existing mines. The situation will
200 18 150 100 0 50 0 FY10 FY11e Domestic FY12e Imported FY17e 84 4 163 103
1 91
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only get worse, impacting the performance of power plants.

Supply from Coal India to grow 6% over FY10-17e, increasing the gap to be filled by imports (MT)
1,500 1,200 900 600 300 0 FY08 CIL FY09 SCCL FY10p FY11e FY12e FY17e Captive /Others Imports CIL supply to grow at 6% pa while demand growing at 9% pa inc the gap to be filled by imports
Another major source of domestic coal is captive coal mines, which contribute c9% of the domestic coal supply to the power sector. The development of captive coal mines has been disappointing, with only 28 of 215 allotted blocks coming into operation (see table). Even though it takes around six years for a coal mine to become productive (see figure below), around 16 mines have not started production despite being allocated seven years ago.
Source: Ministry of Coal, HSBC estimates
Timeline for captive coal mine development
Mining Lease Grant Geological report: For unexplored, 27 months. For explored blocks, concessionaire can buy GR within 1.5 months from the date of allotment. Mining plan approval: 6-months for mining plan preparation Submit to MoC along with application for approval Env./ Forest Clearance: Environmental Mining plan is prepared and presented to MOC Land acquisition: Consists of three types of land 1) Forest, 2) Government and 3) Private Forest Land: Concessionaire need to acquire same quantum of land and give it back to state government. Also, need to pay cost of afforestation and NPV of loss of revenue to central / state government (fixed at Rs 0.52-0.92m per hectare) Private Land: Acquired by concessionaire directly Government land: Easiest to acquire, generally in possession of government 27 months 24 months 12 - 18 months
3 months for prospecting license
Involves approval of Environmental Impact Analysis (EIA) and Specifies Environment production rampManagement Plan up and quantum of (EMP) land required Public consultation through public hearing / written submission
Apply to DGM and Coal controller to take permission for open mining
Entire process takes 72 months, before actual production from mines can commence based on normative timeline.
Source: Infraline
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Status of captive coal blocks (no of blocks) Allocation Till 2003 2004 2005 2006 2007 2008 2009 2010 -Until June 2010 Total __ PSU/Govt___ ___ Private ____ ___ Total ____ Allotted U/P Allotted U/P Allotted U/P 17 4 7 31 34 4 1 0 98 12 0 2 0 0 0 0 0 14 22 0 15 21 18 20 14 7 117 11 0 3 0 0 0 0 0 14 39 4 22 52 52 24 15 7 215 23 0 5 0 0 0 0 0 28
Imports to grow substantially (MT) 400 CAGR of 26% over FY10-17e 300 335
200 89
149 59 68
100
50
0 FY08 FY09 FY10p FY11e FY12e FY17e
Source: Ministry of Coal, Note U/P= Under production
We expect the development of captive coal mines to remain subdued in the medium term, as most of the major issues obtaining clearances, acquiring land etc still persist. Only a few blocks allotted to UMPPs (Sasan, Tilaiya, Chattisgarh/Orissa) and major players (Tata Power, NTPC, Lanco and CESC) are likely to see any progress. We note that c85-90% of the allotted coal mines are in areas affected by periods of local unrest, which may further impede development. We expect a best case supply increase from captive players to c222m tons by FY17 from c50m tons in FY10, implying an incremental supply of c24m tons pa. While this represents an impressive CAGR of c24% over FY10-17e, the incremental supply will not be able to meet even half the demand supply gap for domestic coal of c74m tons pa.
Source: Ministry of coal, HSBC estimates
Coal India to rely on imported coal to meet its supply obligations

As per the New Coal Distribution Policy (NCDP) introduced in October 2007, all project developers consuming more than 4,200 tonnes of coal per annum have to enter Fuel Supply Agreements (FSAs) with the coal supplier (mainly Coal India and its subsidiaries). This is in contrast to the earlier system of linkages. Coal India has signed FSAs with around 1,168 out of a total of 1,223 customers (as of Mar 09) with allotted linkages. It guaranteed at least 90% of the Annual Contracted Quantity (ACQ) of 306m tons to the existing power plants until FY09. (Note: ACQ is equal to 100% of normal coal requirements, equivalent to c90% of a projects PLF). Even though Coal India has continued to guarantee 90% of ACQ for the new projects (post FY09), the penalty for the take or pay default clause is expected to be brought down to 50% of the ACQ Coal India is expected to meet part of its future obligation through coal imports, adding to import requirements.
Coal imports need to rise at a 26% CAGR over FY10-17e

We believe the demand supply gap for domestic coal will have to be met by an increase in imports. After accounting for the contribution from Coal India and captive mines, we expect the gap to be c38m tons per year, or a total of c267m between now and FY17. This implies that coal imports will have to increase at a CAGR of c26% during this period to fill the gap. While imports are probably the only solution, there are several issues that may lead to margin pressure for power players.
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Port capacity and rail wagon availability may restrict imports

The need to import coal may soon become an area of concern as infrastructure bottlenecks become more visible. We believe that a steep rise in coal imports will put pressure on Indias port handling capacity and the associated inland rail/road transportation.
Port capacity problems
Rail network another bottleneck
Most of the power plants requiring coal supply are in the interior of the country, often far from ports (c500-800km). So even if port capacity is put in place to handle increased coal imports, the rail/road network will pose significant challenges to efficient distribution. While increasing reliance on imported coal will lead to severe pricing pressure, it may not actually solve the problem of providing a reliable coal supply.
In India there are major ports, which are under the control of the central government, and minor ports operated by state governments and private players. The coal handling capacity of major ports is c46m tons pa, with a total capacity addition of c70m tons pa planned in Ennore, Paradip and Tuticorin. According to CRISIL, an independent research firm, only c35m tons pa of this planned capacity is realistically achievable by FY14. This will take the total capacity of major ports to c81m tons over the next 3-4 years. The capacity ramp-up at the minor ports is driven by the private players, operating under the private public partnership PPP model). The coal handling capacity at minor ports is c39m tons pa and CRISIL expects this to increase to c128m tons by FY14. This means the total capacity to handle coal will reach only about c210m tons by FY14 as against the import requirement of c335m tons pa by FY17. A majority of large capacity additions at minor ports is expected to happen at only a few ports, such as Mundra in Gujarat, Gangavaram in Andhra Pradesh and Karaikal in Tamil Nadu. This concentration of capacity may constrain the efficient movement of coal from the port.
Equipment design limitations

Power plant equipment is typically customised in terms of the calorific value and sulphur, moisture and ash content of the coal. The boiler is designed to handle coal with a specific calorific value and may not operate efficiently if a different quality coal is used. As a rule of thumb, the boiler can handle a variation in calorific value of 10-15%. The calorific value of the Indian domestic coal is typically around 3,000 Kcal/kg, well below 5,000 Kcal/kg for imported coal (a difference of over 65%). This may lead to operational inefficiencies and lower average PLF. This may lead to an additional squeeze on margins.
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Water availability
Historically, water availability has never been a major concern for
power projects; we expect this to change

1GW of coal based power plant consumes about the same
amount of water a day as a town with a half million population

Worst case impact of 4-5% on sector earnings; power projects
using innovative solutions are likely winners
Water will become increasingly scarce

The recent closure of the 2GW Chandrapur power project due to inadequate water supply is not a one-off issue and should be viewed seriously by investors. We strongly believe that investors can no longer ignore environmental and water related issues, as they have tended to do in the past. Water is mainly used in the cooling tower (80%), ash and slurry washing (15%) and the boiler feed (5%). While coal-based power projects aim to reuse 100% of their water, some is lost during reprocessing. The additional water needed is called make-up water. We estimate a 1GW power project uses about 70m litres of make-up water per day enough to meet the daily needs of a city of half a million people.
Innovation is important
We believe companies which can innovate will have a better chance of success. Solutions include the use of treated sewage water and sea water. For example, a 300MW gas-based Pragati project in Delhi and a 1000MW coal based Kaparkeda project are meeting their water needs by using nearby sewage treatment plants. Elsewhere, a number of costal power projects are planning to use sea water. Acknowledging concerns about water, various ministries have started to give priority to granting environmental clearances and coal mine allocations to operators using treated waste water or sea water.
Earning risks
Power projects existing and especially those in the pipeline in water deficit regions like Tamil Nadu, AP, Karnataka, parts of Maharashtra, Gujarat and Rajasthan will face maximum risk. The risk is expected to be highest during the summer months of April-July which also coincide with the peak power prices for the merchant projects. Our sensitivity on the earnings risk to companies is presented in the table below.
Competition is increasing
Each state has a co-ordinating department to allocate water supply for irrigation, municipal and industrial use. Demand from competing end users has increased rapidly over the last few years, with environmental and climate change becoming increasingly important factors.
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Sensitivity of earnings to unavailability of water Tata Power Capacity (MW) FY13e Capacity prone to risk of Water availability (MW) Scenario of no of plants getting affected Best Most probable Worst case No of months Units m Best Most probable Worst case Net profit per unit (INR) Net profit impact (INRm) FY13e Best Most probable Worst case % Impact on net profit Best Most probable Worst case % Impact on CAGR (FY10-13e) Best case Probable Worst case
CESC 1,725 600 10% 30% 50% 3 112 335 558 0.50 56 168 279 0.8% 2.5% 4.1% 0.4% 1.2% 2.1%
NTPC 42,884 10,096 10% 30% 50% 3 1,879 5,638 9,397 0.45 846 2,537 4,229 0.7% 2.2% 3.7% 0.3% 0.8% 1.4%
Sector 90,898 28,548 10% 30% 50% 3 5,314 15,943 26,571 0.40 2,126 6,377 10,628 0.8% 2.5% 4.2%
6,553 81 10% 30% 50% 3 15 45 75 0.45 7 20 34 0.0% 0.1% 0.1% 0.0% 0.0% 0.1%
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Power prices
Average prices unlikely to correct sharply, moderating to cINR4-
4.25 in long run on increased cost of generation

ROE for merchant power to normalise at c25-30% on the back of
rising cost pressures

Significant capacity addition may not narrow demand supply gap,
hence need not be negative for prices
Power prices unlikely to correct sharply

We expect the average price for power sold on short-term contracts to remain at INR5 per unit given the demand supply gap; however, in the long term, by FY13-14e, we expect the price to moderate to INR4-4.25 and then remain at this level for the following reasons: Domestic fuel shortage should lead to an increasing use of the high cost imported fuel, leading to an increase in the overall cost of power produced (see chart below).
The peak demand supply gap the primary driver of the short-term power market will remain even after beyond FY17 (see chart below). The gap could worsen as the deficit reported does not factor in latent demand from scheduled power outages and non-electrified rural areas. We expect prices for power sold under long-term contracts to increase to cINR3.50-3.75 per unit from the current cINR3 per, given the increase in cost of generation.
Imports to double by FY17 as % to total coal consumption (in MT)
Demand supply gap to remain beyond FY17
30% 25% 20% 15% 10%
250 200 150 100 50 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY17e
24% 20% 16% 12% 8% 4% 0%
5% 0% FY08 FY09 FY10p FY11e FY12e FY17e
Peak demand (GW) Peak shortfall %
Peak met (GW)
Source: Ministry of Coal, HSBC estimates
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Evidence of increasing power prices

The power developers have started to become mindful of fuel availability issues and the related increase in the cost of generation. This is reflected by recent bids in Karnataka, where the lowest price offered was at INR3.76 per unit, much higher than the prices being offered over the last few years (see table below). We expect the tariffs under competitive based bidding to increase from the current INR3 per unit to INR3.50-3.75.
Power price discovery under Case I bidding Year Low (INR/unit) High (INR/unit) Bidder
project the equivalent of an UMPP), which is using the coal from the same captive mine allotted for Sasan UMPP (see table).
Power price bids under UMPPs State Location Fuel type MW Awarded Tariff (INR/unit)
Madhya Pradesh Gujarat
Pithead coal Mundra Imported Coal Andhra Krishnapat Imported Pradesh nam Coal Jharkhand Tilaiyya Pithead coal Madhya Chitrangi Pithead Pradesh coal
Source: Company data, HSBC
Sasan
4,000 4,000 4,000 4,000 1,320
Reliance Power Tata Power Reliance Power Reliance Power Reliance Power
1.19 2.26 2.33 1.77 2.45
2007 2008 2008 2009 2009 2010 2010 2010

Source: HSBC
2.40 2.94 2.64 3.25 2.88 3.23 2.34 3.76
2.89 3.70 4.69 3.79 3.45 4.38 4.95 5.57
Gujarat Haryana MSEDCL Gujarat Maharashtra Rajasthan Gujarat Karnataka
Profitability to normalise despite stable prices

We expect the non-pit head new private sector power projects to get only c50-60% of their coal domestically, with imports making up the balance. This is despite of the fact that the developers will be signing FSAs with Coal India and/or its subsidiaries for c90% of their requirements. Assuming 70:30 blending of domestic and imported coal, the cost of fuel for power generation increases to INR1.29 per unit, c31% higher than the cost of fuel based on domestic coal (refer to table on the next page). Hence the use of high cost imported fuel will increase the cost of power generation over the next few years. This would result in RoEs normalising at c2530% (vs. the current profitability level of c4050%) for the plants based on merchant as well. Given a higher associated risk with merchant projects and a wide range of returns under various business models, such as regulated model (c1620%), bidding (20-25%) and captive (20-25%), we believe developers will try to keep a relatively small surplus of their power for sale on a merchant basis. We are most comfortable with developers with c20% of their power sold on a merchant basis.
UMPP price bids also going upwards

We believe that abnormally low Ultra Mega Power Project (UMPP) prices are a thing of the past. Examples include the INR1.19 per unit for the 4,000MW Sasan project in Madhya Pradesh, based on the captive mines, and INR2.26 per unit for the Mundra project, based on the imported coal. These low bids were due to perceived economies of scale, captive coal block allocation and aggressive bidding to become an early entrant. Going forward, we believe the UMMP bids by power plants with captive coal mines will be in excess of INR2 per unit. The recent Tilaiya UMPP bid at INR1.77 per unit suggests a change in the bidding environment. We believe the price offered in Sasan and Tilaya is sustainable for Reliance Power since it has also won a bid at INR2.45 per unit from Madhya Pradesh SEB for power from Chitrangi (a 4GW
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Comparison of fuel cost using various fuel sources: Cost of fuel using blended coal will mean 31% increase in fuel cost over pure domestic coal Coal - Linkage Captive Coal Coal - Imported Coal Blended (70:30) Gas
Capacity (MW) PLF% Auxiliary % Generation net (MU) Gross Calorific value (kcal/kg) Station Heat rate Fuel requirement (m ton/mmbtu) Fuel cost landed (INR/ton or mmbtu) Fuel cost (INRm) Fuel cost (INR per unit) % Diff to coal though linkage
Source: HSBC estimates
1,000 85% 5% 7,074 3,200 2,100 4.6 1,500 6,963 0.98
1,000 85% 5% 7,074 3,100 2,100 4.8 1,000 4,792 0.68 -31.2%
1,000 85% 5% 7,074 5,000 2,100 3.0 4,140 12,300 1.74 76.6%
1000 85% 5% 7,074 3,740 2,100 3.97 2,292 9,104 1.29 30.7%
1,000 85% 3% 7,223 9,500 1,900 57.3 253 14,503 2.01 104.0%
Capacity addition need not be negative for prices

We do not necessarily agree with the view that significant capacity addition coming on-stream will lead to a significant decline in bulk tariffs (i.e. from current cINR5-5.5 per unit to cINR3-3.5 by FY13-14). We rather expect prices to correct more modestly and reach a level of cINR4-4.25 per unit in the long term. Our view is based on the following observations: Of the capacity expected on stream by major listed players by FY13, only c13% (see table
Summary of capacities on stream by FY13 by revenue mix Developer Covered companies CESC NTPC Tata Power GMR Lanco Infratech R-Infra Total % to capacity Non-covered companies Adani Power GVK Jindal Power Ltd JPVL JSW Energy KSK Energy NHPC Reliance Power Torrent Total % to capacity
below) remains uncommitted. Moreover, the bulk of this untied capacity will be tied up over the next two years through Case I bids (see price determination in appendix). This, in our opinion, will leave little surplus for merchant power sales. The bulk of the demand for short-term power is driven by peak shortages during certain hours of the day and certain seasons. Coal based plants, in our opinion, are not well placed to meet this demand as shutdowns and start-ups take more than 48 hours. Only
Capacity (MW)
Regulated (MW)
Case I/Case II (MW)
Merchant/ Uncommitted (MW)
1,825 42,884 6,811 3,576 5,359 941 61,396 6,600 1,231 1,000 2,575 3,140 862 8,667 3,780 1,647
90,898
1,225 42,129 4,130 927 2,091 941 51,442 84% 0 1,094 150 1,898 1,706 727 8,667 1,200 1,300
68,184 75%
0 0 2,481 350 1,100 0 3,931 6% 4,744 0 0 0 0 0 0 1,980 0

10,655 12%
600 755 200 2,300 2,168 0 6,023 10% 1,856 137 850 678 1,434 135 0 600 347
12,059 13%
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Short term prices Bilateral trade prices hovering around INR5 per unit
10 9 8 7 6 5 4 3 May-09 May-10
Jun-10
Oct-09
Jan-10
Jan-09
Jun-09
Aug-09
Sep-09
Nov-09
Aug-08
Sep-08
Nov-08
Dec-08
Dec-09
Feb-10
Feb-09
Mar-09
Mar-10
Bilateral trade price
IEX
PXIL
UI New Grid
UI SR Grid
Source: CERC *Bilateral trade mean trade of power between two buyers, IEX= India Energy Exchange, PXIL = Power Exchange India Limited, UI= Unscheduled Interchange
power developers with multiple projects (based on multiple fuel types) can take advantage of demand for short term power. As highlighted earlier, we do not see new capacity creating a power surplus. We expect a deficit both at the national level as well as in the key power consuming states of Maharashtra, Gujarat, UP, Karnataka, AP, Tamil Nadu, Punjab and Haryana.
We believe the recent proposal by the Central Electricity Regulatory Commission (CERC) to moderate transmission pricing will provide a major boost to merchant power plants and the power trade business. This could reduce delivered prices by INR0.20 to INR0.30 per KWH and is likely to benefit projects selling power over longer distances. However, we are concerned about the financial health of the state distribution companies which will buy this power. While we do not expect payment defaults in the near future, long payment delays for some states are quite possible.
Bilateral trade forms bulk of the short term power market (volumes in MUs)
9,000 7,500 6,000 4,500 3,000 1,500 0 Oct-08 Mar-09 Apr-09 Oct-09 Mar-10 Nov-08 Dec-08 May-09 Nov-09 Dec-09 Apr-10 Jul-09 May-10 Aug-08 Sep-08 Jan-09 Jun-09 Aug-09 Sep-09 Feb-09 Jan-10 Feb-10 12% 10% 8% 6% 4% 2% 0%
Bilateral
Source: CERC
IEX
PXIL
UI New Grid
% of total generation - RHS
Jun-10
Oct-08
Jul-09
Apr-09
Apr-10
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Financial health of state owned T&D companies?

