In an industry like power that is tackling declining demand, overcapacity and burgeoning debt levels, distressed assets are up for grabs like bargains on a Christmas sale. Making the most of the sale season is JSW Energy, one of the top four power producers in the country today. The company has been snapping up power plants at regular intervals flexing its financial muscle thanks to its strong balance sheet and operating cash flows of ₹4,000 crore.
Over the last two years, the company has acquired two power plants of the Jaypee Group and one power plant of Jindal Steel and Power (JSPL) taking the acquired capacity to 2,891 MW at an enterprise value of about ₹16,000 crore. Post the acquisition spree, the company has almost doubled its power generation capacity to 5,900 MW. News reports suggest that the company is already eyeing its next target and started negotiations with Monnet Power to acquire its 1,050 MW power plant at Angul in Odisha.
In a buyer’s market, JSW Energy has not only ensured that the assets were at a discount but also pencilled in a minimum 15% return on equity (ROE) for themselves. This after making sure that the assets came with long-term purchase agreements and assured fuel supply. To put things in perspective, JSW Energy bought the 1,000 MW thermal power plant from JSPL who is reeling under a huge debt burden for ₹4,000 crore valuing it at ₹4 crore per MW. Now to set up a green field plant it roughly costs about ₹6-6.5 crore per MW apart from the numerous regulatory clearances required. Also, thanks to lower interest rates in the economy, even a 100-150 basis points reduction in interest rates will have a huge impact on the ROE of these plants.
The strategy of acquiring these plants at attractive prices not only helps the company to beef up its overall capacity but also ensures its transition to having a revenue model driven by long-term purchase contracts. Right now nearly half its revenue comes from short-term merchant power contracts. While at one time, attractive realisations led a lot of private players to set up merchant power plants that led to a huge build-up of capacities and lower demand saw realisations tumble and players like JSW Energy bore the brunt.
However, the merchant tariffs have started to stabilise at around ₹2.5-3 per unit as against ₹4 per unit in the year 2012 thanks to an improvement in demand which grew by 5.4% on a year on year basis. The company saw its plant load factor (PLF) at its 860 MW merchant power plant improve to 61% in November from a low of 20% in July. Similarly the PLF at the 1,200 MW Ratnagiri power plant has remained constant at around 70%. With no additional capex planned and after all its interest payments are made, the company is expected to generate close to ₹1,500 crore of free cash flows annually thanks to nearly more than 50% of its revenues coming from long-term PPAs in place. While the company is working on increasing revenues from long-term contracts from utilities, it does take time for these contracts to get signed. However on the bright side, with no capacities coming on stream on the merchant power side, analysts feel the oversupply situation will correct in the next couple of years. “Oversupply in the merchant power space will correct by FY20 as capacity additions are down sharply and inefficient capacities are being retired. Once the balance is restored, players with efficient merchant power capacities will be on a stronger wicket," said Dhruv Muchhal, an analyst who is tracking the company at Motilal Oswal Securities.
Thanks to concerns over slackening demand and declining merchant power realisations, the markets currently are undervaluing JSW Energy. "At current stock price, the market is valuing JSW’s generation portfolio at an FY20 enterprise value at ₹25,700 crore. The net present value of capacity under PPAs as at end of FY20 is valued at ₹18,100 crore. This effectively means that the remaining capacity of 2,600 MW, which caters to the merchant power, is valued at ₹7,600 crore, or ₹2.9 crore per MW,” points out Muchhal.
The value (₹2.9 crore per MW) ascribed for its merchant power capacities are well below the replacement cost at around ₹6 crore per MW. Over the next three years, once the merchant capacities stabilise these valuations are expected to reach closer to replacement value which would add another ₹8,000-8,500 crore or about ₹50 a share on a current market capitalisation of ₹11,000 crore and current share price of ₹60 a share. Moreover, the stock is trading at 1x its book value. "While there could be some short-term pain till realisations improve further, we believe the current stock price factors in all visible concerns. We like the company for its strong balance sheet and robust asset acquisition process, which has placed it in a sweet spot to benefit from the demand recovery in the power sector," he adds.