Most of the state-owned distribution companies are likely to be
loss making; significant revisions in consumer tariff required

Some state transmission companies are profitable, but earnings
remain significantly below their investment needs

Given the deterioration in fiscal health, state guarantees may
prove inadequate in the event of a crisis
Financial health of state utilities a concern

A recent Finance Commission report highlighted that the health of state-owned transmission and distribution companies has been deteriorating. In our opinion, this poses a significant counterparty risk to the power producers. We note that cash losses booked by various state distribution companies have increased significantly over the last few years. We expect this trend to continue as the cost of supply will
Aggregate losses reported by the SEBs (INRbn)
0 -100 -200 -300 -400 -500 -600 FY05 FY06 Cash losses FY07 FY08 Losses w/o subsidy FY09
continue to rise due to rising fuel costs. We estimate the combined losses of state electricity boards (excluding subsidies provided by the state government) will almost double by FY15 from cINR526bn in FY09 (see charts below), unless we see a major revision in the subsidised consumer tariff and a major reduction in the Aggregate Technical and Commercial (AT&C) losses suffered by the network.
Five states contributing to more than half of the losses (INRbn)
50 0 -50 -100 -150 -200 -250 -300 FY06 Other States FY07 FY08 TN,UP,MP, HR & KA FY09 All States
Source: Report on performance of state power utilities by PFC
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State-owned distribution companies are currently not paying any dividends to the government, which is indicative of their financial health. Although, some of the state-owned transmission companies have reported profits, we note that they are not large enough to meet their current years investment requirements.
For example, according to the Power Finance Corporation (PFC), a government body, agricultural consumers use c23% of the total energy supply but contribute just c6% of the revenue (see chart below).
Recovery from agriculture is less than 25% of the cost of supply (INR per unit)
4 3 2 1 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Cost of supply Realization incl Agri. Realization-Agri.
Increasing gap between revenue and the cost of supply

Various consumer categories in each state are supplied subsidised power at tariffs much lower than the cost of supply (see chart below). This is one of the main reasons behind the mounting losses at various distribution companies. According to our analysis, states which require more than 5% revision on average in their tariff to bridge the revenue gap are Bihar, Punjab, UP, Haryana, Tamil Nadu, Jharkhand, Andhra Pradesh and Karnataka.
Increasing gap in cost of supply versus revenue (INR per unit)
0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Gap in cost versus revenue
AT&C losses higher than reported

We believe the understatement of AT&C losses has led to insufficient tariff revisions and has only worsened financial health of the distribution and transmission companies. Under the prevailing multi-year tariff framework, state regulators have provided a road map for AT&C reduction which utilities are expected to follow for the purpose of filing their annual revenue return (ARR) and fixing consumer tariffs. However, we believe the situation is much more opaque as a large part of consumer sales is non-metered and the actual AT&C losses are much higher than reported.
Cross subsidy burden too large to recover
Certain consumer segments are subsidised well below the actual cost of supply, while high paying consumers usually offset these losses. This process has proved counter productive since the cross subsidy burden is too large to be recovered from a small number of consumers who often opt out of the grid and increase their reliance on alternate sources like captive generation or open access.
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Actual AT&C losses are much higher than reported

36% 34% 32% 30% 28% 26% 24% 22% 20% FY03 FY04 FY05 AT&C losses % FY06 FY07 FY08 T&D losses % FY09
Subsidy to electricity sector adds to state government burden

We believe that in addition to the direct losses suffered by the power utilities, the subsidies provided by the state government also add to the burden on state exchequers. States with high agricultural loads have either provided free power to farmers or have provided a subsidy beyond the regulator approved tariff. In these cases, the subsidy amount is paid directly by the state to the utility. States with the highest reported subsidy levels are Rajasthan, Punjab, Haryana, Gujarat, Karnataka, Maharashtra and UP. We remain concerned about the high levels of state subsidy as this, coupled with the reported gap from lower tariff and high AT&C losses, adds to the financial burden on the state.
State guarantees stretched; may prove inadequate

In several states, a significant portion of the loans taken by SEBs are backed by state government guarantees. The finance commission highlighted that a number of states have provided guarantees either close to or in excess of the amount of total revenue they receive. This could limit future state guarantees for signing additional power purchase agreements and financing additional capital expenditure for transmission and distribution. We believe most state utilities have run over their escrow limit and are providing escrow cover for case I bids from projected future cash flow. This creates a high level of uncertainty, especially for states with poor financial management and high losses. In our view, the crunch will come in the next three years, when more than 50GW of new capacity will come on stream. We would not be surprised if independent power producers (IPPs) which sell to poorer states experience lengthy payment delays. We also believe that states that can maximise their long term power contracts while minimising more expensive short-term purchases will have the lowest risk of payment delays.
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Company updates
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BHEL- Deceleration in growth

Order execution to pick up in interim (c22% in FY12e vs. c19% in
FY10), but order inflows to decelerate to c6% in FY11-17e

Earnings growth to slow to c5% in FY13-17e from c30% in FY07-
12e; competition from domestic and foreign suppliers to increase

Downgrade to UW from OW; lower our TP to INR2,300 from
INR2,850
Investment summary
Execution remains key as order growth slows and competition kicks in
While we expect significant capacity additions in the power sector over the next 5-10 years, we expect the yearly run-rate of capacity addition to stabilize at c17GW per annum. This, in our opinion, will depress the y-o-y growth in BHELs power equipment orders relative to the growth seen in the last five years (order intake has gone up from c3.4GW in FY06 to c16.5GW in FY10). Hence, in the near term (i.e. over the next 2 years), we believe that the execution of its currently sizeable order book will remain key for BHEL to achieve the expected earnings growth. Additionally, in the longer term, we expect competition to kick in and pose an incremental challenge to BHEL as some of the new entrants to the BTG segment, such as L&T (4GW) and Thermax (3GW), are currently adding a significant amount of capacity and will compete with BHEL as suppliers of power equipment.
Hence, although the outlook for the power sector, including both utilities and suppliers, remains robust, the future of BHEL will depend a lot on its ability to step-up in terms of execution, especially as the competition is lurking just around the corner. Currently, our FY11-12 estimates assume that BHEL will indeed ramp up its order execution rate to 12-13GW of BTG equipments over the next two years compared to c5.2GW commissioned in FY10. However, we remain cautious on FY13e, where we are c6-7% below consensus on sales and EPS. We note that historically, power capacity addition in any fiveyear plan has always been back-end loaded and we expect this trend to persist going forward. Hence at BHEL, we expect a downward step change in order execution and the annual deliveries during FY13 and FY14 (i.e. for the first two years of the 12th five-year plan), before the momentum picks up again in FY15-17.
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Execution to be strong in FY11-12 but taper off in FY13-14 as intakes slow down (INRm)
adjusted basis. Hence, we downgrade BHEL to Underweight from Overweight and lower our target price to INR2,300 from INR2,850.
600,000 500,000 400,000 300,000 200,000 100,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e FY14e
42% 35% 28% 21% 14% 7% 0%
Positives
We expect BHELs earnings, and in turn the share price, to find support from several positive factors in the short term. We highlight some of the key positives for the company below:
Strong execution in FY11-12
Rev enue
% Change
We are slightly ahead of cons on FY12 but remain cautious on FY13
We remain broadly in line with consensus on FY11, but are modestly ahead of it on FY12 (c5% on EPS), driven mainly by our more positive view on margin development in FY12. However, we remain cautious on growth for the subsequent five years (FY13-17) as we believe that muted order execution in the initial years of the 12th five-year plan (i.e. FY13-17) and increase in competition can significantly deteriorate BHELs earnings growth during FY13-17. We expect margins to come under pressure during this period as the delivery of imported supercritical equipment begins, thus putting further downward pressure on earnings. Therefore, we currently forecast the EPS growth during FY13-17e to decelerate at c5% compared to c30% growth during FY07-12e. We believe that the stock should de-rate compared to the average 12M fwd P/E of c22x commanded by the group during FY07-10. Moreover, we note that BHEL is currently trading only at a slight discount to the sector on FY12e P/E (c16.1x vs. sector average of c18.9x), whereas the group is expected to witness a much lower growth in its earnings of c1% during FY13e compared to the sector average of c25%. In our opinion, the stock is expensive vs the rest of the sector on a growth
We expect order execution to continue to increase significantly during FY11 and FY12, given the backend bias of capacity additions in any five year plan. This, we believe, will lead to a sales growth in excess of c20% over the next two years, in spite of muted order intake growth (c5-6% pa).
EBITDA margin expansion in FY11-12
We expect EBITDA margins to continue to recover during FY11-12 and reach a peak of c20% in FY12. This, in our opinion, will be largely driven by (i) leveraged volume growth, (ii) unwinding of raw material price burden, and (iii) completion of wage revision as part of the 6th pay commission review.
Margins to improve on back of volume growth in FY11-12, then taper off as low margin supercritical orders start getting executed
25% 20% 15% 10% 5% 0% FY06 FY09 FY10 FY13e FY14e FY07 FY08 FY11e FY12e
EBITDA margins %
Capacity expansion
BHEL has made significant investments in its production capacity over the last five years and has increased its equipment production capability from c6GW in FY07 to c15GW in FY11e. This
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additional capacity, in our opinion, provides BHEL the ability to execute its order book at higher rates than those achieved historically.
Negatives
The negatives for the BHEL, in our opinion, are long term in nature at this stage; however, we believe that investors will increasingly start recognizing them as they start focusing on FY13 earnings (which we believe will happen over the next 12-18 months). We highlight some of the key negatives for the company below:
Deceleration in growth
BGR, Caldie, JSW and Bharat Forge are adding significant capacities (a total of c15-17GW by FY14e) to supply the power equipment market, in addition to the competition from foreign suppliers, especially the Chinese. This, we believe, may lead to stiff competition, both on pricing and execution, and, in our opinion, will warrant BHEL to reassess and potentially improve its operational efficiency.
Margin contraction beyond FY12
The current 11th five-year plan is nearing its end and while we expect strong order execution and hence strong growth in FY11-12, we remain cautious on sales growth in FY13-14. This is because not only history suggests that power capacity additions are typically backend loaded in any five-year plan, but also in the next five-year plan (i.e. 12th plan) the capacity addition run-rate is expected to stabilize at c17GW pa, thus leading to zero real growth on an average in the BTG equipment market and hence power equipment orders (other than those increasing their market share) (refer to two charts below).
Market share loss
We expect margins to peak in FY12, post which we expect profitability to come under pressure due to (i) delivery of lower margin super-critical equipment and (ii) diminishing sales growth. We expect EBITDA margins to decline by c380bp during FY13-17.
Underutilized capacity
Currently, BHEL has nearly a 65% share in the domestic BTG equipment market; however, some of the other players, such as L&T, Thermax, JSW,
BHEL is currently investing in its production capacity to increase it to c20GW per annum by the end of FY12. Given that we expect order execution to lose pace during FY13-14 (just around when the additional capacity is coming online), the capacity utilization of the companys manufacturing facilities may see a sharp decline during this period, thus putting downward pressure on margins (refer chart on the following page). We do not expect a large export by BHEL since Chinese suppliers are 15-20% cost effective.
Growth in order inflows from power sector to taper off (INRm)
Order inflows in industry segment to grow but not enough (INRm)
500,000 400,000 300,000 200,000 100,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e FY14e
200% 150% 100% 50% 0% -50%
300,000 250,000 200,000 150,000 100,000 50,000 0 FY06 FY07 FY08 FY09 FY10 FY12e FY13e FY11e FY14e
36% 30% 24% 18% 12% 6% 0%
Pow er
% Change
Industry
% Change
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Capacity utilization vs Order execution rate
100% 80% 60% 40% 20% 0% FY08 FY09 FY10 FY11e FY12e FY13e FY14e FY15e FY16e FY17e
Order ex ecution rate (%)

Source: Company data, HSBC Estimates
Capacity Utilisation %
Catalysts
We believe that FY11 results will be the key catalyst for the stock as investors would look for the following: Level of order execution in FY11 Reported margin on the execution Level of order intake report
power capacity, this implies an order intake of c15GW pa with price per MW increasing at a rate of c6%. The Industry segment has seen significant growth (close to c30% pa) in orders over the last three years, driven mainly by the surge in captive power equipment demand. However, with a significant amount of grid- power capacity coming online, we expect demand for the captive-based power equipment to slow down going forward. Hence, we expect the order intake in the Industry segment to grow at a modest rate of c15% during FY11-13. Overall at the group level, we expect the order intake to be flat in FY11 and then grow in a high single-digit range during FY12-17. We expect to see strong pick-up in the order execution rate during FY11 and FY12, in both the Power and the Industry segments. The execution rate in the Power segment will pick up as the government rushes to meet its 11th five-year plan targets, thus putting pressure on the entire Power value chain. The execution rate in the Industry segment will pick up as orders deferred in 2009-10 come online again. Hence, we expect BHEL to
Forecasts
As we mentioned earlier, we are broadly in line with consensus on our FY11 estimates, but are modestly ahead (c5% on EPS) of it on our FY12 estimates. Our relatively more bullish view on FY12 earnings is based on the premise that the power capacity addition and hence, the order execution rate for equipment suppliers, usually peaks in the last year of a five-year plan. By the same token, we expect the order execution to be sluggish in FY13 (it being the first year of the 12th five-year plan); hence, we are more cautious on FY13 earnings when compared to consensus. We highlight some of the key estimates and earnings drivers below: In the Power segment, we forecast an order intake of INR429bn in FY11, INR441bn in FY12 and INR467bn in FY13. In terms of
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record a sales growth of c22-24% over the next two years, assuming no hiccups in order execution. We expect the sales growth to decline to single digits in FY13, driven by lower execution rate and muted order intake growth. As we have mentioned earlier, we expect EBITDA margins to improve to c19.8% in FY11 and reach a peak of c20.6% in FY12. The sharp improvement in margins during FY11-12, in our opinion, will be largely driven by (i) leveraged volume growth, (ii) unwinding of raw material price burden, and (iii) completion of wage revision as part of the 6th pay commission review. We, however, think that margins will come under pressure from FY13 onwards and will decline by c380bp during FY13-17, driven largely by muted growth and pricing pressure, especially in the super critical equipment categories. We are currently c50-80bp ahead of consensus on our FY12-13 EBITDA margin estimate. We currently forecast reported EPS of INR114.6 in FY11, INR146.3 in FY12 and INR147.5 in FY13 compared to INR88.1 in
FY10. Our estimates imply a CAGR of c29% in reported EPS during FY11-12 and then a relatively flat EPS growth in FY13. When compared to consensus, we are broadly in line on FY11 EPS, c5% ahead on FY12 EPS and c6% below on FY13 EPS ( refer chart).
Consequently EPS to flatten by FY13-14 after strong growth in FY11-12e (INR)
180 150 120 90 60 30 0

FY07 FY08 FY09 FY10 FY12e FY13e FY14e
FY13e
CAGR of 29% CAGR of 30% ov er FY06-10 ov er FY10-12e
FY06
HSBC (recurring) EPS

Valuation
We use Economic Value Added approach to value BHEL (please refer to our valuation methodology section in the appendix for details) assuming a WACC of 10.6% (cost of debt: 9.0%, cost of equity: 11.0%, beta: 0.9) and target sales growth of 10% and operating return of 18.5% to derive a
BHEL Key assumptions (INRm) FY08 FY09 FY10 FY11e FY12e
Order inflow Power % Change Industry % Change Total % Change Execution Rate % Power Industry Total Revenue (gross) Power % Change Industry % Change Total % Change EBITDA margins %
407,187 45% 95,513 27% 502,700 41% 18.2% 31.5% 20.4% 159,188 15% 55,790 12% 214,977 14% 19.0%
471,456 16% 125,324 31% 596,780 19% 17.8% 26.8% 19.4% 213,444 34% 67,451 21% 280,895 31% 15.8%
430,970 -9% 159,400 27% 590,370 -1% 18.8% 22.1% 19.4% 268,607 26% 73,378 9% 341,985 22% 17.7%
429,428 0% 184,904 16% 614,332 4% 20.0% 23.0% 20.6% 325,424 21% 98,949 35% 424,373 24% 19.4%
440,510 3% 212,639 15% 653,150 6% 22.0% 25.0% 22.7% 383,285 18% 135,976 37% 519,261 22% 20.2%
FY11e
466,941 6% 244,535 15% 711,476 9% 21.0% 27.0% 22.6% 383,431 0% 176,165 30% 559,596 8% 19.4%
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fair value of INR2300 per share providing a downside of c6% from the current share price. This is a change from our previous MACC valuation methodology.
BHEL TP sensitivity (INR) _____________Target sales growth % ____________ 8% 9% 10% 11% 12% 16.5% 17.5% 18.5% 19.5% 20.5%
Despite strong outlook in near term, stock has underperformed the index in last one year with meagre returns
9% 6% 3% 0% -3% -6% -9% -12% 1w Absolute% Rel. - Sensex %

Source: Thomson Datastream
1,856 1,979 2,102 2,225 2,348
1,942 2,071 2,201 2,331 2,460
2,027 2,164 2,300 2,436 2,573
2,113 2,256 2,399 2,542 2,685
2,199 2,349 2,498 2,648 2,797
Target Operating return %
1m
3m
6m
12m
Rel. - Cap Goods index %
Our target price implies a target 12M fwd PE of 15.7x vs. the current 12M fwd P/E of c19.3x. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Indian stocks of 10.5%. For BHEL, this translates into a Neutral band of 5.5-15.5% around the current share price. Our target price of INR2,300 implies a potential return (including dividend yield) of -6%, which is below the Neutral band; thus we have an Underweight rating.
BHEL PE to Sensex PE
2.5 2.0 1.5 1.0 0.5 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09
Source: Datastream, HSBC
BHEL vs Sensex 12 month forward PE
EV/EBITDA
40 30 20 10 0 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09
25 20 15 10 5 0 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-08 Jul-09 Jul-10 Jul-05 Jul-06 Jul-07 Historic av erage of 8.7
BHEL PE
Sensex PE
EV/EBITDA
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Risks
Key upside risks are higher than expected execution as well order inflow intake. Key downside risks are lower-than-expected margins and competition.
BHEL Valuation Summary Key assumptions
Target sales growth Target OR margin Target asset turn Tax rate WACC CAP
Value of current Op (INRm)
10.0% 18.5% 2.0 31.0% 10.6% 10.0
Trend Sales Trend CE CE growth RoIC Trend OR Value of current op

Value of future inv (INRm) Incremental return Incremental cost EVA Value of future inv Total fair value (FY12e) - INRm EV EV 12M fwd Net debt Customer advances Minorities Investments/Associates Implied M.Cap 12M fwd TP (INR)
499,613 236,402 5.0% 37.0% 87,469 570,659
9,243 1,248 5,120 438,505
1,009,163 1,115,739 (165,501) 156,241 0 (898) 1,125,898 2,300
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BHEL Valuation FY08 FY09 FY10 FY11e FY12e FY13e
Avg Price Market Cap Net debt Customer advances Minorities Investments/Associates Enterprise Value (EV) EV/Sales EV/CE EV/EBITDA EV/EBIT P/E P/Book Dividend Yield FCF Yield FCF Yield - post dividend RoCE RoCE - excl Cust Adv RoE
1,928 943,795 (82,908) 104,739 0 (83) 965,542 500% 746% 25.8 28.0 33.0 8.8 0.8% 3.6% 2.7% 20.4% 92.5% 26.5%
1,512 740,252 (101,653) 148,827 0 (523) 786,903 300% 447% 18.7 20.3 23.6 5.7 1.1% 3.8% 2.6% 17.5% 94.9% 24.2%
2,198 1,076,014 (96,623) 126,984 0 (798) 1,105,577 336% 586% 18.7 20.2 25.0 6.8 1.1% 0.6% -0.4% 21.5% 58.8% 27.1%
2,479 1,213,275 (132,179) 141,885 0 (848) 1,222,133 299% 592% 15.2 16.4 21.6 6.1 1.2% 4.4% 2.9% 26.4% 77.0% 28.4%
2,479 1,213,275 (165,501) 156,241 0 (898) 1,203,117 241% 509% 11.7 12.7 16.9 4.9 1.5% 4.6% 2.8% 28.9% 78.8% 29.1%
2,479 1,213,275 (211,261) 170,085 0 (948) 1,171,151 218% 461% 11.1 12.1 16.8 4.1 1.5% 5.7% 3.8% 27.5% 76.7% 24.4%
Source: Company data, HSBC estimates. *Prices as at close of 30 September 2010
BHEL Income statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Net Sales Cost of Goods Sold (COGS) Gross Income Employee expense Selling General & Admin exp (SG&A) Other operating expense Other operating income EBITDA Depreciation & Amortization Impairment EBIT Interest income Interest expense Other financial exp/inc HSBC Profit before tax (PBT) Exceptionals Reported Profit before tax (PBT) Income tax Profit after tax (PAT) Extraordinary Items Minorities Reported Net income HSBC Net income No. of shares outstanding (mn) Reported EPS INR HSBC EPS (Recurring) - INR
193,046 (118,209) 74,838 (26,077) (16,442) 873 4,223 37,414 (2,972) 0 34,442 8,954 (354) 1,271 44,313 (9) 44,304 (15,711) 28,594 0 0 28,594 28,599 490 58.4 58.4
262,123 (176,201) 85,923 (29,837) (18,358) (683) 5,145 42,190 (3,343) 0 38,847 7,695 (307) 2,134 48,369 119 48,488 (17,107) 31,381 0 0 31,381 31,304 490 64.1 63.9
328,614 (206,723) 121,891 (64,492) (21,550) 18,417 4,934 59,200 (4,580) 0 54,620 8,080 (335) 3,468 65,834 73 65,907 (22,800) 43,106 0 0 43,106 43,059 490 88.1 88.0
408,315 (227,049) 181,266 (67,097) (26,121) (13,896) 6,500 80,651 (5,911) 0 74,741 6,853 (128) 2,904 84,370 0 84,370 (28,264) 56,106 0 0 56,106 56,106 490 114.6 114.6
499,613 (287,445) 212,169 (69,808) (31,440) (15,720) 7,485 102,685 (7,699) 0 94,986 9,342 (156) 3,550 107,721 0 107,721 (36,087) 71,635 0 0 71,635 71,635 490 146.3 146.3
538,422 (313,465) 224,957 (72,628) (37,094) (16,923) 7,485 105,796 (9,212) 0 96,584 8,339 (168) 3,821 108,576 0 108,576 (36,373) 72,203 0 0 72,203 72,203 490 147.5 147.5
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BHEL Income statement trend & margin analysis FY08 FY09 FY10 FY11e FY12e FY13e
Income Statement: Sales growth Organic growth EBITDA growth EBIT growth Reported EPS growth HSBC EPS growth Gross margins EBITDA margins EBIT margins OR margins HSBC PBT margins Reported PBT margins Change in no. of Employees Wage inflation Rate on interest income Rate on interest expense P&L tax rate Dividend tax rate Excise & Service tax Dividend payout ratio
13.3% 14.1% 3.8% 3.4% 18.4% 18.5% 38.8% 19.4% 17.8% 20.6% 23.0% 22.9% 3.6% 6.3% 15.4% 37.2% 35.5% 17.0% 9.8% 26.1%
35.8% 30.7% 12.8% 12.8% 9.7% 9.5% 32.8% 16.1% 14.8% 17.7% 18.5% 18.5% 4.7% 9.3% 8.0% 20.6% 35.3% 17.0% 6.5% 26.5%
25.4% 21.7% 40.3% 40.6% 37.4% 37.6% 37.1% 18.0% 16.6% 18.6% 20.0% 20.1% 1.3% 113.3% 7.0% 26.2% 34.6% 16.8% 3.8% 26.5%
24.3% 24.1% 36.2% 36.8% 30.2% 30.3% 44.4% 19.8% 18.3% 20.0% 20.7% 20.7% 2.0% 2.0% 7.0% 10.0% 33.5% 17.0% 3.8% 27.0%
22.4% 22.4% 27.3% 27.1% 27.7% 27.7% 42.5% 20.6% 19.0% 20.6% 21.6% 21.6% 2.0% 2.0% 7.0% 12.2% 33.5% 17.0% 3.8% 27.0%
7.8% 7.8% 3.0% 1.7% 0.8% 0.8% 41.8% 19.6% 17.9% 19.5% 20.2% 20.2% 2.0% 2.0% 5.0% 13.2% 33.5% 17.0% 3.8% 27.0%
BHEL Balance sheet (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Share Capital Reserves & Surplus Shareholders Equity Minorities Total Equity Secured Loans Unsecured Loans Total Debt Cash & Equivalents Net (Debt)/Cash Net Block Capital Work-in-progress (CWIP) Deferred tax assets Investments Other assets Total Long Term Assets Inventories Sundry Debtors Other current assets Loan & Advances Current Liabilities Provisions Total Working Capital Net Assets
4,895 102,847 107,742 0 107,742 0 (952) (952) 83,860 82,908 9,813 6,580 13,379 83 0 29,855 57,364 119,749 4,211 11,863 (165,765) (32,444) (5,021) 107,742
4,895 124,493 129,388 0 129,388 0 (1,494) (1,494) 103,147 101,653 14,704 11,570 18,403 523 0 45,200 78,370 159,755 3,502 24,237 (233,573) (49,756) (17,465) 129,388
4,895 154,278 159,174 0 159,174 0 (1,278) (1,278) 97,901 96,623 24,154 15,296 15,272 798 0 55,520 92,355 206,888 4,069 28,137 (280,237) (44,180) 7,030 159,174
4,895 192,660 197,556 0 197,556 0 (1,278) (1,278) 133,456 132,179 38,984 15,296 15,272 848 0 70,400 102,283 250,026 4,069 34,094 (340,944) (54,551) (5,023) 197,556
4,895 241,666 246,561 0 246,561 0 (1,278) (1,278) 166,779 165,501 56,640 15,296 15,272 898 0 88,106 125,038 305,648 4,069 41,679 (416,793) (66,687) (7,046) 246,561
4,895 291,060 295,955 0 295,955 0 (1,278) (1,278) 212,538 211,261 61,075 15,296 15,272 948 0 92,592 134,607 329,039 4,069 44,869 (448,690) (71,790) (7,897) 295,956
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BHEL Balance sheet ratios FY08 FY09 FY10 FY11e FY12e FY13e
Balance Sheet: Gearing Gearing incl Cust Adv Leverage Leverage incl Cust Adv Interest Cover (on EBIT) Net debt to EBITDA Fixed Asset turns Asset (CE) turn Asset (CE) turn - excl Cust Adv Total Working Capital Days Inventories Sundry Debtors Other current assets Loan & Advances Current Liabilities Provisions Working Capital as % sales
-77.0% 20.3% 0.23 1.20 4.00 (2.22) 11.78 1.49 7.80 59 177 226 8 22 (313) (61) -2.6%
-78.6% 36.5% 0.21 1.36 5.26 (2.41) 9.98 1.49 9.63 29 162 222 5 34 (325) (69) -6.7%
-60.7% 19.1% 0.39 1.19 7.05 (1.63) 8.33 1.74 5.32 68 163 230 5 31 (311) (49) 2.1%
-66.9% 4.9% 0.33 1.05 11.11 (1.64) 7.52 1.98 6.33 69 164 224 4 30 (305) (49) -1.2%
-67.1% -3.8% 0.33 0.96 10.34 (1.61) 6.95 2.11 6.23 62 159 223 3 30 (304) (49) -1.4%
-71.4% -13.9% 0.29 0.86 11.82 (2.00) 7.05 2.12 6.43 60 157 223 3 30 (304) (49) -1.5%
BHEL Cash flow statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Profit before tax Add back: Interest income Interest expense Other financial expense Depreciation & Amortization Impairment Exceptionals Change in Working Capital Tax paid Net Interest paid Change in Deferred tax liability Cash flow from operations Capital Expenditure Change in other assets Free cash flow (FCF) Dividends FCF post dividend Acquisition Subs/Assoc/Investments Change in debt Net cash flow
44,304 (9,038) 354 0 2,972 0 282 18,638 (22,733) 6,506 0 41,285 (6,976) 0 34,309 (8,589) 25,720 0 51 25,771
48,488 (7,881) 307 0 3,343 0 (263) 11,986 (23,069) 8,255 0 41,167 (13,236) 0 27,931 (8,730) 19,201 (441) 526 19,286
65,907 (8,239) 336 0 4,582 0 (273) (27,428) (19,035) 7,409 0 23,259 (17,137) 0 6,122 (10,879) (4,756) (275) (215) (5,246)
84,370 (6,853) 128 0 5,911 0 0 12,053 (28,264) 6,725 0 74,070 (20,741) 0 53,329 (17,724) 35,605 (50) 0 35,555
107,721 (9,342) 156 0 7,699 0 0 2,023 (36,087) 9,186 0 81,356 (25,355) 0 56,002 (22,629) 33,372 (50) 0 33,322
108,576 (8,339) 168 0 9,212 0 0 851 (36,373) 8,171 0 82,266 (13,648) 0 68,618 (22,809) 45,809 (50) 0 45,759
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BHEL Cash ratios FY08 FY09 FY10 FY11e FY12e FY13e
Cashflow Statement: Cash tax rate Change in WC as % sales Capex to depreciation Capex as % sales Operating cash conversion FCF Yield FCF Yield post dividend
51.3% 9.7% 2.3 3.6% 119.9% 3.6% 2.7%
47.6% 4.6% 4.0 5.0% 106.0% 3.8% 2.6%
28.9% -8.3% 3.7 5.2% 42.6% 0.6% -0.4%
33.5% 3.0% 3.5 5.1% 99.1% 4.4% 2.9%
33.5% 0.4% 3.3 5.1% 85.7% 4.6% 2.7%
33.5% 0.2% 1.5 2.5% 85.2% 5.6% 3.7%
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Financials & valuation: BHEL

Financial statements Year to 03/2010a 03/2011e 03/2012e 03/2013e Valuation data Year to 03/2010a 03/2011e
Underweight
03/2012e 03/2013e
Profit & loss summary (INRm)
Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit
Cash flow summary (INRm)
333,549 59,200 -4,580 54,620 11,214 65,907 65,907 -22,800 43,106 43,034
414,815 80,651 -5,911 74,741 9,629 84,370 84,370 -28,264 56,106 56,106
507,098 102,685 -7,699 94,986 12,735 107,721 107,721 -36,087 71,635 71,635
545,906 105,796 -9,212 96,584 11,992 108,576 108,576 -36,373 72,203 72,203
EV/sales EV/EBITDA EV/IC PE* P/Book value FCF yield (%) Dividend yield (%)
3.3 18.8 24.0 28.2 7.6 0.4 0.9
2.6 13.4 21.9 21.6 6.1 4.4 1.2
2.1 10.2 16.1 16.9 4.9 4.6 1.6
1.8 9.5 14.6 16.8 4.1 5.7 1.6
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (INR) 23,191 -17,756 -18,031 -13,321 5,030 5,363 74,070 -20,741 -20,791 -17,724 -35,556 53,329 81,356 -25,355 -25,405 -22,629 -33,322 56,002 82,266 -13,648 -13,698 -22,809 -45,759 68,618
2478.50 Target price (INR)
2300.00 Potent'l return (%)
-6.0
Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity
Reuters (Equity) BHEL.BO Market cap (USDm) 27,213 Free float (%) 32 Country India Analyst Arun Kumar Singh
Bloomberg (Equity) BHEL IN Market cap (INRm) 1,213,275 Enterprise value (INRm) 1080248 Sector Electrical Equipment Contact +9122 22681778
Balance sheet summary (INRm)
Price relative
Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders funds Invested capital
0 39,450 429,348 97,901 484,868 324,417 1,278 -96,623 159,174 46,480
0 54,280 523,928 133,456 594,328 395,495 1,278 -132,179 197,556 49,256
0 71,935 643,212 166,779 731,318 483,479 1,278 -165,501 246,561 64,890
0 76,371 725,122 212,538 817,714 520,481 1,278 -211,261 295,955 68,474
3798 3298 2798 2298 1798 1298 798 2008

BHEL
3798 3298 2798 2298 1798 1298 798 2009

Rel to BOMBAY SE SENSITIVE INDEX
2010
2011
Ratio, growth and per share analysis Year to Y-o-y % change 03/2010a 03/2011e 03/2012e 03/2013e
Source: HSBC
Note: price at close of 30 Sep 2010
Revenue EBITDA Operating profit PBT HSBC EPS

Ratios (%)
24.8 40.3 40.6 35.9 37.7
24.4 36.2 36.8 28.0 30.4
22.2 27.3 27.1 27.7 27.7
7.7 3.0 1.7 0.8 0.8
Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt
Per share data (INR)
12.1 129.2 29.8 9.6 17.7 16.4 -60.7 -1.6
8.7 103.8 31.5 10.4 19.4 18.0 -66.9 -1.6
8.9 110.7 32.3 10.8 20.2 18.7 -67.1 -1.6
8.2 96.3 26.6 9.3 19.4 17.7 -71.4 -2.0
EPS Rep (fully diluted) HSBC EPS (fully diluted) DPS Book value
88.06 87.91 23.30 325.16
114.61 114.61 30.95 403.57
146.34 146.34 39.51 503.68
147.50 147.50 39.82 604.58
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CESC- Doubling capacity

Growing equity base of regulated business with cash flow margin
of over 30% protects any downside and provides stable growth

Chandrapur and Haldia projects with 400-500MW merchant
capacity provides strong growth momentum in FY13 and 14

Spencer performance disappoints but to become less significant
compared to earnings from power (50% in FY10 vs 10% in FY13)

Reiterate OW rating with TP of INR475 (INR518 previously)
Investment summary
We assume coverage of CESC with an Overweight rating and a price target of INR475, which offers c25% potential return from the current levels. We believe that the group remains well positioned to continue to grow its regulated power business with a gradual expansion in its equity base. We discuss the key drivers of our investment case in the following sections.
Generation capacity to double by FY14
Steady regulated business

We believe that the regulated business of CESC provides the company with strong and steady income flow. The business, servicing mainly the Calcutta region and with a capacity of 1,225 MW (1,600 MW peak load) has two clear streams of Return on Equity (RoE). While the group earns a RoE of c15% on distribution, it earns an additional RoE of c14% for equity invested in their generation capacity (including the latest 250 MW Budge Budge III plant) We expect the equity base of the regulated business to grow to cINR24.6bn by FY13 from the current levels of cINR21bn in FY10. CESC currently earns a steady return of c18-20% on average on their total regulated power business. We expect this business to grow at a CAGR of c5.4% over the next three years and provide a cash flow margin of c3032%. This should provide the group with sufficient additional cash and equity to execute their existing expansion plans.
2,500 2,000 1,500 1,000 500 0
CAGR of 17.4% ov er FY10-14e
FY11e
FY12e
FY08
FY06
FY07
FY09
FY10
FY13e
Capacity (MW)
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Comfortable mix of business models with significant power on regulated model (FY14 : 2.4GW)
EPS CAGR of 50% over FY10-13e (INR)
Untied 12% Merchant 21%
60 CAGR of 50% ov er 50 40 30 20 10
Regulated 67%
FY10-13e
0 FY11e FY12e FY06 FY10 FY13e FY07 FY08 FY09
Expanding territories
We believe that CESC, which in the past has focussed primarily in West Bengal, will see significant expansion beyond its traditional turf once its Chandrapur and Haldia plants become operational in FY13-14 (refer table on page 50). In addition, the company would be able to sell c400-500 MW on the merchant basis from its total capacity of 2,400 MW (refer pie chart above). Consequently, we not only expect the group to witness a sales CAGR of c15% over the next three years but also expect EBIDTA margins to expand from c22% in FY10 to c33-34% in FY13-14. The net income should further benefit from the 80IA income tax provision and PAT margins should improve to c15% by FY14 from 13% in FY10.
We note that company also has a pipeline of 3.3 GW of new projects in Orissa, Jharkhand and Bihar. The land acquisition and the TOR of environmental clearance for the 1.3GW Orissa project have already been initiated and the project may start operations by FY14. The company has made some progress on land acquisition for the Dumka project in Jharkhand. We are awaiting more clarity on these projects and hence we have currently not included them in our valuation, but we believe that once commissioned, they should provide significant upside to CESCs earnings post FY14.
Spencer continues to be a concern

The key concern of CESC is the ongoing losses from its Spencer business. However the positive news is that the company has been able to reduce
Retail business: Increase in volumes and price
to help reduce losses in retail (INRm)
2.0 1.5 1.0 0.5 0.0 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
12,000 9,000 6,000
0 -500 -1,000 -1,500
3,000 0
-2,000 -2,500 -3,000 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Trading Area (mn sqft)

Rev enue (per sft)
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its losses from Spencer over the years and expects it to turn cash positive by FY13. According to the company, it has already become cash positive at the store level but at the corporate level it will take another three years. We also note that Spencers losses, which were 50% of earnings from power in FY10, will be only 10% in FY13. We have however accounted for the negative cash flow of Spencer in our valuation.
Fuel and price risk covered

CESCs current business under the regulated regime has no price risk for power sale. All of its current generation projects are selling to its distribution region in Kolkota. CESC will also use part of its Haldia power for its own distribution in Kolkota, though power from its Chandrapur project in Maharashtra remains totally untied.
Better positioned on coal supply
Positives
Existing business with no downside risk
CESC earns fixed ROE plus incentives on the equity base for its distribution and generation business in the Kolkota region, which will continue to grow steadily. It is the only private generator in India which has been able to expand its generation equity base for fixed ROE to the extent the power is sold in Kolkota region.
Given that all of its current projects have some level of assured domestic coal supply, we do not expect CESC to face any major negative impact due to coal shortage in the country. CESC has recently concluded a coal supply agreement in Australia which should protect the company from future fuel supply risk.
Water supply risk limited
Funding in place for 1.2GW of capacity under construction

CESC plans to expand its power portfolio by 3.6x, from 1.2GW to 4.4GW by FY15-16. It will require INR170bn to fund its capex for the power projects under development. At a debt of 70-75%, we estimate that it will require additional debt of INR122bn and equity of INR48bn over the next 3-5 years. In addition, CESC expects to incur INR9.0bn capex in its power distribution business over FY10-13. This will increase net debt to two-fold, from INR35.2bn in FY10 to INR70.5bn in FY13e. We estimate that CESC is well funded for its first phase of capacity expansion, including the 600MW Chandrapur and the 600MW Haldia projects. It has already achieved financial closure for both. We expect the company to raise capital to take on additional projects, namely Jharkhand and Orissa.
Except for the Chandrapur project, all of CESCs projects are in the eastern part of India and hence its exposure to a potential water supply shortage remains limited. The maximum downside to its income from Chandrapur is 4% in FY13 as per our sensitivity.
Merchant capacity provides upside

We expect CESC to sell c400-500MW of power on a merchant basis, which in our opinion, should provide the group with a decent margin upside without compromising on the risk (as a significant portion of its generation capacity is already tied up in long-term power sale agreements).
Pipeline in place
CESC has a pipeline of c3.3 GW of projects in Orissa, Jharkahand and Bihar, which shall provide growth beyond FY14 (see table on page 50). In addition, the company plans to leverage its extensive experience in distribution to enter the franchisee business. We believe that given its
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track record as one of the four private power distribution companies in a major city in India, CESC is well positioned to take advantage of any private sector participation in distribution, which provides a much higher return on capital.
Negatives
Spencer remains a key concern
We remain concerned about the continued losses at Spencer; however, we note that the situation has improved during the last year and we expect the improvement to continue. The company has been able to break-even at the store level and although the business is still cash negative, the cash loss remains quite small compared to their current cash accruals from the power business.
capex. Similarly, in the case of generation, the growth is driven by additional capacity commissioned. We forecast the earnings from power business to grow at 19% CAGR over FY10-13e on the back of revenue growth of 15% CAGR based on Capacity addition of 600MW of Chandrapur in FY13 and 250MW of Budge Budge 3 in end FY10 Distribution capex of INR9bn over FY10-13e in Kolkata on the back of growth in demand 50% of Chandrapur capacity is expected on merchant, where the margins are higher than its existing regulated business, driving earnings growth higher than revenue growth
Future investment requirements

We believe that the company will have to raise capital to finance the equity for the Orissa, Jharkhand and Bihar projects when their investment phase begins; hence containing the cash outflow from the retail business will be of critical importance
Reduction of losses in retail business to drive earnings

CESC retail business has been incurring losses which peaked in FY09 at INR2.5bn. The company is in a consolidation phase and has closed c60 loss making stores over FY09-10 in order to reduce losses. We expect the losses in its retail business to reduce from INR2.1bn in FY10 to INR700mn in FY13 driven by Increase in volumes in terms of trading area increased from 0.9m sq ft in FY10 to 1.5m sq ft in FY13 Revenue per sq ft increasing from cINR8,400 per annum in FY10 to cINR11,800 by FY13 Gross margins to improve by 600bps from 12% to 18% on the back of increased sales from the high margin non food segment We expect the company retail business to break even only by FY14 on the back of increase in volumes and margin expansion, while profitability at the net profit level seems to be distant at the current pace of volume growth, given the low
Catalysts
Retail business hive off/ reduction in losses. Any
positive news which will reduce potential cash outflow from CESC will reduce the negative overhang and will act as the catalyst for the stock price.
Progress on the capacities addition on its
Orissa and Jharkhand project since these can push its valuation further.
Winning of any franchisee bid especially in
Patna, for which CESC is a serious contender.
Forecasts
Earnings from power business to grow at 19% CAGR
The power distribution business is a stable business earning fixed RoE on regulated equity and the growth is driven by regulator approved
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CESC Key Assumptions FY08 FY09 FY10 FY11e FY12e FY13e CAGR (FY10-13e)
Power Business Capacity (MW) % Change Gross Generation (MU) % Change PLF % Energy sales (MU) % Change Average Tariff (INR/unit) % Change Average Fuel cost (INR/unit) % Change Retail Business Trading Area (mn sqft) % Change Revenue (per sft) % Change Gross profit (per sft) % Change EBITDA (per sft) % Change Revenue (INRm) Power % Change Retail % Change Total % Change Net Profit (INRm) Power % Change Retail % Change Total % Change
975 0% 7,980 4% 93.4% 7,483 7% 3.7 4% 1.7 4% 1.16 105% 8,937 1% 1,286 -5% (1,738) 78% 27,750 12% 7,681 55% 35,428 43% 3,554 18% -893 71% 2,674 -11%
975 0% 7,900 -1% 92.5% 7,601 2% 4.0 8% 1.8 7% 1.13 -2% 8,938 0% 1,028 -20% (3,042) 75% 30,313 9% 10,212 33% 40,514 14% 4,097 15% -2,542 185% 1,565 -41%
1,225 26% 7,835 -1% 91.7% 7,828 3% 4.2 5% 2.2 23% 0.90 -20% 8,423 -6% 1,017 -1% (2,583) -15% 32,928 9% 8,566 -16% 42,042 4% 4,333 6% -2,153 -15% 2,004 28%
1,225 0% 9,570 22% 89.2% 8,216 5% 4.4 5% 1.9 -12% 1.10 22% 10,192 21% 1,529 50% (1,644) -36% 36,156 10% 10,233 19% 46,389 10% 4,677 8% -2,016 -6% 2,932 46%
1,125 -8% 9,220 -4% 89.6% 8,623 5% 4.5 2% 2.1 11% 1.30 18% 11,109 9% 1,889 24% (885) -46% 38,884 8% 13,375 31% 52,259 13% 4,706 1% -1,465 -27% 3,471 18%
1,725 53% 11,870 29% 95.1% 11,519 34% 4.3 -4% 2.0 -5% 1.50 15% 11,776 6% 2,237 18% (187) -79% 49,904 28% 16,533 24% 66,437 27% 7,277 55% -696 -52% 6,756 95%
12.1% 14.9% 13.7% 1.0% -2.5% 18.5% 11.8% 30.0% -58.3%
14.9% 24.5% 16.5% 18.9% -31.4% 49.9%
margins and relatively high non operating costs such as interest and deprecation. Overall, we expect the companys earnings to grow at a 49% CAGR on the back of growth in the power business and reduction in retail losses (see above table of key assumptions). The consensus data comparison on a consolidated basis is not reliable as most of the houses publish on a standalone level. Our standalone EPS estimates are 2% and 7% below consensus for FY11e and FY12e respectively.
risk/reward profiles for its various projects and businesses. Our price target implies a fair value (target) 12M fwd PE multiple of c10.0x vs the current 12M fwd PE of c15.1x. We believe that the stock will re-rate as the projects under construction pass additional milestones in the next 6-12 months and the market starts ascribing higher valuation to them. We expect the most upside to come from a) faster than expected loss reduction in its retail business and b) progress at the Chandrapur power plant over the next 12 months. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Indian stocks of 10.5%. For CESC, this translates into a Neutral band of 5.5-15.5% around
Valuation
We assume coverage of CESC with an Overweight rating and a price target of INR475 (INR518 previously). We continue to use a sum-of-the-parts (SOTP) valuation to value CESC, given the differing
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CESC: 12 month ford PE vs. Sensex PE
CESC: 12 month forward PB vs Sensex PB
25 20 15 10 5 0 Mar-07 Mar-05 Mar-06 Mar-08 Mar-09 Mar-10
CESC PE
Sensex PE
CESC P/B
Sensex P/B
the current share price. Our target price of INR475 implies a potential return (including dividend yield) of c25%, which is above the Neutral band; thus we have an Overweight rating.
Risks
Downside risks to our view include a) higher than expected losses in the retail business, b) execution risks for power projects under development, c) disallowance of capex by the regulator in the distribution business, and d) merchant tariff risk, particularly for the Chandrapur power project a lower tariff than we anticipate could affect the projects profitability.
CESC - Valuation summary Particulars Details Basis Equity Value (INRm) % Stake Equity Value (INRm) INR per share Equity Invested (INRm) P/Bv
Power West Bengal Licence Area Under Construction Chandrapur Haldia Phase I Sub-total Retail Real Estate Investments (Liquid) Net debt / -Cash Total
1,225 MW 600 MW 600 MW
FCF - WACC of 11.0% FCF - WACC of 11.0% FCF - WACC of 11.0% FCF - WACC of 13.0% 1x book value
33,522 10,395 7,043 50,960 -3,829 1,948 4,374 5,660 59,113
100% 100% 100% 95% 100% 100% 100%
33,522 10,395 7,043 50,960 -3,627 1,948 4,374 5,660 59,315
268 83 56 408 -29 16 35 45 475
22,380 5,412 5,221 33,013 408 1,948 3,964 5,660 44,992
1.5 1.9 1.3 1.5 -8.9 1.0 1.1 1.0 1.3
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CESC: Power portfolio and progress, well placed in terms of fuel security and cost pass through Projects Chandrapur (Maharashtra) Haldia I (West Bengal) Dumka (Jharkhand) Dhenkanal (Orissa) Pirpainty (Bihar)
Type Capacity (MW) Project cost (INRbn) D/E CoDe Status Environmental clearance obtained Land
Domestic coal 600 29 75:25 FY13 Yes
70% Domestic & 30% imported coal 600 30 75:25 FY14 Yes
Domestic coal (captive) 1000 50 75:25 FY14
Domestic coal 1320 65 75:25 FY14
Domestic coal 1000 48 75:25 FY15
PPA terms Fuel
Water Financial closure Equipment and EPC Fuel source
Total 455 acres of land in 82% of land acquired possession (282 acres). Process for payment for balance of 40 acres initiated as per the company (1HFY11e) Mix Mix Regulated - 50% Regulated 67% Merchant - 50% Merchant - 33% Coal linkage awaited Coal linkage obtained Coal linkage obtained Captive coal mine allotted, Mining prospecting licence obtained Water supply agreement Approval to water has Approval to draw water NA has been obtained with Govt. of Maharashtra been obtained Done Yes BTG Shanghai Electric EPC Punj Lloyd South Eastern Fuel Coal fields, 600km from plant Done No Expected in Q3FY11 Mahanadi coal fields No No 110 MT coal block allocated No No NA
Terms of reference for Terms of reference for Terms of reference for project approved and project approved and project approved and EIA studies completed EIA studies completed EIA studies completed Land acquisition 678 acres (62%) land Land acquisition process initiated already acquired process initiated
Mix Applied for coal linkage Approval to draw water has been obtained No No NA
Source: Company data; HSBC. EIA = Environmental Impact Assessment. Note: Shaded power projects under implementation and not included in our valuation
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CESC Valuation FY08 FY09 FY10 FY11e FY12e FY13e
485 57,351 5,525 0 12 (310) 62,578 177% 124% 15.7 31.1 21.4 1.3 0.9% -5.9% -6.5% 4.2% 4.2% 5.9%
307 38,355 10,945 0 0 (379) 48,921 121% 88% 19.3 127.9 24.5 0.9 1.3% -15.6% -17.1% 1.1% 1.1% 3.5%
349 43,603 19,496 0 9 (360) 62,747 149% 97% 13.8 30.8 21.8 1.0 1.1% -13.3% -14.6% 2.9% 2.9% 4.4%
385 48,069 34,003 0 (98) (360) 81,614 176% 101% 11.0 17.9 16.4 1.0 1.2% -28.8% -30.2% 4.2% 4.2% 6.2%
385 48,069 51,781 0 (167) (360) 99,323 190% 98% 12.1 18.9 13.9 1.0 1.4% -35.3% -37.0% 4.0% 4.0% 6.9%
385 48,069 60,222 0 (183) (360) 107,747 162% 94% 7.6 10.2 7.1 0.9 2.8% -14.3% -17.6% 7.0% 7.0% 12.2%
CESC Income statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Net Sales Cost of Goods Sold (COGS) Gross Income Employee expense Selling General & Admin exp (SG&A) Other operating expense Other operating income EBITDA Depreciation & Amortization Impairment EBIT Interest income Interest expense Other financial exp/inc HSBC Profit before tax (PBT) Exceptionals Reported Profit before tax (PBT) Income tax Profit after tax (PAT) Extraordinary Items Share of Associates profit Minorities Reported Net income HSBC Net income No. of shares outstanding (mn) Reported EPS (INR) HSBC EPS (Recurring) - INR
35,428 (19,017) 16,411 (12,434) 3,977 (1,962) 2,015 (1,480) 1,962 2,496 2,496 131 2,627 0 47 2,674 2,674 118 22.6 22.6
40,514 (22,650) 17,864 (15,324) 2,540 (2,158) 382 (1,571) 2,184 996 996 557 1,553 (790) 12 775 1,565 125 6.2 12.5
42,042 (25,099) 16,942 (12,391) 4,552 (2,514) 2,038 (2,040) 2,173 2,171 2,171 (175) 1,995 (432) 9 1,572 2,004 125 12.6 16.0
46,389 (24,559) 21,829 (14,433) 7,396 (2,849) 4,547 (2,595) 1,787 3,739 3,739 (913) 2,826 0 106 2,932 2,932 125 23.5 23.5
52,259 (29,566) 22,693 (14,475) 8,219 (2,967) 5,252 (2,539) 1,630 4,342 4,342 (949) 3,393 0 77 3,471 3,471 125 27.8 27.8
66,437 (36,746) 29,690 (15,569) 14,121 (3,537) 10,585 (3,262) 1,473 8,795 8,795 (2,075) 6,720 0 37 6,756 6,756 125 54.1 54.1
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CESC Income statement trend & margin analysis FY08 FY09 FY10 FY11e FY12e FY13e
Income Statement: Sales growth EBITDA growth EBIT growth Reported EPS growth HSBC EPS growth Gross margins EBITDA margins EBIT margins HSBC PBT margins Reported PBT margins
42.6% -31.2% -52.0% -37.5% -37.5% 46.3% 11.2% 5.7% 7.0% 7.0%
14.4% -36.1% -81.0% -72.6% -44.6% 44.1% 6.3% 0.9% 2.5% 2.5%
3.8% 79.2% 432.8% 102.9% 28.1% 40.3% 10.8% 4.8% 5.2% 5.2%
10.3% 62.5% 123.1% 86.5% 46.3% 47.1% 15.9% 9.8% 8.1% 8.1%
12.7% 11.1% 15.5% 18.4% 18.4% 43.4% 15.7% 10.1% 8.3% 8.3%
27.1% 71.8% 101.5% 94.7% 94.7% 44.7% 21.3% 15.9% 13.2% 13.2%
CESC Balance sheet (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
1,256 44,107 45,362 10 45,372 (15,952) (4,732) (20,683) 15,159 (5,525) 55,252 7,119 620 310 (9,308) 53,993 3,520 3,403 287 3,787 (12,876) (1,219) (3,097) 45,372
1,256 43,754 45,010 0 45,010 (22,661) (5,084) (27,745) 16,800 (10,945) 59,369 13,515 1,745 379 (11,483) 63,524 3,776 4,119 422 2,887 (17,525) (1,249) (7,569) 45,010
1,256 44,137 45,393 9 45,402 (28,063) (7,127) (35,189) 15,694 (19,496) 78,450 4,422 2,463 360 (13,355) 72,340 3,739 5,176 155 2,816 (18,080) (1,249) (7,442) 45,402
1,256 46,386 47,642 (98) 47,544 (38,088) (7,127) (45,214) 11,211 (34,003) 80,211 18,412 2,463 360 (13,355) 88,091 4,114 5,641 155 2,816 (18,021) (1,249) (6,544) 47,544
1,256 49,047 50,303 (175) 50,128 (53,263) (7,127) (60,389) 8,608 (51,781) 81,554 38,211 2,463 360 (13,355) 109,233 4,952 6,355 155 2,816 (20,354) (1,249) (7,324) 50,128
1,256 54,228 55,484 (212) 55,272 (63,388) (7,127) (70,514) 10,293 (60,222) 109,835 24,412 2,463 360 (13,355) 123,715 6,155 8,080 155 2,816 (24,178) (1,249) (8,221) 55,272
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CESC Balance sheet ratios FY08 FY09 FY10 FY11e FY12e FY13e
12.2% 12.2% 1.12 1.12 (1.36) 1.39 0.57 0.70 0.70 (1) 68 35 3 39 (133) (13) -8.7%
24.3% 24.3% 1.24 1.24 (0.24) 4.31 0.56 0.73 0.73 (41) 61 37 4 26 (158) (11) -18.7%
42.9% 42.9% 1.43 1.43 (1.00) 4.28 0.51 0.65 0.65 (43) 54 45 1 24 (157) (11) -17.7%
71.4% 71.5% 1.71 1.72 (1.75) 4.60 0.47 0.57 0.57 (23) 61 44 1 22 (142) (10) -14.1%
102.9% 103.3% 2.03 2.03 (2.07) 6.30 0.44 0.51 0.51 (25) 61 44 1 20 (142) (9) -14.0%
108.5% 109.0% 2.09 2.09 (3.24) 4.26 0.49 0.58 0.58 (18) 61 44 1 15 (133) (7) -12.4%
CESC Cash flow statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Profit before tax Add back: Interest income Interest expense Other financial expense Depreciation & Amortization Impairment Others Change in Working Capital Tax paid Net Interest paid Change in Deferred tax liability Cash flow from operations Capital Expenditure Change in other assets Free cash flow (FCF) Dividends FCF post dividend Acquisition - Subs/Assoc/Investments Change in debt Share buyback/issue Others Net cash flow
2,496 (309) 1,480 (31) 1,962 (44) 1,765 (472) (1,308) 5,540 (8,937) (3,398) (343) (3,741) (2,662) (1,493) 5,697 4,834 2,636
996 (532) 1,571 (184) 2,158 340 4,606 (584) (1,108) 7,263 (13,248) (5,985) (582) (6,567) 1,333 7,693 0 208 2,667
2,171 (532) 2,040 (225) 2,514 502 1,908 (888) (2,316) 5,174 (10,952) (5,778) (582) (6,360) (2,839) 6,380 18 1,325 (1,477)
3,739 0 2,595 0 2,849 0 (899) (913) (2,595) 4,776 (18,600) (13,824) (684) (14,508) 0 10,025 0 0 (4,483)
4,342 0 2,539 0 2,967 0 781 (949) (2,539) 7,140 (24,109) (16,969) (809) (17,778) 3,500 15,175 0 0 897
8,795 0 3,262 0 3,537 0 897 (2,075) (3,262) 11,154 (18,018) (6,864) (1,576) (8,440) 0 10,125 0 0 1,685
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CESC Cash ratios FY08 FY09 FY10 FY11e FY12e FY13e
Cash flow Statement: Cash tax rate Change in WC as % sales Capex to depreciation Capex as % sales Operating cash conversion FCF Yield FCF Yield post dividend
18.9% 5.0% 4.6 25.2% 275.0% -5.9% -6.5%
58.7% 11.4% 6.1 32.7% 1898.7% -15.6% -17.1%
40.9% 4.5% 4.4 26.1% 253.9% -13.3% -14.6%
24.4% -1.9% 6.5 40.1% 105.0% -26.9% -28.2%
21.9% 1.5% 8.1 46.1% 136.0% -33.0% -34.6%
23.6% 1.4% 5.1 27.1% 105.4% -13.4% -16.4%
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Financials & valuation: CESC

Overweight
03/2012e 03/2013e
42,042 4,552 -2,514 2,038 -2,040 1,739 5,221 -175 1,572 2,004
46,389 7,396 -2,849 4,547 -2,595 3,739 5,666 -913 2,932 2,932
52,259 8,219 -2,967 5,252 -2,539 4,342 5,732 -949 3,471 3,471
66,437 14,121 -3,537 10,585 -3,262 8,795 9,430 -2,075 6,756 6,756
1.6 14.8 1.1 24.0 1.1 -15.4 7.3
1.8 11.0 1.0 16.4 1.0 -35.7 1.9
1.9 12.1 1.0 13.9 1.0 -39.4 2.0
1.6 7.6 0.9 7.1 0.9 -17.7 3.0
Issuer information
Share price (INR) 4,813 -10,952 -13,792 -582 8,601 -6,708 4,776 -18,600 -18,600 -684 14,508 -15,611 7,140 -24,109 -20,609 -809 14,278 -18,598 11,154 -18,018 -18,018 -1,576 8,440 -8,337
475.00 Potent'l return (%) 25.4
Reuters (Equity) CESC.BO Market cap (USDm) 1,078 Free float (%) 48 Country India Analyst Arun Kumar Singh
Bloomberg (Equity) CESC IN Market cap (INRm) 48,069 Enterprise value (INRm) 81712 Sector Electric utilities Contact +9122 22681778
Price relative
0 82,872 23,566 11,680 113,346 31,506 35,189 23,509 45,393 63,252
0 98,622 19,924 7,197 125,454 31,447 45,214 38,017 47,642 79,902
0 119,765 22,373 8,094 145,546 33,780 60,389 52,295 50,303 100,264
0 134,246 26,985 9,779 164,639 37,604 70,514 60,735 55,484 113,848
708 608 508 408 308 208 108 2008

Cesc Ltd
708 608 508 408 308 208 108 2009

2010
2011
Source: HSBC

Ratios (%)
3.8 79.2 432.8 742.7 28.1
10.3 62.5 123.1 115.0 46.3
12.7 11.1 15.5 16.1 18.4
27.1 71.8 101.5 102.5 94.7
0.7 3.1 4.4 3.1 10.8 4.8 2.2 51.8 5.2 20.5
0.6 4.8 6.3 4.0 15.9 9.8 2.8 80.0 5.1 12.6
0.6 4.6 7.1 4.0 15.7 10.1 3.2 104.3 6.4 13.7
0.6 7.6 12.8 5.9 21.3 15.9 4.3 109.9 4.3 18.4
12.59 16.04 28.01 363.33
23.47 23.47 7.49 381.33
27.78 27.78 7.53 402.63
54.08 54.08 11.65 444.10
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NTPC - Capacity addition?

Owns c20% of national installed capacity and generates c30% of
national power; low price and fuel risk now but fuel availability a concern going forward
Regulated equity base of INR245bn earning 15.5% ROE; large
un-deployed cash of INR270bn brings down ROE to c14%

Execution on capacity addition targets remains weak; progress on
development of captive coal mines has also been disappointing

Upgrade to Neutral from UW and raise TP to INR225 from INR185
Investment summary
Owner of biggest generation asset base in India
NTPC capacity add to be faster than historical
50,000 40,000 30,000 20,000 10,000 0 FY08 FY09 FY10 CAGR of 6.1% ov er FY06-10
CAGR of 11.3% ov er FY10-14e
NTPC remains not only the biggest power generation company within India (c20% of national capacity and c30% of national generation) but also one of the best in class in terms of plant utilization measured by Plant Load Factor (PLF). We note that NTPC currently operates at an average PLF of c90% compared to the national average of c70%. Moreover, it already has a firm Fuel Supply Agreement (FSA) with Coal India for c89% of its existing coal requirement (i.e. an annual supply of c110mt). In addition to this, currently all the power plants owned by NTPC sell power based on regulated RoE, thus providing the company with an ability to pass any increase in fuel prices to the customers through an automatic increase in tariff. Hence, we believe that NTPC has both, the lowest fuel risk and the lowest price risk, within the industry.
FY11e
FY12e
FY13e
Capacity (MW)
Further improvement in PLF looks unlikely in the medium term
However in order to further increase its average PLF from the current level (and hence its earnings power) and improve the efficiency of its underperforming plants, NTPC will require additional stable supply of coal in the future, especially as the new generation capacity comes online. We note that NTPC has been awarded
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EPS to grow at 12% CAGR over FY10-13e (INR)
ROE to remain constant since regulated business
15 12 9 6 3 0 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
20% 15% 10% 5% 0% FY06 FY07 FY08 FY09 FY10 FY12e FY11e FY13e
RoCE
RoE
several captive coal mines over the last five years; however, the development/utilization of these mines still remains poor. We believe that the progress on the development of these mines has been disappointing and NTPC will find little supply support from its captive mines over at least the next two years. Hence, we believe it remains difficult for the company to further improve its plant efficiency in the medium term.
Little confidence in timely addition of new capacity, but may surprise on the upside
GW (refer to table on page 62). However, we note that management so far remains confident in its ability to achieve this years targeted capacity addition. In that context, if the management is able to deliver on their targets, there remains an upside to our current forecasts.
Earnings outlook remains robust, largely driven by efficiency gains
NTPC historically has almost consistently underperformed its capacity addition targets. While the company added c70% of its targeted generation capacity during the 9th and 10th five year plan, the progress so far in the first three years of the current plan has been rather abysmal (with NTPC managing to add only c45% of its targeted capacity). The reason for the slippage has been NTPCs lack of flexibility in equipment procurement along with its poor project management, leading to a much higher lead time (c6-12 months higher) between equipment delivery and project synchronization when compared to the private players. Consequently, we remain cautious on the capacity additions planned this year and currently forecast only c2.2 GW generation capacity to come online vs. the companys guidance of c4.2
We expect earnings growth to moderate during the current fiscal year (c7.5% vs. c13% in FY10) before accelerating again in FY12 to c16.5%. The moderation in the earnings growth this year is largely driven by lower project execution in the previous years and significant decline in PLF at two of the power plants (Kahalgaon and Farakka) this year due to coal supply disruptions. The project execution, however, has improved this year and we expect it to improve further going forward as the company rushes to meet its fiveyear capacity target. Hence, we expect the earnings growth in FY12 to accelerate over FY11. More importantly, we expect earnings growth to find support from the efficiency gains as can be gauged by an improvement in the Station Heat Rate (SHR) and the auxiliary consumption. This expected improvement, in our opinion, is largely driven by the use of the latest and more efficient technology in the newer power plants and an increasing use of coal washing. Consequently, we
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expect EBITDA margins to improve to c30.8% in FY11e from c27.1% in FY10. In addition, we expect PAT margins to find further support from a lower tax rate going forward (as various new projects of NTPC fall under the 80IA tax deduction implying a lower tax rate). As such, we expect PAT margins to improve to c18% in FY11 vs. c17.1% in FY10
Little valuation upside in the near term
Business risk low given significant portion on regulated model (FY14: 49.3GW)
Merchant 2%
Regulated 98%
On our FY12 estimates NTPC is trading at 2.4x PB and 17.6x PE, at a premium to sector PB of 2.2x and PE of 17.4x, respectively. We expect the stock to remain under pressure in the near term due to the overhang of slippages in project implementation. However, we believe that the recent change in management and the appointment of Mr. Anup Roy Choudhary as the CMD bodes well for the group in the longer term, as he has a background of project implementation and a prior experience of turning around NBCC project performance.
Power price risk does not exist
The company is fully secured from any price risk, being on a regulated ROE, and any cost escalation is fully passed through. Even on the fuel cost it is best placed since it can pass off any cost escalation in fuel. Its current FSA with Coal India guarantees NTPC with 90% of the fuel supply, but given Coal India supply constraints it may put future fuel supply pressures on NTPC.
Limited water supply risk
Positives
30% of operational thermal capacity in India operating at high PLF
NTPC currently has 30% operational thermal power capacity in India operating at an average PLF of over 88%. It generated 30% of the power generated in the country from all sources in FY10. NTPC has some of the most efficient plants in the country and three out of its 15 coal based plants operated at over 97% PLF in FY10.
Consistent ROE
We also believe there will be limited impact on NTPCs projects from water supply constraints in the near future. Most have firm water allocation and we are not aware of any seasonal shortages around any of its plants; as per our sensitivity the maximum risk on its profit due to water supply is 1.4%.
No funding concern
The company does not have any funding concerns given the balance sheet size and low D/E (refer to chart below).
We like the consistent return of around 20% achieved by the company, including its regulated equity base and incentives through efficiency gains (refer to following chart).
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Gearing to increase but still comfortable
0.6 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 FY07 FY08 FY09
requirement and we see as an area of potential pressure on their operational efficiency As is well known, two of its plants, Khalgaon and Farakka, have been running at lower efficiency due to shortage in supply from Coal India on the fuel commitment and the PLF of these plants have been impacted. Fuel is one of the key areas of concern going forward since at the margin this can impact the overall efficiency gains for NTPC and its average cost of generation if it has to increasingly rely on the imported coal. Development of captive coal mines has been very slow and this has been one of the key disappointments given the current coal shortage concern for power projects.
Undeployed cash
FY10 FY11e FY12e FY13e
Negatives
Poor Implementation track record
Our key concern about the company is its track record of failing to meet targets and this has a strong negative impact on its earnings growth for future (refer to chart below).
But capacity addition still to lag the targets and back ended (MW)
6,000 4,500 3,000
NTPC currently has a INR160bn of cash which needs to be deployed optimally; it is currently earning less than 10% on term deposits while another INR115bn is on 11% return with SEB bonds, putting pressure on its ROC.
Catalysts
1,500
Actual achievement on implementing 4.2 GW

0 FY11e FY12e HSBC
of its promised capacity in FY2011

FY13e Company FY14e
Operationalization of its first Pakri Barwadih coal mine, which is one of the six mines allotted to NTPC in 2003. Productive deployment of cash in terms of capacity addition, else pay out dividend
Fuel supply could become a concern
The company has also started to feel the pressure of coal availability; though it has a 90% FSA with Coal India, it has not been able to operationalize the coal mines awarded in 2003 and hence it is entirely dependent on Coal India for its fuel supply. The recent increase in demand due to upcoming capacities has put pressure on coal for future supply to power projects. NTPC will be forced to seek imports to meet its future coal
Forecasts
Earnings to grow at 11.6% CAGR over FY10-13e
We forecast earnings to grow at 11.6% CAGR over FY10-13e on the back of revenue growth of 11.4% CAGR over the same period. We highlight some of the key drivers below:
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NTPC Key Assumptions FY08 FY09 FY10 FY11e FY12e FY13e CAGR (FY10-13e)
Capacity (MW) % Change Gross Generation (MU) % Change PLF % Energy sales (MU) % Change Average Tariff (INR/unit) % Change Average Fuel cost (INR/unit) % Change
29,144 6% 203,520 7% 82.2% 190,290 7% 2.0 7% 1.2 4%
30,144 3% 210,910 4% 81.2% 197,156 4% 2.1 7% 1.4 14%
31,704 5% 224,074 6% 82.7% 209,129 6% 2.3 6% 1.4 4%
33,854 7% 231,338 3% 80.6% 216,456 4% 2.4 4% 1.4 -2%
37,264 10% 258,335 12% 82.9% 242,148 12% 2.4 3% 1.5 4%
42,884 15% 286,328 11% 81.6% 268,976 11% 2.5 1% 1.4 -3%
10.6% 8.5% 8.8% 2.5% 0.0%
Capacity addition of 11.2GW, mostly back ended in FY13 over the next three years driving the energy generation, and consequently energy sales. The company guides to add 14GW of capacity over the same period, but we factor delays of 6 to 12 months given the progress at various projects. On back of capacity addition, we expect the energy sales volumes to increase from 209bn MUs to c271bn MUs by FY13e at a CAGR of 9%. We assume PLF to slightly decline over FY11-13 on a project to project basis to account for lower availability of the coal. On average, the PLF declines by c100bps over FY11 to FY13e. Tariff is expected to marginally increase from INR2.4 to INR2.5 by FY13 (2.6% CAGR) on the premise of flat increase in fuel costs (average fuel costs being cINR1.4 per unit). Any increase in fuel costs is generally a pass through to the end consumer since the company operates on a cost plus model. We are currently c5% below consensus on FY11e EPS, c9% below consensus on FY12e EPS and c4% below consensus on FY13e EPS. We differ from consensus mainly because of our lower assessment of the projects being operational on a y-o-y basis.
Valuation
We use DCF to value shares of NTPC, which is changed from the average of three different approaches (DCF, SOTP, PB) with the transfer of coverage. We apply a discount rate of 10.3% (cost of debt: 8.7%, cost of equity: 10.9%, beta: 0.9, terminal growth of 4%) to derive a fair value of INR225 per share, providing a potential return of 6% from the current share price. Our price target implies a fair value (target) 12M fwd PE multiple of c17.2x vs the current 12M fwd PE of c18.4x.
NTPC: DCF summary Particulars INRm INR/Share
Enterprise value Less: Gross Debt Add: Cash & bank Add: Investments Less: Minorities Equity value
2,202,362 631,448 203,963 84,746 2,790 1,856,833
267 77 25 10 0 225
We are Neutral on the stock as we expect the company to disappoint on its capacity addition plan, which should likely keep the share price range-bound. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Indian stocks of 10.5%. For NTPC, this translates into a Neutral band of 5.5-15.5% around the current share price. Our target price of INR225 implies a potential return (including
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dividend yield) of c6%, which is in the Neutral band; thus we have a Neutral rating on the stock.
Risks
Key upside risks are faster-than-expected execution of projects under construction and higher than expected PLF. Downside risks include non-availability of fuel.
NTPC: 12 month forward PE vs. Sensex PE
NTPC: 12 month forward PB vs Sensex PB
30 25 20 15 10 5 0 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10
NTPC PE
Sensex PE
NTPC P/B
Sensex P/B
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NTPC: Schedule of projects to be commissioned over FY11-13e Project name Parent Sipat - I Barh - II Korba - III Farakka - III Dadri - II (NCTPP - II) Simhadri - II Bongaigaon Mauda Rihand - III Vindhyachal - IV Koldam Tapovan Vishnugad Sub total Joint Ventures Indira Gandhi STPP Vallur - Phase I (JV with TNEB) Nabinagar (JV with Railways) Muzaffarpur - II (JV with BSEB) Sub total Total Company target State Ownership % Ultimate Capacity (MW) Type of fuel FY11e FY12e FY13e Total by FY13e 1,980 660 500 500 490 1,000 750 500 500 500 400 260 8,040 1,500 1,000 250 390 3,140 11,180 14,090
Chh Bih Chh WB UP AP Ass Mah UP MP HP Utt Har TN Bih Bih
100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 50% 50% 74% 51%
1,980 1,320 500 500 490 1,000 750 1,000 1,000 1,000 800 520 10,860 1,500 1,000 1,000 390 3,890 14,750
Coal Coal Coal Coal Coal Coal Coal Coal Coal Coal Hydro Hydro Coal Coal Coal Coal
660 0 500 0 490 0 0 0 0 0 0 0 1,650 500 0 0 0 500 2,150 4,150
660 0 0 500 0 1,000 250 0 0 0 0 0 2,410 1,000 0 0 0 1,000 3,410 5,620
660 660 0 0 0 0 500 500 500 500 400 260 3,980 0 1,000 250 390 1,640 5,620 4,320
Note: AP = Andhra Pradesh, MP=Madhya Pradesh, Ass= Assam, UP= Uttar Pradesh, WB= West Bengal, Mah= Maharashtra, Chh= Chhattisgarh, Bih= Bihar, Utt= Uttranchal, TN= Tamil Nadu, Har= Haryana, HP= Himachal Pradesh Source: Company data, HSBC estimates
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NTPC Valuation FY08 FY09 FY10 FY11e FY12e FY13e
194 1,599,467 18,295 0 3,758 (3,223) 1,618,297 418% 297% 13.8 17.0 19.7 3.0 1.8% -0.1% -2.2% 12.6% 12.6% 15.3%
173 1,429,321 100,989 0 4,138 (2,228) 1,532,220 359% 227% 14.3 18.6 21.0 2.5 2.1% -1.8% -4.2% 10.6% 10.6% 11.9%
208 1,714,949 182,738 0 7,640 (19,559) 1,885,768 390% 238% 14.4 18.5 20.8 2.7 1.8% -2.3% -4.5% 10.3% 10.3% 13.2%
217 1,788,854 255,514 0 7,330 (19,559) 2,032,139 392% 221% 13.1 16.4 19.2 2.6 1.8% -1.9% -4.1% 10.2% 10.2% 13.7%
217 1,788,854 362,298 0 6,729 (19,559) 2,138,322 359% 197% 12.3 15.5 17.6 2.4 1.9% -3.7% -6.0% 9.7% 9.7% 13.7%
217 1,788,854 431,326 0 6,133 (19,559) 2,206,753 330% 180% 10.8 13.8 15.6 2.2 2.0% -1.5% -3.9% 9.9% 9.9% 14.1%
Source: Company data, HSBC Estimates, *Prices as at close of 30 September 2010
NTPC Income Statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Net Sales Cost of Goods Sold (COGS) Gross Income Employee expense Selling General & Admin exp (SG&A) Other operating expense Other operating income EBITDA Depreciation & Amortization Impairment EBIT Interest income Interest expense Other financial exp/inc HSBC Profit before tax (PBT) Exceptionals Reported Profit before tax (PBT) Income tax Profit after tax (PAT) Reported Net income HSBC Net income No. of shares outstanding Reported EPS INR HSBC EPS (Recurring) - INR
386,823 (233,022) 153,801 (19,533) (16,842) (74) 117,352 (22,060) 95,292 28,183 (11,381) (5,836) 106,258 (2,748) 103,510 (28,811) 74,699 74,699 81,127 8,245 9.1 9.8
427,299 (274,708) 152,591 (25,325) (19,749) (299) 107,218 (24,949) 82,269 29,894 (14,687) (3,308) 94,168 (1,095) 93,073 (12,148) 80,925 80,925 68,067 8,245 9.8 8.3
483,243 (303,712) 179,531 (25,231) (23,348) (123) 130,829 (28,944) 101,885 25,825 (13,706) (4,109) 109,895 596 110,491 (22,114) 88,377 88,377 82,554 8,245 10.7 10.0
518,049 (307,433) 210,615 (29,552) (25,826) 0 155,237 (31,206) 124,030 21,190 (13,882) (8,231) 123,107 0 123,107 (29,837) 93,270 93,270 93,270 8,245 11.3 11.3
596,083 (358,892) 237,191 (33,871) (29,319) 0 174,001 (36,081) 137,919 19,665 (15,173) (9,476) 132,936 0 132,936 (31,498) 101,438 101,438 101,438 8,245 12.3 12.3
667,828 (387,810) 280,018 (40,552) (34,767) 0 204,700 (44,531) 160,169 19,652 (18,072) (10,623) 151,125 0 151,125 (36,396) 114,729 114,729 114,729 8,245 13.9 13.9
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NTPC Income statement trend & margin analysis FY08 FY09 FY10 FY11e FY12e FY13e
Income Statement: Sales growth EBITDA growth EBIT growth Reported EPS growth HSBC EPS growth Gross margins EBITDA margins EBIT margins HSBC PBT margins Reported PBT margins P&L tax rate Dividend payout ratio
14.2% 15.4% 18.1% 8.3% 17.8% 39.8% 30.3% 24.6% 27.5% 26.8% 27.8% 38.7%
10.5% -8.6% -13.7% 8.3% -16.1% 35.7% 25.1% 19.3% 22.0% 21.8% 13.1% 36.7%
13.1% 22.0% 23.8% 9.2% 21.3% 37.2% 27.1% 21.1% 22.7% 22.9% 20.0% 35.6%
7.2% 18.7% 21.7% 5.5% 13.0% 40.7% 30.0% 23.9% 23.8% 23.8% 24.2% 35.5%
15.1% 12.1% 11.2% 8.8% 8.8% 39.8% 29.2% 23.1% 22.3% 22.3% 23.7% 34.2%
12.0% 17.6% 16.1% 13.1% 13.1% 41.9% 30.7% 24.0% 22.6% 22.6% 24.1% 31.8%
NTPC Balance Sheet (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
82,455 446,174 528,629 1,242 529,871 (104,388) (198,759) (303,147) 284,852 (18,295) 281,604 256,296 (2,556) 3,223 (13,728) 524,839 27,512 31,727 9,272 41,041 (62,155) (24,070) 23,327 529,871
82,455 491,621 574,076 1,662 575,738 (132,117) (256,109) (388,226) 287,237 (100,989) 349,655 309,293 3,111 2,228 (19,354) 644,933 33,616 38,189 9,934 70,389 (87,191) (33,143) 31,794 575,738
82,455 543,824 626,279 2,790 629,069 (153,764) (287,721) (441,485) 258,747 (182,738) 388,042 376,820 945 19,559 (16,102) 769,264 35,330 70,808 8,680 56,807 (97,579) (31,503) 42,543 629,069
82,455 598,407 680,862 2,790 683,652 (237,593) (287,721) (525,314) 269,800 (255,514) 448,567 437,702 945 19,559 (16,102) 890,671 35,980 76,534 8,680 56,807 (97,579) (31,927) 48,496 683,652
82,455 659,224 741,679 2,790 744,469 (343,727) (287,721) (631,448) 269,150 (362,298) 558,554 477,754 945 19,559 (16,102) 1,040,710 42,003 89,327 8,680 56,807 (98,418) (32,341) 66,058 744,469
82,455 731,301 813,756 2,790 816,546 (441,364) (287,721) (729,085) 297,759 (431,326) 780,138 387,344 945 19,559 (16,102) 1,171,884 45,387 101,088 8,680 56,807 (103,198) (32,777) 75,988 816,546
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NTPC Balance sheet ratios FY08 FY09 FY10 FY11e FY12e FY13e
3.5% 3.5% 1.03 1.03 5.67 0.16 0.72 0.71 0.71 39 43 30 9 39 (59) (23) 6.0%
17.6% 17.5% 1.18 1.18 5.41 0.94 0.65 0.63 0.63 43 45 33 8 60 (74) (28) 7.4%
29.2% 29.0% 1.29 1.29 8.41 1.40 0.63 0.61 0.61 48 42 53 7 43 (74) (24) 8.8%
37.5% 37.4% 1.38 1.37 16.97 1.65 0.58 0.56 0.56 52 43 54 6 40 (69) (22) 9.4%
48.8% 48.7% 1.49 1.49 30.70 2.08 0.58 0.55 0.55 57 43 55 5 35 (60) (20) 11.1%
53.0% 52.8% 1.53 1.53 101.41 2.11 0.57 0.54 0.54 59 43 55 5 31 (56) (18) 11.4%
NTPC Cash Flow Statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
106,258 (12,578) 18,792 1,062 22,060 7,373 (16,922) (21,962) (6,334) 97,749 (99,442) 0 (1,693) (33,853) (35,546) 16,937 34,134 588 511 16,624
94,168 (11,330) 27,292 4 24,949 (254) (6,749) (25,663) (14,457) 87,960 (113,444) 0 (25,484) (34,801) (60,285) 17,500 62,241 (614) 58 18,900
109,895 (10,080) 29,779 (42) 28,944 (2,274) (9,001) (27,986) (19,003) 100,232 (140,093) 0 (39,861) (36,720) (76,581) (812) 64,243 0 1,175 (11,975)
123,107 (21,190) 22,113 0 31,206 0 (6,377) (29,837) (923) 118,100 (152,613) 0 (34,513) (38,263) (72,776) 16,515 83,829 0 0 27,568
132,936 (19,665) 24,649 0 36,081 0 (17,977) (31,498) (4,983) 119,543 (186,120) 0 (66,577) (40,206) (106,784) 16,515 106,134 0 0 15,866
151,125 (19,652) 28,695 0 44,531 0 (10,366) (36,396) (9,044) 148,894 (175,706) 0 (26,811) (42,216) (69,028) 16,515 97,636 0 0 45,124
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NTPC Cash ratios FY08 FY09 FY10 FY11e FY12e FY13e
20.7% -4.4% 4.5 25.7% 102.6% -0.1% -2.2%
27.3% -1.6% 4.5 26.5% 106.9% -1.8% -4.2%
25.5% -1.9% 4.8 29.0% 98.4% -2.3% -4.5%
24.2% -1.2% 4.9 29.5% 95.2% -2.0% -4.3%
23.7% -3.0% 5.2 31.2% 86.7% -3.9% -6.3%
24.1% -1.6% 3.9 26.3% 93.0% -1.6% -4.1%
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Financials & valuation: NTPC

Financial statements Year to 03/2010a 03/2011e 03/2012e 03/2013e Valuation data Year to 03/2010a 03/2011e 03/2012e
Neutral
03/2013e
483,243 130,829 -28,944 101,885 -20,782 110,491 110,491 -27,341 83,150 83,150
518,049 155,237 -31,206 124,030 -22,113 123,107 123,107 -29,837 93,270 93,270
596,083 174,001 -36,081 137,919 -24,649 132,936 132,936 -31,498 101,438 101,438
667,828 204,700 -44,531 160,169 -28,695 151,125 151,125 -36,396 114,729 114,729
4.0 14.9 2.4 21.5 2.9 -4.0 1.8
3.9 13.0 2.1 19.2 2.6 -3.3 1.8
3.6 12.3 1.9 17.6 2.4 -5.1 1.9
3.3 10.8 1.7 15.6 2.2 -2.7 2.0
Issuer information
Share price (INR) 100,300 -140,093 -140,905 -31,386 65,234 -66,388 118,100 -152,613 -136,098 -32,728 56,261 -55,704 119,543 -186,120 -169,605 -34,364 90,269 -86,243 148,894 -175,706 -159,191 -36,082 52,513 -46,463
225.00 Potent'l return (%)
5.6
Reuters (Equity) NTPC.BO Market cap (USDm) 40,123 Free float (%) 11 Country India Analyst Arun Kumar Singh
Bloomberg (Equity) NATP IN Market cap (INRm) 1,788,854 Enterprise value (INRm) 2024809 Sector Electric Utilities Contact +9122 22681778
Price relative
6 764,862 332,155 160,530 1,214,799 114,807 441,485 280,955 626,279 821,686
6 886,269 366,099 188,098 1,353,635 114,893 525,314 337,216 680,862 949,383
6 1,036,308 400,780 203,963 1,521,840 115,792 631,448 427,485 741,679 1,117,339
6 1,167,482 461,050 249,087 1,696,769 120,635 729,085 479,998 813,756 1,258,816
486 436 386 336 286 236 186 136 86 2008

NTPC
486 436 386 336 286 236 186 136 86 2009

2010
2011
Source: HSBC

Ratios (%)
13.1 22.0 23.8 18.7 24.2
7.2 18.7 21.7 11.4 12.2
15.1 12.1 11.2 8.0 8.8
12.0 17.6 16.1 13.7 13.1
0.6 10.1 13.9 8.5 27.1 21.1 6.3 44.7 2.1 35.7
0.6 10.6 14.3 8.6 30.0 23.9 7.0 49.3 2.2 35.0
0.6 10.2 14.3 8.4 29.2 23.1 7.1 57.4 2.5 28.0
0.6 10.2 14.8 8.5 30.7 24.0 7.1 58.8 2.3 31.0
10.08 10.08 3.82 75.95
11.31 11.31 4.01 82.57
12.30 12.30 4.21 89.95
13.91 13.91 4.42 98.69
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PTC trade growth, investment unlocking

Strong and stable growth phase with c42% earnings CAGR
expected over next three years

Assured long term PPA and PSA make business model robust
compared to historical trends

Subsidiaries and associate investment to deliver significant value
creation in FY11 and FY12. Upgrade to OW(V) from N(V); raise TP to INR161 from INR122
Investment summary
Significant potential for re-rating
We believe that the company has entered a high growth phase for its core business which we expect to continue for a few more years. We also expect there to be significant opportunity for value enhancement over the next two years from the groups investments in subsidiaries and associates companies. And although the net cash position of PTC is a bit of a concern, we upgrade the stock to Overweight (V). Our view is driven largely by the following factors.
Entering a stable high growth phase
We believe PTC remains well placed to benefit from strong and stable growth in the power trade business in the medium term. In our opinion, the visibility around future growth has significantly improved lately, as the company has successfully achieved both backward and forward linkages, through PPAs (c16,000MW), PSAs (c5,500 MW) and several short-term power contracts from its
traditional segments. The company has also won several Case I bids for both long- and mediumterm power supply to various distribution utilities (recent wins include c1.5 GW of long term and c1.0 GW of medium-term power sale to the state of Karnataka). Consequently, we expect the power trade business to witness a CAGR of c32% over the next three years, leading to a trading income growth of c27%. In addition to growth in volumes, the trading income growth should also find support from (i) c75% higher margins on power sold at more than INR3/kwh, and (ii) an increase in the proportion of long-term power contracts (which typically have higher returns) to over 60% of sales.
Assured supply of c4.2GW to support growth over the next 3 years
The company has also made significant progress in addressing its supply side bottlenecks by expanding beyond its core Bhutan projects. Over the next three years, we expect PTC to have an assured power supply of at least c4.2GW for trading, thus
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Long term trading volumes to drive strong growth at a CAGR of 54% over FY10-13e
Outpacing the growth in short term volumes
30,000 25,000 20,000 15,000 10,000 5,000 0 FY08 FY09 FY10 FY11e FY12e FY13e Long term trading (MU)
20,000 15,000 10,000 5,000 0 FY08 FY09 FY10 FY11e FY12e FY13e Short term trading (MU)
increasing our confidence in the companys ability to manage its growth profitably.
Subsidiaries and associates to deliver significant value over the next 3 years
PTC retains comfort for future investments
PTC has two main subsidiaries, PFS and PTE, both of which in our opinion have strong potential to add significant value to the parent company. PFS (c78% stake) is expected to add value not only through a planned IPO (The Economic Times) which should attract a much higher multiple to the business vs. our current assumption of c1.5x P/B, but also through the disinvestment of c21% of its 26% stake (total investment of cINR69m) in Indian Energy Exchange by FY13. PTE (c100% stake), on the other hand, should become earnings (EPS) accretive in FY13e as we expect the company to ramp up on its new power projects and reach a margin of 4-5% in the power tolling business, thus adding further value to PTC. Moreover, as reported in a Reuters article (17 March 2010), Asian Genco could consider a listing among various other options in the correct market conditions. PTC holds an economic interest in Asian Genco via its JV interest in Athena Energy Ventures (an associate company of PTC with c20% holding).
PTC currently has cash and cash equivalents of cINR14.4bn (c42% of market cap) on its books, most of which management expects to deploy in various projects during the course of this fiscal year. While such significant cash holding provides PTC with strong firepower for future investments and is currently seen favourably, any failure/delay in finding value accretive projects in the near term may put substantial pressure on the stock. This is because, like other participants in the market, we assume that the cash will soon find profitable projects. Hence, we currently value cash at 1x (thus contributing c28% to the fair value of the stock) even though it generates significantly lower returns compared to the core operations and suppresses the overall Return on Capital Employed (RoCE). However, in the absence of a credible expansion plan, we believe that the market and investors alike will start discounting the cash to reflect its true return (i.e. close to risk free rate), thus putting downward pressure on the value of the company.
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Driving EPS CAGR of 41% over FY10-13e (INR)
Consequently increasing the ROCE and ROE
12 10 8
80% 60% 40%
6 4 2 0 FY08 FY09 FY10 FY11e FY12e FY13e 20% 0% FY08 FY09 FY10 RoCE
FY11e
FY12e
FY13e
RoE
Business overview
PTC is the largest power trading company in India, trading at c2.5% volume of the total power produced in the country. Central Electricity Authority (CEA) has projected power demand to increase from 724bn units in 2008-09 to 970bn units in 2012 and 1,915bn units by 2022. The demand increase will be much higher if the economy grows above 7-8% in the coming years. We expect power sold through traders to increase to c5% of total power generated by 2012 as compared to c3-4% today (global benchmark for mature markets is in excess of 15% to as high as 60% by Nordpool in the Nordic region).
Smarter backward and forward linkage

PTC, with track record of over 10 years in power trade, has smartly built up the backward and forward linkage to the power trade business to make the business more secure and multiply potential returns. While it has already signed more than 5500Gw of long-term power sale contract to ensure stable sales volume, it is also in the process of bidding for more sales contracts through case I bids. It has invested in the power exchange, and hence has control on the alternate channel of power trade which it needs to dilute to 5% by FY13 as per the recent regulation. In addition, it has backward linkage through signed firm PPAs for 16000 MW and has invested in both hydro and thermal projects either directly or through their subsidiary, either via equity or debt. These projects will give PTC a portfolio of projects to choose from to be able respond to demand change. These factors provide certainty to the growth of their power trade business as well as it gives PTC or its subsidiaries the possibility of value unlocking in the next two years. PTC has also taken a minority stake in the PE fund with Ashmore Corporation to make equity investment for the power projects, which can potentially help PTC diversify its return.
Power trade leadership sustainable

PTC formed in 1999 as a PPP venture with stake holding by NTPC, NHPC, PGCIL and PFC of 16% as the core promoter group. It led the power trader market since its inception and continues to hold the leadership with a 40% market share in the business. The business, which had in past been constrained by supply available for trading, is likely to see a number of projects from which power will be available for trading, thus increasing the capacity available from 4.3Gw in FY10 to 9.4Gw in FY13.
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Positives
High future growth
investment of INR69m
Negatives
Historic flat growth of trading
A significant increase in the uncommitted capacity available for short-term merchant sale in the next two years will translate into a c235% increase in power trade volume for PTC between FY10-13 at a c33% CAGR.
Stability in trading business
PTC growth in the past from FY04 to FY08 was flat and declined in the past since the short-term market is quite uncertain.
Underployed cash
Power trade business of PTC will become more stable unlike in past since short-term sale will decline from 62% in FY10 to 40% in FY13 on the back of 137% CAGR increase in long-term trade volumes.
Higher trading margin
PTC has a cash and cash equivalents amounting to INR14.4bn, which brings down the ROC of the company. This is one of the key concerns of investors, since the requirement for its working capital is not more than 25% of this amount The company will also generate further cash from its business on an ongoing basis. If it is not able to quickly identify the right investment opportunity, then it will continue to depress its ROC.
Power trading small part of its valuation
75% increased trading margin for power sold above INR3/Kwh (refer to two charts below) will reflect in increased trading income starting FY11.
Investment unlocking
Investments in subsidiaries and associates will reflect in increased income (both subsidiaries become profitable in FY11) and higher valuation as the invested projects start getting commissioned or get closer to implementation. PTC is expected to unlock the value in Indian Energy Exchange in FY12 or FY13 by diluting its PFS stake from 26% to 21% to comply with regulatory order; it would then be expected to earn more than 200% return on its original
Leading to favourable mix of more stable long term volumes as against short term volumes
Power trading, the core business, forms only 36.7% of the valuation of the company. 28% of its valuation is from the cash in the bank, which should get deployed during the current year.
Catalysts
Progress on the cash deployment by the company over various quarters Various case I bids the company wins over the next 9 months
Favourable revenue mix as well lifting of trading margin cap leading to increase in margins (INR paise/unit)
100% 80% 60% 40% 20% 0% FY08 FY09 FY10 FY11e FY12e FY13e Long term trading
6 5 4 3 2 1 0 FY08 FY09 FY10 FY11e FY12e FY13e
Short term trading

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Project completion progress during FY11 and FY12
during the same period. The increase in cap for short-term trading by the regulator from INR4 paise/unit in end FY10 to INR7 paise per unit will result in margin expansion as the short-term contracts start getting negotiated in FY11 as well as new contracts start to kick in at a higher margin. Since there is no such regulation for long-term trading volumes, the margins are slightly better for the long term (2-2.5% of sale price), which will further drive margin expansion. We assume 2% of the sale price for our forecasts. Contribution from the power tolling business to start in FY13 for c360MW. We expect the company to earn cINR10 paise per unit on the same. Overall, we expect the companys earnings to grow at 42% CAGR on the back of growth in both long-tem and short-term trading volumes, as well contribution from the power tolling business in FY13 (see table below of key assumptions). Our EPS estimates are 5 to 6% higher than consensus for FY11-12, however we are 29% higher than consensus in FY13 on the back of our estimate of tolling income of INR250m.
Forecasts
Earnings to grow at 42% CAGR over FY10-13e
We forecast earnings to grow at a CAGR of 42% over FY10-13 e on the back of robust revenue growth of 29% respectively driven by Growth in short-term volumes from c11.3bn units in FY10 to c16.9bn units in FY13 at a CAGR of 14% on back of strong capacity addition in India. India is expected to add c53GW over next three years at a CAGR of 10%. We expect c5% of the generated power to be sold though traders. Robust growth in long-term trading volumes from c6.9bn units in FY10 to c25.3bn units in FY13 at a CAGR of 54%, on the back of commissioning of projects for which the company has signed long-term PSAs. The company has signed power sales agreement (PSA) for 5500MW of capacities with various customers. It has also signed power purchase agreements (PPA) for 16000MW to source the said power from various power generators, which are expected to be on stream over the next 5-7 years. Overall, we expect the volumes traded to grow at 32% CAGR to 42.1bn units over FY10-13e, driving revenue CAGR of 27%
PTC Key assumptions FY08 FY09 FY10 FY11e FY12e FY13e CAGR (FY10-13e)
Short term trading (MU) % Change Long term trading (MU) % Change Total % Change Gross margins - blended (INR paise/unit) % Change
4,661 -29% 5,228 76% 9,889 4% 4.5 -4%
7,942 70% 5,883 13% 13,825 40% 3.8 -14%
11,315 42% 6,860 17% 18,175 31% 3.6 -6%
13,140 16% 8,145 19% 21,285 17% 5.2 44%
14,947 14% 15,712 93% 30,658 44% 5.5 5%
16,863 13% 25,250 61% 42,113 37% 5.6 3%
14.2% 54.4% 32.3% 16.0%
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PTC: 12 month forward PE vs Sensex PE
PTC: 12 month forward PB vs Sensex PB
10 8 6 4 2 0 Mar-05 Mar-07 Mar-08 Mar-10

Implied P/B
Mar-06
PTC PE
Sensex PE
PTC P/B
Sensex P/B
Valuation
We continue to use sum-of-the-parts (SOTP) valuation to value PTC, given the differing risk/reward profiles for its various businesses. Based on our assumption as enumerated in the below table, our target price is INR161 (previously INR122), providing potential return of 41% from the current share price. Our price target implies a fair value (target) 12M fwd P/E multiple of c19.9x vs the current 12M fwd P/E of c22.1x. We believe the current share price captures part of the upside from the growth in long-term volumes. The visibility on the projects for which the company has signed PPAs would improve as the projects pass additional milestones over the next 12-18 months. This will improve the certainty on the long-term volumes and the market should start ascribing higher valuation. We expect the maximum upside to come from a) unlocking of value from its subsidiary PFS and b) deployment of un-utilised cash of INR10bn.
PTC- Valuation summary Business Method Multiple
Under our research model, for stocks with a volatility indicator, the Neutral band is 10 percentage points above and below the hurdle rate for Indian stocks of 10.5%. For PTC, this translates into a Neutral band of 0.5-20.5% around the current share price. Our target price of INR161 implies a potential return (including dividend yield) of c41%, which is above the Neutral band; thus we have an Overweight (V) rating.
Risks
Downside risks include a) delays in projects where PPAs are signed impacting the outlook on long-term volumes and b) renegotiation of PPAs by developers impacting the margins.
Value (INRm)
INR/Share
Book value (FY12)
Trading Business Power Exchange - IEX Investments - Deployed Investments - Current Cash Debt (net of loan financing) Total
DCF PE PB PB PB
WACC of 11.8% 25x 1.50 1.00 1.00 1.00
19,317 491 12,683 1,966 13,336 -446 47,347
66 2 43 7 45 -2 161
71 8,455 1,966 13,336 -446 23,381
Mar-09
7.0 1.5 1.0 1.0 1.0 2.0
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PTC Valuation FY08 FY09 FY10 FY11e FY12e FY13e
98 22,287 (13,597) 0 659 (1,465) 7,884 20% 2683% 31.2 35.8 46.1 1.5 1.0% 0.9% 0.1% 62.3% 62.3% 3.2%
73 16,602 (11,695) 0 1,451 (3,946) 2,411 4% 216% 7.4 9.2 17.6 1.1 2.1% 0.3% -1.3% 19.1% 19.1% 6.0%
96 28,277 (11,309) 0 1,882 (6,130) 12,719 16% 479% 18.0 19.6 26.4 1.3 1.3% -0.6% -2.1% 17.5% 17.5% 5.0%
115 33,947 (10,366) 0 2,259 (7,579) 18,261 21% 1049% 19.1 20.3 25.0 1.5 1.0% 6.9% 5.7% 37.1% 37.1% 6.1%
115 33,947 (8,420) 0 2,226 (8,526) 19,227 16% 944% 12.4 12.9 19.3 1.4 1.0% 4.5% 3.3% 52.0% 52.0% 7.5%
115 33,947 (7,888) 0 2,127 (8,526) 19,660 12% 818% 7.7 7.9 11.4 1.3 1.0% 8.0% 6.8% 73.6% 73.6% 11.4%
PTC Income Statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Net Sales Cost of Goods Sold (COGS) Gross Income Employee expense Selling General & Admin exp (SG&A) Other operating expense Other operating income EBITDA Depreciation & Amortization Impairment EBIT Interest income Interest expense Other financial exp/inc HSBC Profit before tax (PBT) Exceptionals Reported Profit before tax (PBT) Income tax Profit after tax (PAT) Extraordinary Items Income from Associates Minorities Reported Net income HSBC Net income No. of shares outstanding (mn) Reported EPS - INR HSBC EPS (Recurring) - INR
39,061 (38,693) 369 (66) (50) 253 (32) 220 86 0 271 578 578 (97) 480 0 1 2 483 483 227 2.1 2.1
65,289 (64,736) 553 (129) (99) 325 (62) 263 352 0 590 1,205 1,205 (228) 978 0 (18) (19) 941 941 227 4.1 4.1
77,972 (77,010) 963 (174) (83) 706 (56) 651 630 0 411 1,692 1,692 (486) 1,207 0 (80) (54) 1,073 1,073 295 3.6 3.6
86,671 (85,476) 1,195 (131) (108) 955 (58) 898 793 0 283 1,973 1,973 (554) 1,420 0 0 (63) 1,356 1,356 295 4.6 4.6
119,642 (117,800) 1,841 (141) (150) 1,551 (58) 1,494 819 0 266 2,578 2,578 (749) 1,829 0 0 (67) 1,762 1,762 295 6.0 6.0
168,272 (165,395) 2,876 (112) (210) 2,554 (58) 2,497 828 0 1,016 4,341 4,341 (1,266) 3,075 0 0 (92) 2,983 2,983 295 10.1 10.1
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PTC Income statement trend & margin analysis FY08 FY09 FY10 FY11e FY12e FY13e
3.7% -29.9% -32.8% -9.1% -9.1% 0.9% 0.6% 0.6% 1.5% 1.5% 16.9% 47.1%
67.1% 28.8% 19.5% 94.6% 94.6% 0.8% 0.5% 0.4% 1.8% 1.8% 18.9% 37.5%
19.4% 117.0% 147.3% -12.0% -12.0% 1.2% 0.9% 0.8% 2.2% 2.2% 28.7% 33.0%
11.2% 35.3% 38.0% 26.5% 26.5% 1.4% 1.1% 1.0% 2.3% 2.3% 28.1% 26.1%
38.0% 62.4% 66.4% 29.9% 29.9% 1.5% 1.3% 1.2% 2.2% 2.2% 29.1% 20.1%
40.6% 64.7% 67.2% 69.3% 69.3% 1.7% 1.5% 1.5% 2.6% 2.6% 29.2% 11.8%
PTC Balance sheet (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Share Capital Reserves & Surplus Shareholders Equity Minorities Total Equity Secured Loans Unsecured Loans Total Debt Cash & Equivalents Net (Debt)/Cash Net Block Capital Work-in-progress (CWIP) Deferred tax assets Investments Loan Financing Total Long Term Assets Inventories Sundry Debtors Other current assets Loan & Advances Current Liabilities Provisions Total Working Capital Net Assets
2,274 12,641 14,915 441 15,356 0 0 0 13,597 13,597 534 11 (46) 1,465 0 1,965 1,794 6 207 (1,914) (299) (206) 15,356
2,274 13,322 15,596 1,363 16,959 (200) 0 (200) 11,895 11,695 466 10 (91) 3,946 200 4,532 3,546 17 180 (2,569) (443) 732 16,959
2,945 18,390 21,335 1,420 22,755 (3,108) 0 (3,108) 14,417 11,309 767 9 (128) 6,130 2,663 9,441 5,315 123 552 (3,551) (435) 2,005 22,755
2,945 19,334 22,280 1,483 23,763 (4,522) 0 (4,522) 14,888 10,366 709 9 (128) 7,579 4,076 12,246 5,130 123 552 (4,220) (435) 1,151 23,763
2,945 20,684 23,629 1,550 25,179 (6,642) 0 (6,642) 15,062 8,420 652 9 (128) 8,526 6,197 15,256 7,078 123 552 (5,814) (435) 1,504 25,179
2,945 23,255 26,201 1,642 27,842 (9,470) 0 (9,470) 17,358 7,888 594 9 (128) 8,526 9,024 18,025 9,420 123 552 (7,732) (435) 1,929 27,842
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PTC Balance sheet ratios FY08 FY09 FY10 FY11e FY12e FY13e
-91.2% -88.5% 0.09 0.11 2.55 (53.82) 71.59 132.93 132.93 (2) 0 17 0 2 (18) (3) -0.5%
-75.0% -69.0% 0.25 0.31 0.75 (35.93) 136.92 58.41 58.41 4 0 20 0 1 (14) (2) 1.1%
-53.0% -49.7% 0.47 0.50 1.03 (16.01) 100.43 29.39 29.39 9 0 25 1 3 (17) (2) 2.6%
-46.5% -43.6% 0.53 0.56 1.13 (10.85) 120.59 49.78 49.78 5 0 22 1 2 (18) (2) 1.3%
-35.6% -33.4% 0.64 0.67 1.82 (5.43) 180.96 58.75 58.75 5 0 22 0 2 (18) (1) 1.3%
-30.1% -28.3% 0.70 0.72 3.01 (3.09) 278.82 69.99 69.99 4 0 20 0 1 (17) (1) 1.1%
PTC Cash flow statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Profit before tax Add back: Interest income Interest expense Other financial expense Depreciation & Amortization Impairment Exceptionals Change in Working Capital Tax paid Net Interest paid Change in Deferred tax liability Cash flow from operations Capital Expenditure Change in other assets Free cash flow (FCF) Dividends FCF post dividend Acquisition Subs/Assoc/Investments Change in debt Share buyback/issue Others Net cash flow
578 (300) 17 0 50 0 23 36 (118) 284 570 (369) 201 (175) 25 (11,775) 0 12,486 0 735
1,205 (832) 101 0 62 0 (36) (1,081) (176) 807 51 (7) 44 (266) (222) 8,502 0 981 (0) 9,262
1,692 (680) 225 0 56 0 0 (1,190) (503) 584 185 (356) (171) (413) (584) (2,851) 446 4,967 (42) 1,936
1,973 (1,217) 0 0 58 0 0 854 (554) 1,217 2,331 0 2,331 (412) 1,919 (1,449) 0 0 0 471
2,578 (1,269) 0 0 58 0 0 (353) (749) 1,269 1,533 0 1,533 (412) 1,121 (947) 0 0 0 174
4,341 (2,083) 0 0 58 0 0 (425) (1,266) 2,083 2,708 0 2,708 (412) 2,295 0 0 0 0 2,295
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PTC Cash ratios FY08 FY09 FY10 FY11e FY12e FY13e
Cashflow Statement: Cash tax rate Change in WC as % sales Capex to depreciation Capex as % sales Operating cash conversion FCF Yield FCF Yield post dividend Key Ratios
20.3% 0.1% 11.4 0.9% 258.7% 0.9% 0.1% FY08
14.6% -1.7% 0.1 0.0% 19.5% 0.3% -1.3% FY09
29.7% -1.5% 6.4 0.5% 28.4% -0.6% -2.1% FY10
28.1% 1.0% 0.0 0.0% 259.7% 6.6% 5.5% FY11e
29.1% -0.3% 0.0 0.0% 102.7% 4.4% 3.2% FY12e
29.2% -0.3% 0.0 0.0% 108.5% 7.7% 6.5% FY13e
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Financials & valuation: PTC India

Overweight (V)
03/2012e 03/2013e
77,972 706 -56 651 0 1,692 1,692 -486 1,073 1,073
86,671 955 -58 898 0 1,973 1,973 -554 1,356 1,356
119,642 1,551 -58 1,494 0 2,578 2,578 -749 1,762 1,762
168,272 2,554 -58 2,497 0 4,341 4,341 -1,266 2,983 2,983
0.2 25.4 5.6 31.6 1.6 -4.9 1.0
0.2 18.3 7.6 25.0 1.5 4.9 1.0
0.2 12.0 7.1 19.3 1.4 1.8 1.0
0.1 7.5 6.5 11.4 1.3 3.4 1.0
Issuer information
Share price (INR) -556 -356 -2,467 -413 972 -1,325 1,115 0 -232 -412 943 1,256 264 0 322 -412 1,947 449 625 0 2,083 -412 532 863
Reuters (Equity) PTCI.BO Market cap (USDm) 761 Free float (%) 73 Country India Analyst Arun Kumar Singh
Bloomberg (Equity) PTCIN IN Market cap (INRm) 33,947 Enterprise value (INRm) 17484 Sector Independent Power Producers Contact +9122 22681778
Price relative
0 776 18,442 12,452 29,977 3,551 3,108 -9,344 21,335 3,216
0 719 18,727 12,922 33,067 4,220 4,522 -8,401 22,280 2,304
0 661 20,849 13,096 38,199 5,814 6,642 -6,454 23,629 2,600
0 604 25,487 15,392 45,607 7,732 9,470 -5,922 26,201 2,967
205 185 165 145 125 105 85 65 45 25 2008

PTC India
205 185 165 145 125 105 85 65 45 25 2009 2010 2011

Source: HSBC

Ratios (%)
19.4 117.0 147.3 40.4 -12.0
11.2 35.3 38.0 16.6 26.5
38.0 62.4 66.4 30.6 29.9
40.6 64.7 67.2 68.4 69.3
32.0 19.1 5.8 4.8 0.9 0.8 -41.1 -13.2
31.4 23.4 6.2 4.5 1.1 1.0 -35.4 -8.8
48.8 43.2 7.7 5.1 1.3 1.2 -25.6 -4.2
60.5 63.5 12.0 7.3 1.5 1.5 -21.3 -2.3
3.64 3.64 1.20 72.43
4.61 4.61 1.20 75.64
5.98 5.98 1.20 80.22
10.13 10.13 1.20 88.95
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Tata Power- Ultra mega

Growth in regulated equity base and new power projects to
contribute to overall EBIT growth of 24% over FY11-13

New projects Mundra (first UMPP) and Maithon will help capacity
triple to 8.2GW by FY14

Coal margin expected to decline but not a major negative Reiterate OW and raise TP to INR1,565 from INR1,525
Investment Summary
We believe Tata Powers business can be divided into three major segments, all of which in our opinion have different drivers and growth trajectory. We discuss each of them below.
Standalone business to witness steady growth; margins may come under pressure
Power business EBIT to grow at c24% CAGR over FY11-13e on back of strong capacity addition (INRm)
40,000 30,000 20,000 10,000 0 FY09 FY10 FY11e FY12e FY13e
40% 30% 20% 10% 0%
The first segment is the standalone business of Tata Power (c37% of the group revenues), which includes the original generation business (current capacity of c3.1 GW), the transmission business and the Mumbai distribution business. We believe that the growth outlook for this business remains robust in the medium term supported by the expected equity infusion of cINR4.5bn over FY11-13e. In addition, we believe that growth in the distribution business and the currently 200 MW merchant power business may surprise on the upside, particularly in FY11 and FY12. However, in spite of robust growth, we believe EBITDA margins may come under pressure in the near term, driven largely by increasing fuel costs and rising outlay on short-term power procurement in lieu of growing demand. This should offset the tax benefits under the 80IA tax regime, leading to stable PAT margins of c11-12% over the next three years (refer to chart below).
Pow er - EBIT
% grow th y /y
Coal prices, although key in the short term, may not materially affect profits in the long term
The second major segment of the group (c30% of the group revenues) is its 30% holding in the coal mines of KPC and Arutmin (located in Indonesia). We believe that the key driver to watch in the near term here would be coal prices. We currently do not expect coal prices to increase beyond the current price of cUSD60 per tonne, thus implying a minimal contribution to PAT growth of Tata Power (refer to following charts). However, given the commodity nature of the business, there remains significant uncertainty regarding future coal prices, hence there is significant scope for
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Coal business c30% of group EBIT to complement power, strong EBIT growth in FY11 and then growth to decline in FY12-13e (INRm)
Capacity to triple by FY14 driven by commissioning of Mundra UMPP
FY08
FY09
FY10
FY11e
FY12e
FY13e
-100% FY09 FY10 FY11e FY12e FY13e Coal - EBIT % growth y/y
Capacity (MW)
surprises, both on the upside and the downside. In our opinion, while a sudden drop in coal prices may put some pressure on the margins in the near term, its effect in the long term (c5 years) should be more subdued as Tata Power should eventually consume the coal produced from these mines for its own plants.
New projects to provide significant boost to earnings over the coming years
to capture a sizeable share of the 2 GW of annual solar capacity planned by the Government of India for the next 10 years, NDPL has now reached the 15% AT&C loss level and is in a good position to increase its incentive RoE by a few percentage points if it is able to further reduce its losses.
Positives
Limited price and fuel risks
The third major segment of the group includes the new and upcoming generation projects at Mundra and Maithon, which together with a projected generation capacity of c5GW are expected to give a significant boost to the groups revenues and income over the coming years (refer to following chart and table on page 85). There are several other projects which have been announced by the group, but we have not considered them in our projections because they are at a very early stage (refer to table on page 85). Overall, for the group, we expect revenue to grow at a CAGR of c11% over the next five years, leading to a strong 100%+ growth in the EBITDA and PAT between FY10 and FY14. We believe that further upside to our current estimates may come from two of Tata Powers subsidiaries, Tata BP Solar and NDPL. While Tata BP solar is now well positioned
One of the key reasons for our positive view on Tata Power is because we feel the company is currently fully covered for the price and fuel risks for its existing regulated business, which includes its current 3.1GW generation as well as distribution business in Mumbai and in Delhi through its subsidiary NDPL. These businesses, which constitute over 40% of its revenue, provide strong regulated return; despite some pressure on EBITDA margin, we expect this business to continue to provide strong support for the companys power business. We believe that the company has been able to address the issues of uncertainty, including those from the government order regarding Mumbai distribution area, and will come out strongly.
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FY14e
18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0
300% 200% 100% 0%
9,000 7,500 6,000 4,500 3,000 1,500 0 CAGR of 28.3% over FY10-14e
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Favourable sales mix and tied up power (FY14: 8.1GW)
Merchant 2%
factored into our earnings and we do not see any major downside from this for the company.
Catalysts
Regulated 49%
Case - II 49%
We would look at all or few of these in the next few months, which could provide further upside to the stock: Commissioning of the Mundra and Maiton project on or before time.
Major gains in the distribution business in Mumbai Another coal asset acquisition Major breakthrough in the growth of solar energy in India
Strong growth engines
We also believe that the company is expected to create strong engines from FY12-13 onwards once its new projects, including Mundra and Maithton, become operational. We note that these projects are progressing on time and we expect them to meet their schedule (refer to table on page 85).
BP Solar- Ace up its sleeve
Forecasts
New generation capacities to drive growth over FY10-13
Tata Powers existing capacity of 3.1GW is based on a regulated model, except for 200MW of merchant based capacities. We expect the capacities to almost triple to 8.2GW by FY14e. We forecast robust growth in the power business with EBIT growth of 24% CAGR over FY10-13e driven by revenue CAGR of 15%. This would be underpinned by: Capacity addition of 3.5GW, Maithon (1GW) and three out of four units of Mundra power plant (4GW) to be commissioned by FY13 increasing the capacity by two-fold. Higher margins under the 200MW merchant based power capacity. Reduction in AT&C losses in its Delhi Distribution business meaning higher incentives to contribute to margins.
Another aspect of Tata Power we like is its subsidiary Tata BP Solar, which currently has 50 MW solar PV equipment manufacturing capacity and is the largest player in India. It can potentially capture a large share of the planned 2000MW per year capacity addition proposed in the country. The company is also currently developing a 3 MW PVbased, grid-connected solar plant at Mulshi, which is amongst the largest in the country.
Negatives
Contracting coal margins
We believe that coal mines in Indonesia which are currently contributing c30% to the revenue of the company may not be able to sustain its margins if the coal prices were to fall substantially below USD60/MT and the company is unable to reduce its extraction cost substantially below its current level of USD32/ MT. However, since the company plans to use 12-15Mt of its production from KPC and Arutmin at its Mundra plant, this has already been
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Coal business to complement growth EBIT CAGR of 7%

Tata Power has a 30% stake in two coal mines of Bumi Resources, namely Arutmin and KPC, with an estimated 2.1bn ton reserves. Volumes: Tata Power is looking to ramp up production at its two mines from c63m tons in FY10 to 75m tons by FY12e (c10% CAGR over FY10-12e). At 30%, we expect the volumes to increase from 19m tons in FY10 to 22.5m by FY13, a CAGR of 6% over FY10-13e. Prices: In FY10, the profitability of coal business was affected by lower sales price realisation compared to FY09 and increase in stripping costs (some of which are related to prior periods). However, sales price realisation has improved over the last few quarters (cUSD58/ton in 2Q FY10 to cUSD64 in 1Q FY11), driven by firming up of global coal prices. Recently, Tata Power signed contracts (most of them for a year), which pegged its sale price at cUSD90/ton. Our coal analyst, Sarah Mak, expects regional coal prices to weaken to USD90/ton as Chinas NDRC notice to stabilise coal prices in the near term will cap the upside on regional coal prices. (HSBCe of thermal coal prices: CY10e- USD98/ton, CY2011e-USD90/ton Driving EPS growth of c23% CAGR over FY10-13e (INR)
see Metals and Mining Chartbook Q3 2010, 16 July 2010). We factor USD65 per ton in FY11, USD62 in FY12 and USD60 in FY13, in line with the trend in our coal price forecast. We expect the cost of production to marginally increase from the current USD35 per ton, hence margins to decline, however it is expected to be compensated by higher volumes. Overall, we expect EBIT to grow at 7% CAGR over FY10-13e on the back of revenue growth of 4% over a similar period. On a consolidated basis, we expect the group EPS to grow at a 23% CAGR on the back of revenue growth of 12%. We forecast EPS of INR83.6 in FY11, INR85 in FY12 and INR105.8 in FY13 compared to INR82.9 in FY10. We are currently 10% ahead of consensus on FY11e EPS, c5% below consensus on FY12e EPS and largely in line on FY13e EPS. We differ from consensus for FY11-12 largely on account of our assumptions regarding project commissioning and margins.
Gearing to lower as earnings start kick in
120 100 80 60 40 20 0 FY06 FY09 FY11e FY07 FY08 FY10 FY12e FY13e
1.6 1.2 0.8 0.4 0.0 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
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Tata Power Key assumptions Power Business Capacity (MW) % Change Gross Generation (MU) % Change PLF % Energy sales (MU) % Change Average Tariff (INR/unit) % Change Average Fuel cost (INR/unit) % Change Coal Business Volumes (MT) % Change Realisation (INR/ton) % Change Cost of production (INR/ton) % Change EBIT (INR/ton) % Change Mix Revenue (INRm) Power and others Coal EBIT (INRm) Power and others Coal Mix % to revenue - Power and others - Coal % to EBIT - Power and others - Coal
FY08
FY09
FY10
FY11e
FY12e
FY13e
CAGR (FY10-13e)
2,365 ! 14,717 ! 142.1% 14,959 3.7 ! 2.5 15.6 1,360 ! 994 ! 252
2,785 18% 14,807 1% 65.6% 14,703 -2% 4.4 18% 3.3 31% 15.0 -4% 3,184 134% 1,613 62% 976 287% 123,514 47,766 15,291 14,639 72.8% 27.2% 51.1% 48.9%
3,103 11% 16,787 13% 65.1% 16,373 11% 3.7 -16% 2.4 -25% 19.0 27% 2,955 -7% 1,778 10% 525 -46% 127,263 56,210 19,763 9,992 70.4% 29.6% 66.4% 33.6%
3,628 17% 21,173 26% 71.8% 20,189 23% 4.0 7% 2.3 -4% 20.4 7% 2,990 1% 1,748 -2% 785 49% 140,747 60,996 22,136 16,008 70.8% 29.2% 58.0% 42.0%
4,953 37% 27,137 28% 72.2% 25,855 28% 3.8 -5% 2.2 -7% 21.4 5% 2,841 -5% 1,794 3% 593 -24% 158,553 60,844 27,975 12,712 73.2% 26.8% 68.8% 31.2%
6,553 32% 40,519 49% 80.4% 38,566 49% 3.3 -11% 1.8 -16% 22.5 5% 2,784 -2% 1,794 0% 541 -9% 192,631 62,608 37,827 12,161 76.2% 23.8% 75.7% 24.3%
28.3% 34.1% 33.1% -3.2% -9.2% 5.7% -2.0% 0.3% 1.0%
83,629 21,220 11,693 3,936 80.5% 19.5% 74.8% 25.2%
14.8% 3.7% 24.2% 6.8%
Valuation
We continue to use sum-of-the-parts (SOTP) valuation to value Tata Power, given the differing risk/reward profiles of its various businesses. Based on our assumptions as enumerated in the following table, we raise our target price to INR1,565 from INR1,525, providing a potential return of c16% from the current share price. Our price target implies a fair value (target) 12M fwd PE multiple of c16.4x vs the current 12M fwd PE of c16.1x. We believe the current share price captures part of the upside from the projects under construction and pipeline. As the projects pass additional milestones over the next 6-12 months, the market should ascribe higher valuation to these projects.
We expect the most upside to come from a) faster than expected commissioning of Mundra power plant, b) strong profitability expected in its coal business in FY11 and c) progress at its various projects in the pipeline (6.2GW) over the next 12 months. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Indian stocks of 10.5%. For Tata Power, this translates into a Neutral band of 5.5-15.5% around the current share price. Our target price of INR1,565 implies a potential return (including dividend yield) of 16%, which is above the Neutral band; thus we have an Overweight (V) rating.
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Tata Power: 12 month forward PE vs. Sensex PE
Tata Power: 12 month forward PB vs Sensex PB

INR per share
Tata Pow er PE
Sensex PE
Tata Pow er P/B

Sensex P/B
Risks
The downside risks include execution delays, higher than expected mining costs, increased interest rates and unfavourable regulatory changes in India or Indonesia.
Tata Power - Valuation summary Business Type Value (INRm) Mutiple % Share Value (INRm)
Parent company Subsidiaries IEL - 240MW Maithon - 1,050MW Mundra - 4,000MW NDPL Power Links Tata Power Trading Associates/JVs Stake in KPC and Arutmin (30%) Tata BP Solar Investments Cash surplus
Total Equity value Projects under development Target Price
DCF Basis. WACC of 10.1%, g=5% DCF Basis. WACC of 10.1% DCF Basis. WACC of 10.1% DCF - FCFE Basis. COE of 11.5% Regulated Equity Equity base 15x on FY12e Earnings DCF Basis. WACC of 10.1% FY10e EV/Sales Market price/Premium to book Consolidated Cash net of Parent Company - 50%
139,358 5,050 20,108 55,798 7,210 4,640 120 262,130 12,617 30,823 10,331
548,184
100% 74% 74% 100% 51% 51% 100% 30% 49% 100%
139,358 3,737 14,880 55,798 9,193 5,916 1,793 78,639 8,284 42,745 5,166
365,507 20,993 386,500
564 15 60 226 37 24 7 318 34 173 21

1,480 85 1,565
2.50x 2.50x 15.00x 1.34x
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Tata Power: Progress at projects under construction on track; upside could come from early execution at Mundra Project Status
4000 MW Mundra
1050 MW Maithon
114 MW Dagachhu
Overall 53% work completed; 10,500 people on site Unit 1: Boiler Hydro testing successfully completed on April 3, 2010 Unit 1: TG and Auxiliaries received on site; TG Stator placed on deck Unit 2: Structural erection work is in very advanced stages Unit 3, 4, 5: Progress on track CW and coal handling systems as well as other civil works are also on track Coal jetty with coal unloading facilities is expected to be ready by end of 2010 All packages have been issued to bidders and over 92% of hard costs awarded Commissioning of Unit 1 by Sep 2011, all subsequent units with intervals of 4-5 months HSBC expects commissioning of 1 unit in Feb FY12e Overall 82% of work completed Unit 1:Boiler Hydro test completed on March 23rd, 2010 Unit 1:Turbine erection to start shortly FSA with BCCL signed for 1.6 MTPA; other FSAs expected soon FSAs with CCL (2 MTPA) and Tata Steel (1 MTPA) expected soon Railway to undergo some modification due to Delhi-Kolkata rail corridor being planned. Involves additional land acquisition and rail work Would require additional capex INR3.8bn Plan to transport coal from BCCL mines by road (a distance of 15 km) Commissioning of Unit 1: Q3 FY11 and Unit 2: 4 months after Unit 1 Contracts for civil work and Equipment in place All statutory clearances, land, water and environment clearances received PPA for the entire quantum has been signed with Tata Power Trading Commissioning of Unit 1: 2013
Tata Power: Progress at projects under pipeline on track, investment approval to act as catalysts Project Fuel source Capacity (MW) Status
Corus (Tata Steel) Production Gases Coastal Maharashtra Imported Coal (Dehrand) Naraj Marthapur IPP Captive coal Mandakini
Tirulidh IPP/CPP
Captive coal Tubed+Coal from Tata Steel Hydro Solar
Tama Koshi, Nepal Mulshi Total

Source: Company data
525 Captive power plant for Tata Steels Corus plant in the Netherlands 2,400 Land acquisition under progress - Consents for 62% of land received, balance in Q2FY11e 1,200 7.5MTPA jointly allocated to Jindal Photo Film, Monnet Ispat and Tata Power Mining plan approved by Ministry of Coal (MoC). Environment and forest clearance, land acquisition (LA) under process. Land acquisition for coal block expected by March 2012. Mines expected to be operational from mid-2014 1,200 5.75MTPA jointly allocated to Hindalco (60%) and Tata Power (40%). Mining plan approved by MoC. Environment and forest clearance, land acquisition under process. Mines expected to be operational by FY13. 800 Joint development with SN Power 3 Largest grid connected solar plant in Maharashtra (PV based) 6,128
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Tata Power Valuation FY08 FY09 FY10 FY11e FY12e FY13e
951 209,910 85,513 0 22,112 (31,253) 286,282 273% 206% 13.5 18.3 31.0 2.7 1.1% -6.3% -7.5% 7.8% 7.8% 8.8%
948 209,869 129,655 0 22,995 (32,512) 330,007 193% 171% 9.0 11.0 16.7 2.4 1.2% -15.4% -17.0% 9.0% 9.0% 14.6%
1,232 292,301 161,362 0 31,016 (30,823) 453,856 247% 177% 11.8 15.3 21.7 2.6 1.0% -19.2% -20.5% 7.5% 7.5% 11.8%
1,355 321,575 186,921 0 33,770 (31,471) 510,796 253% 170% 10.7 13.4 16.2 2.5 0.9% -6.9% -7.9% 8.5% 8.5% 15.2%
1,355 334,698 180,482 0 32,791 (32,150) 515,821 235% 158% 10.0 12.7 16.0 2.1 1.0% -1.1% -2.3% 8.7% 8.7% 13.0%
1,355 334,698 175,630 0 33,571 (32,864) 511,036 200% 148% 7.8 10.2 12.8 1.8 1.0% 2.7% 1.4% 10.5% 10.5% 14.2%
Tata Power Income Statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
Net Sales Cost of Goods Sold (COGS) Gross Income Employee expense Selling General & Admin exp (SG&A) Other operating expense Other operating income EBITDA Depreciation & Amortization Impairment EBIT Interest income Interest expense Other financial exp/inc HSBC Profit before tax (PBT) Exceptionals Reported Profit before tax (PBT) Income tax Profit after tax (PAT) Extraordinary Items Income from Associates Minorities Reported Net income HSBC Net income No. of shares outstanding (mn) Reported EPS - INR HSBC EPS (Recurring) - INR
104,850 (71,161) 33,689 (16,527) 4,059 21,222 (5,593) 15,629 (5,323) 1,259 11,564 11,564 (3,982) 7,583 4,187 (49) (1,170) 10,551 6,761 221 47.8 30.6
171,280 (112,511) 58,769 (26,869) 4,595 36,496 (6,565) 29,931 (8,129) 1,330 23,131 23,131 (9,914) 13,217 (231) 276 (1,076) 12,187 12,568 221 55.0 56.8
183,473 (116,764) 66,708 (34,562) 6,386 38,532 (8,777) 29,755 (7,818) 1,454 23,391 23,391 (8,647) 14,743 6,643 617 (2,335) 19,668 13,454 237 82.9 56.7
201,743 (138,354) 63,388 (22,721) 6,864 47,531 (9,388) 38,144 (9,020) 1,984 31,108 31,108 (10,308) 20,800 0 647 (1,608) 19,840 19,840 237 83.6 83.6
219,396 (150,145) 69,252 (24,987) 7,454 51,719 (11,032) 40,687 (10,631) 2,066 32,122 32,122 (9,715) 22,407 0 680 (2,132) 20,955 20,955 247 84.8 84.8
255,239 (169,567) 85,673 (28,210) 7,929 65,392 (15,403) 49,988 (13,468) 2,151 38,671 38,671 (10,662) 28,009 0 714 (2,592) 26,132 26,132 247 105.8 105.8
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Tata Power Income statement trend & margin analysis FY08 FY09 FY10 FY11e FY12e FY13e
71.2% 94.5% 131.1% 24.5% 11.5% 32.1% 20.2% 14.9% 11.0% 11.0% 31.0% 22.9%
63.4% 72.0% 91.5% 15.1% 85.3% 34.3% 21.3% 17.5% 13.5% 13.5% 42.2% 21.0%
7.1% 5.6% -0.6% 50.6% -0.1% 36.4% 21.0% 16.2% 12.7% 12.7% 35.1% 14.5%
10.0% 23.4% 28.2% 0.9% 47.5% 31.4% 23.6% 18.9% 15.4% 15.4% 33.1% 15.0%
8.8% 8.8% 6.7% 1.5% 1.5% 31.6% 23.6% 18.5% 14.6% 14.6% 30.2% 15.4%
16.3% 26.4% 22.9% 24.7% 24.7% 33.6% 25.6% 19.6% 15.2% 15.2% 27.6% 12.8%
Tata Power Balance Sheet (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
2,817 73,713 76,530 8,062 84,592 (82,081) (9,055) (91,136) 5,623 (85,513) 65,195 32,342 (2,820) 31,253 38,224 164,193 6,529 25,318 603 13,890 (29,815) (10,638) 5,887 84,567
2,214 83,975 86,189 9,444 95,633 (110,507) (30,928) (141,434) 11,780 (129,655) 94,004 58,756 (5,168) 32,512 50,288 230,391 10,146 30,235 499 21,805 (48,072) (19,725) (5,112) 95,625
2,373 111,631 114,004 12,097 126,101 (147,001) (37,468) (184,469) 23,108 (161,362) 107,731 116,927 (4,308) 30,823 36,577 287,750 9,539 39,845 321 24,089 (59,505) (14,576) (287) 126,101
2,373 128,132 130,505 13,705 144,210 (172,809) (37,468) (210,277) 23,357 (186,921) 127,542 132,499 (4,308) 31,471 36,577 323,781 9,781 46,033 321 24,089 (58,299) (14,576) 7,349 144,210
2,470 159,182 161,652 15,837 177,489 (175,235) (37,468) (212,703) 32,221 (180,482) 179,712 104,922 (4,308) 32,150 36,577 349,053 10,748 47,791 321 24,089 (59,455) (14,576) 8,918 177,489
2,470 181,261 183,731 18,429 202,159 (180,505) (37,468) (217,973) 42,342 (175,630) 240,810 60,257 (4,308) 32,864 36,577 366,201 12,471 52,810 321 24,089 (63,526) (14,576) 11,589 202,159
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Tata Power Balance sheet ratios FY08 FY09 FY10 FY11e FY12e FY13e
111.7% 101.1% 2.12 2.01 (2.94) 4.03 1.07 0.76 0.76 31 33 88 2 48 (104) (37) 5.6%
150.4% 135.6% 2.50 2.36 (3.68) 3.55 1.12 0.89 0.89 0 33 64 1 46 (102) (42) -3.0%
141.5% 128.0% 2.42 2.28 (3.81) 4.19 0.82 0.71 0.71 10 30 79 1 48 (118) (29) -0.2%
143.2% 129.6% 2.43 2.30 (4.23) 3.93 0.78 0.67 0.67 21 26 83 1 44 (105) (26) 3.6%
111.6% 101.7% 2.12 2.02 (3.83) 3.49 0.77 0.67 0.67 23 26 80 1 40 (99) (24) 4.1%
95.6% 86.9% 1.96 1.87 (3.71) 2.69 0.85 0.74 0.74 26 27 76 0 34 (91) (21) 4.5%
Tata Power Cash Flow Statement (INRm) FY08 FY09 FY10 FY11e FY12e FY13e
11,564 (920) 4,982 5,593 (4,033) (4,104) (142) 39 12,981 (25,378) (910) (13,307) (2,365) (15,672) (44,429) 41,799 7,248 (125) (11,178)
23,131 (814) 7,907 6,565 311 (6,083) (2,806) (7,824) 20,388 (52,941) 136 (32,417) (3,333) (35,749) (1,217) 39,513 1,492 0 4,039
23,391 (876) 7,746 8,777 4,888 (100) (19,397) (9,965) 14,464 (70,285) (288) (56,109) (3,703) (59,811) 2,047 37,614 2,712 30,083 12,645
31,108 0 9,020 9,388 0 (7,636) (10,308) (9,020) 22,552 (44,772) 0 (22,220) (3,339) (25,559) 0 25,808 0 0 249
32,122 0 10,631 11,032 0 (1,568) (9,715) (10,631) 31,871 (35,624) 0 (3,753) (3,908) (7,662) 0 2,426 14,100 0 8,864
38,671 0 13,468 15,403 0 (2,671) (10,662) (13,468) 40,742 (31,837) 0 8,905 (4,053) 4,852 0 5,269 0 0 10,122
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Tata Power Cash ratios FY08 FY09 FY10 FY11e FY12e FY13e
1.2% -3.9% 4.5 24.2% 83.1% -6.3% -7.5%
12.1% -3.6% 8.1 30.9% 68.1% -15.4% -17.0%
82.9% -0.1% 8.0 38.3% 48.6% -19.2% -20.5%
33.1% -3.8% 4.8 22.2% 59.1% -7.4% -8.5%
30.2% -0.7% 3.2 16.2% 78.3% -1.2% -2.4%
27.6% -1.0% 2.1 12.5% 81.5% 2.8% 1.6%
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Financials & valuation: Tata Power

Overweight
03/2012e 03/2013e
189,858 38,532 -8,777 29,755 -7,818 30,222 30,222 -8,219 19,668 13,454
208,607 47,531 -9,388 38,144 -9,020 31,756 31,756 -10,308 19,840 19,840
226,851 51,719 -11,032 40,687 -10,631 32,802 32,802 -9,715 20,955 20,955
263,168 65,392 -15,403 49,988 -13,468 39,385 39,385 -10,662 26,132 26,132
2.4 12.0 1.7 23.9 2.8 -15.8 0.9
2.4 10.3 1.5 16.2 2.5 -8.0 0.9
2.1 9.4 1.4 16.0 2.1 -1.9 1.0
1.8 7.4 1.3 12.8 1.8 2.2 1.0
Issuer information
Share price (INR) 1355.20 Target price (INR) 14,464 -70,384 -67,737 -3,703 31,707 -47,988 22,552 -44,772 -44,772 -3,339 25,559 -24,204 31,871 -35,624 -35,624 -3,908 -6,438 -5,819 40,742 -31,837 -31,837 -4,053 -4,852 6,754 Reuters (Equity) TTPW.BO Market cap (USDm) 7,213 Free float (%) 67 Country India Analyst Arun Kumar Singh
Bloomberg (Equity) TPWR IN Market cap (INRm) 321,599 Enterprise value (INRm) 490754 Sector Electric Utilities Contact +9122 22681778
Price relative
0 271,297 96,901 23,108 399,021 69,567 184,469 161,362 114,004 275,524
0 306,681 103,581 23,357 441,733 68,361 210,277 186,921 130,505 318,544
0 331,273 115,169 32,221 478,593 69,517 212,703 180,482 161,652 344,704
0 347,706 132,033 42,342 512,604 73,588 217,973 175,630 183,731 363,809
1814 1614 1414 1214 1014 814 614 414 2008

Tata Power
1814 1614 1414 1214 1014 814 614 414 2009 2010 2011
Source: HSBC

Ratios (%)
8.0 5.6 -0.6 31.3 -0.1
9.9 23.4 28.2 5.1 47.5
8.7 8.8 6.7 3.3 1.5
16.0 26.4 22.9 20.1 24.7
0.8 8.8 13.4 7.7 20.3 15.7 4.9 128.0 4.2 9.0
0.7 8.7 16.2 6.6 22.8 18.3 5.3 129.6 3.9 12.1
0.7 8.6 14.3 6.6 22.8 17.9 4.9 101.7 3.5 17.7
0.7 10.3 15.1 7.8 24.8 19.0 4.9 86.9 2.7 23.2
82.89 56.70 12.03 480.44
83.61 83.61 12.53 549.98
84.85 84.85 13.03 654.53
105.81 105.81 13.53 743.93
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Appendix 1: Price determination

DISCOMS current power purchase has a pre-dominance (70%)
of regulated ROE based power but this is likely to change

Companies building power plants on merchant basis are likely to
tie up around 70-80% using case I bidding route

Development of power market with a good mix of short-term and
long-term purchase will help both distributors and generators
Summary
Power prices are a key element of utilities revenues and hence it becomes imperative to understand various price determination models to gauge the value offered by different upcoming power projects. In this section, we discuss how bulk power prices are determined both from power generators to the bulk buyer perspective.
only 14%) and the equity is usually capped at c30% of the project cost incurred by the developer. In addition to this, generators are allowed to earn incentives for efficient operations of the power plant (on SHR and Aux consumption).
Competitive based pricing

Case I bidding
Sale of power by generators

Power is sold by the generators, either under the regulated equity model (which was the main model until very recently), or under the competitive based pricing model (which is a relatively new model introduced in 2006). We discuss each of these in the following sections.
Under this model, the developer is open to choose the fuel type and the location for setting up of the power plant. Also the developer has the flexibility to choose any number of buyers for a single project. The bidding is conducted by the buyers who are mainly the State Electricity Boards (SEBs). Under the bid, the developer quotes the amount of capacity and the price per unit for a definite term (usually between 20 to 25 years). Based on his quotation, a levelised tariff is calculated by discounting the future years tariffs with an appropriate rate and then various projects are compared on this levelised tariff.
Regulated model
Under this model, the tariff is determined based on regulated norms. All those expenses which are within the norms set by the regulator are allowed as a pass through. The generator is allowed a fixed return on equity of c15% (some states still allow
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Case II bidding
Under this model, the state/central government decides the fuel source and the location for the project. The government then invites bids from various developers who quote a price, similar to levelised tariff in Case I bids, to win the project. The fuel source is usually a major factor in determining the price and could either be the captive coal mine allotted by the government or the imported coal. For example, the price quoted for the Sasan UMPP was lower (INR1.19 per unit) than the Mundra UMPP (INR2.26 per unit) as the former is based on the captive coal mine while the latter is based on the imported coal (implying higher fuel cost and risk). In both cases, there is a variable component of tariff which is indexed and is allowed to change after fixed tenure, which is usually five years.
Short-term merchant sale
or a bilateral agreement (1-3 months). The price is determined based on market forces (demand and supply) and through bilateral arrangements between the buyer and the seller and are usually not regulated. Although, the regulator has powers to intervene from time to time to maintain price efficiency; however, the regulator has categorically mentioned that it has no intentions to impose any price restrictions on the merchant tariff.
Captive power plants
Under this model, typically large users of power, such as metal and cement companies, set up an inhouse power plant (typically less than 100MW) in order to ensure uninterrupted power for production process. A majority of the power (minimum 50% for captive purpose) is consumed internally by the developer while a portion of it is sold in the open market. The tariff is mostly based on the cost plus agreed return on equity model (typically 16-20%).
MOU Route
Under this model, the developer has either a full portion or a portion of its capacity from a project untied and available for sale in the short term market, either through a trader or a power exchanges
Under this model, a developer signs an MOU with the state government to set up a power plant in the respective state. Under the MOU, the developer is required to supply c7.5% to SEBs at variable cost
Various business models for power generators Particulars Regulated cost plus model Competitive tariff (Case I and Case II bids) Merchant /Short term Captive power plants
Power purchaser
Sales to single or multiple-utility companies
Fuel price Interest rate Allowed ROE
50% of power for captive users A part of the power can be sold in the open market 26% equity ownership required by the customer Passed on to the customer Case-to-case basis Borne by the developer Share the impact of changes Passed on to the customer Risk rests with the generator Borne by the developer Passed on to the customer 14%-15.5% allowed Returns not set by the regulator but Returns not set by the regulator; Returns not set by the regulator but Incentives for efficient operations are left on the developer to bid depends on developer ability to sell left on the developer and procurer allowed successfully at high prices 16-20% Central PSUs such as NTPC and NHPC 20-25% Power supply commitment and price determination through competitive bidding under Case I and Case II bids by private developers such as Adani Power, Tata Power, Reliance Power, CESC, Lanco Infratech, GMR etc 40-45% 16-25%
Sales to single or multiple utility companies
Power sold in the open market
Typical ROE Examples
Private developers setting up plants Cement and Steel plants having and having a portion of capacity as their own power plants etc. untied and selling in short term Ex: Jindal Power for Jindal Steel, market Tata Power for Tata Steel.
Source: HSBC
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of generation and another 30% based on tariff determined by CERC. The developer is free to sell the balance power. For instance the Bina (1.2GW) and Nigrie (1.32GW) power projects being set up by the Jindal Power Ventures are based on the MoU route committed to the MP government. This is in slight contradiction to the National Electricity Policy 2006, which mandates output from private sector to be contracted only through Case I/ Case II bids.
Cost of procurement
Typically for a distribution company, the power purchase cost constitutes c70-75% of the overall expenditure and hence the price at which they source the power is of significance. In terms of scheduling they follow the merit order despatch system and hence the state load despatch system schedules the procurements in increasing order of their cost.
Tariff to final consumer

The distribution companies sell power to the final consumer based on the tariff set by the state regulator on cost (power purchase cost from generators, O&M cost, interest etc ) plus regulated RoE of 16%. The equity portion is usually 30% of the capital cost incurred by the distribution companies for the distribution of power. However the final tariff also takes into consideration the ability of the consumer to pay. Hence, certain sections of the consumer base, such as the agricultural consumers and the low power consuming domestic consumers, are charged tariff at lower than the cost of service. High end consumers, both domestic and commercial, are charged higher than the cost of service thus subsidizing the other consumers. The National Tariff Policy has given time until 2012 to bring the cross subsidy under 25%. State regulators are required to draw a road map using the MYT framework to eliminate cross subsidy beyond this level, thus ensuring that tariff for all consumers does not deviate from +/- 20% of the cost of service.
How distribution companies procure power

Distribution companies are primarily state owned, except for Tata Power and Reliance Infrastructure in Mumbai and Delhi, CESC in Kolkatta and Torrent Power in Ahmedabad and Surat. The state owned distribution companies are usually known as DISCOMS, and they procure power through: Long term contracts entered usually for 25 years with state owned generation companies, and/or central PSUs, such as NTPC and NHPC, who operate under the regulated model. They also procure power from the private sector under the regulated model (prior to National Electricity Policy in 2006) and under Case I and Case II bids post the policy. Short term purchase typically the distribution companies procure power on a short term basis either through traders, bilateral agreements or power exchanges to meet peaking demand supply shortage. Unscheduled Interchange (UI) This is a process by which a state draws excess power from the regional gird managed by the regional load despatch centre (RLDC)
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Appendix 2: Valuation methodology

The existence of several revenue models and different stages of
various projects implied that each project and/or holding may offer a different value. Hence, we use a SOTP approach in most cases
Within SOTP, we use a target multiple (PB) based approach for
projects based on regulated ROE whereas we use DCF for other projects
For equipment manufacturers (BHEL), we use EVA based approach
The utilities business is a project driven business and because of the existence of several revenue models and different stages of various projects, each project and/or holding may offer a different value. Hence, it becomes difficult to value all the companies using a single consistent valuation methodology. Therefore, we have used different valuation methodologies for different companies under our coverage. In most cases, where there are several major projects and investment holdings, we have used a sum-of-theparts (SOTP) approach wherein we have valued each individual project or holding using the most suitable valuation methodology (usually either a P/B based multiple or a DCF approach). For others, like NTPC, where the business is largely based on a regulated RoE model, with minimal investment holdings, we have used the Discounted Cash Flow (DCF) approach for the entire company. For the equipment manufacturers, like BHEL, where the value is largely driven by the firms ability to generate a superior return on its capital employed, we have used the Economic Value Added (EVA) approach to
value the company, assuming a competitive advantage period (CAP) of 10 years. We discuss below the valuation methodologies employed and their key aspects.
Valuation methodologies
Multiple based approach PB
A significant portion of the utilities business is still based on a regulated Return on Equity (RoE) model. In this case, the firms equity base and its capability to expand it and initiate new projects remains the key driver of the value of the firm. Therefore, we believe that using a forward justified Price/Book (P/B) multiple in this case is the most suitable valuation methodology. Consequently, within our SOTP analysis, we have valued all major projects which are based on regulated model using target P/B multiples.
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Discounted Cash Flow DCF

We note that the utilities business is highly capital intensive and most of the utilities are currently in a high growth phase, adding significant generation capacity. Therefore, all the projects which are currently under construction require significant annual investments and may not be profitable at this stage. In such situations, we believe that the value of the project is driven largely by its capability to generate future cash flows and hence we have used DCF for valuing all those projects which are currently under construction and/or are not based on the regulated return model.
Key considerations in our valuation

Customer advances treatment?
Most of the equipment manufacturers with long lead times for their products often rely on customer advances to fund their working capital requirements and the cost of manufacturing the products. This is particularly true in cases, where the lead time for the product can stretch up to as long as 2 to 3 years. The Return on Capital Employed (RoCE) for companies which have significant customer advances, and hence a significant cash position, on balance sheet usually appears superior to their peers in the industry. However, we note that for a company which is a going concern, the customer advances sitting within the cash in the balance sheet cannot be used to repay the debt (as they are earmarked/required against a particular product) and hence, should not be netted off against the debt when calculating the Capital Employed (CE) for a company. Consequently, we have adjusted customer advances in our calculation of CE and, in turn, EV by treating them as an operating asset. In principle, what this means is that we view customer advances as the financing provided by the customers and hence we take it out of the cash or simply add it to the capital employed. To make the return comparable, we assume a fictional risk free rate of return (c.5%) on these advances and add it to our clean EBIT to calculate the Operating Return (OR) on the adjusted Capital Employed (CE). This is what we call the HSBC RoCE and use in our EVA valuation methodology. This is a more conservative approach of evaluating a companys performance than when you treat customer advances as cash; however, this is less conservative than treating customer advances as debt.
Economic Value Added EVA

For capital equipment manufacturers, such as BHEL, we believe that the firms earnings power and, in turn, its value is driven by the managements capability to generate superior return on the total capital committed to them (as can be gauged from the RoCE). To value such companies, we adopt a technique similar to Miller-Modigliani/EVA analysis, which values the company as the sum of the cash flow of its assets now in place, plus the value of its growth opportunities. The first part of the equation represents a companys sustainable target earnings, being the product of a target RoCE and our company forecasts of capital employed. The second part represents the net present value of future returns accruing during a ten-year forecasting period the competitive advantage period (CAP). This we calculate by inputting a target sales growth, a target return on sales and the amount by which the company have to increase its capital employed in order to achieve this sales growth.
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Strong cash position good, bad or ugly?

While a strong cash position is usually seen as a positive, a stale net cash position with no real visibility on future investments, in our opinion, doesnt bode well for the company, as then investors are effectively buying cash rather than future earnings when investing into the stock. In such cases, we believe it is prudent to discount cash to reflect its true return, which is usually the risk free rate.
We are currently not discounting the net cash position of any of the companies; however, we note that some of the companies, like PTC, currently derive a significant portion of their total fair value from their cash position. The company has been reassuring investors that it has identified suitable investments for its cash position and hence, we have given PTC the benefit of doubt at this stage, valuing its cash at 1x. However, in case the company fails to deploy its cash in profitable ventures, we believe the market may start discounting the cash and the stock price may come under pressure.
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Notes
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Notes
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India Research Team

India
Roopesh Patel Head of Research, India +91 22 2268 1271 roopeshpatel@hsbc.co.in Banks Sachin Sheth Analyst +91 22 2268 1224 Tejas Mehta Analyst +91 22 2268 1243 Consumer & Retail Percy Panthaki Analyst +91 22 2268 1240
Hong Kong
Banks Todd Dunivant Analyst +852 2996 6599 Telecom Tucker Grinnan Analyst +852 2822 4686
tdunivant@hsbc.com.hk
sachinsheth@hsbc.co.in
tuckergrinnan@hsbc.com.hk
Global
tejasmehta@hsbc.co.in
Strategy Garry Evans Global Head of Equity Strategy +852 2996 6916 garryevans@hsbc.com.hk
percypanthaki@hsbc.co.in
Industrials, Utilities Suman Guliani Analyst +91 80 3001 3747 sumanguliani@hsbc.co.in Infrastructure, Real Estate Ashutosh Narkar Analyst +91 22 2268 1474 ashutoshnarkar@hsbc.co.in IT Services Yogesh Aggarwal Analyst +91 22 2268 1246 Oil & Gas Kumar Manish Analyst +91 22 2268 1238 Puneet Gulati Analyst +91 22 2268 1235 Telecom Rajiv Sharma Analyst +91 22 2268 1239 Equity Strategy Vivek Misra Strategist +91 80 3001 3699
yogeshaggarwal@hsbc.co.in
kmanish@hsbc.co.in
puneetgulati@hsbc.co.in
rajivsharma@hsbc.co.in
vivekmisra@hsbc.co.in
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Arun Singh and Rahul Garg
Important disclosures
Stock ratings and basis for financial analysis
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below. This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website. HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.
Rating definitions for long-term investment opportunities

Stock ratings
HSBC assigns ratings to its stocks in this sector on the following basis: For each stock we set a required rate of return calculated from the risk free rate for that stock's domestic, or as appropriate, regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral. Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change. *A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However,
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stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
Rating distribution for long-term investment opportunities

As of 04 October 2010, the distribution of all ratings published is as follows: Overweight (Buy) 50% (21% of these provided with Investment Banking Services) Neutral (Hold) Underweight (Sell) 36% 14% (18% of these provided with Investment Banking Services) (19% of these provided with Investment Banking Services)
Share price and rating changes for long-term investment opportunities

BHEL (BHEL.BO) Share Price performance INR Vs HSBC rating history Recommendation & price target history From To Date
3198 2698 2198 1698 1198 698 198 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10
Overweight Overweight (V) Neutral (V) Overweight (V) Target Price Price 1 Price 2 Price 3 Price 4 Price 5 Price 6 Price 7 Price 8 Price 9
Source: HSBC
Overweight (V) Neutral (V) Overweight (V) Overweight Value 2500.00 2645.00 3250.00 2750.00 2300.00 1750.00 1670.00 2450.00 2850.00
03 March 2008 03 June 2009 14 July 2009 26 May 2010 Date 10 October 2007 19 October 2007 11 January 2008 08 April 2008 23 July 2008 27 October 2008 19 March 2009 03 June 2009 26 October 2009
Source: HSBC
NTPC (NTPC.BO) Share Price performance INR Vs HSBC rating history
Recommendation & price target history From To Date
275 225 175 125 75 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10
Underweight Underweight (V) Neutral (V) Underweight (V) Target Price Price 1 Price 2 Price 3 Price 4 Price 5
Source: HSBC
Underweight (V) Neutral (V) Underweight (V) Underweight Value 163.00 142.00 157.00 177.00 185.00
17 March 2008 27 October 2008 14 January 2009 01 February 2010 Date 29 August 2008 27 October 2008 09 June 2009 04 August 2009 01 February 2010
Source: HSBC
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Tata Power (TTPW.BO) Share Price performance INR Vs HSBC rating history
1194 694 194 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10
Overweight Underweight Underweight (V) Overweight (V) Overweight Overweight (V) Target Price Price 1 Price 2 Price 3 Price 4 Price 5
Source: HSBC
Underweight Underweight (V) Overweight (V) Overweight Overweight (V) Overweight Value 1244.00 1000.00 1350.00 1585.00 1525.00
07 November 2007 17 March 2008 29 August 2008 01 June 2010 30 June 2010 01 July 2010 Date 29 August 2008 14 January 2009 21 July 2009 30 November 2009 02 March 2010
Source: HSBC
PTC India (PTCI.BO) Share Price performance INR Vs HSBC rating history
191 141 91 41 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10
Overweight (V) Underweight (V) Overweight (V) Target Price Price 1 Price 2 Price 3 Price 4
Source: HSBC
Underweight (V) Overweight (V) Neutral (V) Value 98.00 91.00 100.00 122.00
07 November 2007 29 August 2008 29 October 2009 Date 29 August 2008 27 January 2009 29 October 2009 13 January 2010
Source: HSBC
Cesc Ltd (CESC.BO) Share Price performance INR Vs HSBC rating history
658 558 458 358 258 158 58 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10
N/A Overweight (V) Target Price Price 1 Price 2 Price 3

Source: HSBC
Overweight (V) Overweight Value 428.00 345.00 518.00
29 August 2008 01 July 2010 Date 29 August 2008 31 October 2008 08 January 2010
Source: HSBC
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HSBC & Analyst disclosures

Disclosure checklist Company Ticker Recent price Price Date Disclosure
BHEL NTPC PTC INDIA TATA POWER

Source: HSBC
BHEL.BO NTPC.NS PTCI.BO TTPW.NS
2590.70 219.45 117.65 1391.05
01-Oct-2010 01-Oct-2010 01-Oct-2010 01-Oct-2010
2 1, 2, 5, 11 4 2, 7
1 2 3 4 5 6 7 8 9 10 11
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Additional disclosures
1 2 3 This report is dated as at 04 October 2010. All market data included in this report are dated as at close 30 September 2010, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. As of 31 August 2010, HSBC beneficially owned 5% or more of a class of common equity securities of the following company(ies) : PTC INDIA As of 31 August 2010, HSBC beneficially owned 2% or more of a class of common equity securities of the following company(ies) : BHEL As of 31 August 2010, HSBC and/or its affiliates (including the funds, portfolios and investment clubs in securities managed by such entities) either, directly or indirectly, own or are involved in the acquisition, sale or intermediation of, 1% or more of the total capital of the subject companies securities in the market for the following Company(ies) : PTC INDIA
4 5 6
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Disclaimer
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Recipients in Singapore should contact a "Hongkong and Shanghai Banking Corporation Limited, Singapore Branch" representative in respect of any matters arising from, or in connection with this report. In Australia, this publication has been distributed by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for the general information of its wholesale customers (as defined in the Corporations Act 2001). Where distributed to retail customers, this research is distributed by HSBC Bank Australia Limited (AFSL No. 232595). These respective entities make no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. In Japan, this publication has been distributed by HSBC Securities (Japan) Limited. In Hong Kong, this document has been distributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business for the information of its institutional and professional customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited makes no representations that the products or services mentioned in this document are available to persons in Hong Kong or are necessarily suitable for any particular person or appropriate in accordance with local law. All inquiries by such recipients must be directed to The Hongkong and Shanghai Banking Corporation Limited. In Korea, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch ("HBAP SLS") for the general information of professional investors specified in Article 9 of the Financial Investment Services and Capital Markets Act (FSCMA). This publication is not a prospectus as defined in the FSCMA. It may not be further distributed in whole or in part for any purpose. HBAP SLS is regulated by the Financial Services Commission and the Financial Supervisory Service of Korea. Copyright. HSBC Securities and Capital Markets (India) Private Limited 2010, ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC Securities and Capital Markets (India) Private Limited. MICA (P) 142/06/2010 and MICA (P) 193/04/2010
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Same problem, new execution risks
Arun Kumar* Senior Analyst, Power utilities HSBC Securities and Capital Markets (India) Private Ltd (Mumbai) +91 22 2268 1778 arun4kumar@hsbc.co.in Arun, who joined HSBC in June 2010, brings with him over 15 years of experience with leading consulting firms, most of it in the power and infrastructure sector advising policy makers and corporations. He was also recently head of infrastructure research at a securities firm. Arun holds an MBA from IMI, Delhi, and an MA in economics from the Delhi School of Economics, India. Suman Guliani* Analyst HSBC Bank plc (London) +91 80 3001 3747 sumanguliani@hsbc.co.in Suman joined HSBC in May 2005. She previously worked in corporate finance at a large Indian multinational company and was also a management consultant with a large chartered accountancy practice. She holds a bachelors degree in commerce and is a chartered accountant.
Rahul Garg* Analyst HSBC Securities and Capital Markets (India) Private Ltd (Mumbai) rahul1garg@hsbc.co.in Rahul joined HSBC in August 2010, bringing with him over five years of international experience in equity research with leading investment banks, most of it in the European Capital Goods sector advising institutional investors. Prior to that, he worked at a US investment bank. Rahul holds a B.Tech in Chemical Engineering from Indian Institute of Technology (IIT) Bombay and recently passed CFA level III.
Utilities
Murtuza Zakiuddin* Associate Bangalore
* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.
October 2010

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Utilities India October 2010

Same problem, new execution risks

Utilities India 4 October 2010

Utilities India 4 October 2010

Overview: Same problem, new execution risks

Utilities India 4 October 2010

Utilities India 4 October 2010

Sensitivity analysis - coal and water related risk

Utilities India 4 October 2010

Risk reward benchmarking

Company NTPC Tata Power CESC PTC BHEL Sector

Fair value summary coverage universe

Source: HSBC estimates *Prices as at close of 30 September 2010

Utilities India 4 October 2010

HSBC versus Consensus

518,049 201,743 36,156 86,671 408,315

155,237 47,531 9,047 955 80,651 293,422

1,250,934 1,473,618 1,679,665 Sales (INRm) FY12e FY13e

FY11e 12.0 75.8 38.0 4.3 114.0 244.1

164,320 41,201 9,684 956 78,714 294,875

Divergence % NTPC Tata Power CESC PTC BHEL Sector Average**

FY11e -4.4% 9.6% -4.3% -11.9% -1.5% -2.0%

FY13e -1.6% -4.1% 16.4% 4.7% -6.8% -2.7%

FY11e -5.5% 15.4% -6.6% -0.1% 2.5% -0.5%

FY13e -13.0% -6.1% 26.0% -11.7% -2.2% -8.1%

FY11e -5.4% 10.4% -1.6% 6.3% 0.5% 3.1%

FY13e -4.1% 2.0% 23.0% 28.8% -5.7% 1.7%

PTC: OW(V), TP INR161

Utilities India 4 October 2010

Tata Power: OW, TP INR1,565

CESC: OW, TP INR475

Utilities sector Valuation summary

CESC NTPC Tata Power PTC India

385 217 1,355 115

Total Average - simple Total Average - weighted Total Average - aggregated

Source: HSBC estimates, Reuters, Prices as at close of 30 September 2010

Utilities India 4 October 2010

NTPC: Neutral, TP INR225

Capital goods sector Valuation summary

40% 9% -15% -61% 40% na na 12% 4% -4% -33% 44% 4% 4% 43%

Utilities India 4 October 2010

Utilities sector Share price performance summary

Total Average - simple Total Average - weighted

BHEL: UW, TP INR2,300

Utilities India 4 October 2010

Capital goods sector Share price performance summary

Total Average - simple Total Average - weighted

Utilities India 4 October 2010

Source: Company data, HSBC estimates

Utilities India 4 October 2010

Capacity addition accelerating

amount added over last three years

double, with c17GW of capacity addition per annum

Significant capacity addition over next three years

Power capacity addition to accelerate in 11th plan

suggests that things are improving

Utilities India 4 October 2010

11 plan to add c49Gw: Our project level

25 20 15 45% 10 25% 5 0 FY08 FY09 Target FY10 Actual 63% 58%

90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

FY11e FY12e % Achieved

Source: CEA, HSBC estimates

Transmission in excess of INR560bn during FY11-12