Adani Power Initiating Coverage

21 September 2011

Recommendation CMP Target Upside Potential Sector Sensex Bloomberg code Reuters Code AT A GLANCE Issued Equity Capital (Rs .Mn) Mkt. Cap (Rs. in Bn) Mkt. Cap (In Bn USD) Major Shareholders Promoters (%) Free Float (%)

: : : : : : : :

Market performer Rs 88.15 Rs 97 10.04% Power 17,099 ADANI.IN ADAN .BO

Strong Execution track record

Adani Power (APL) is likely to benefit from rapid capacity expansion of about 3,960 MW capacities in FY12 and 660 MW in FY13 taking its total capacity to about 5,940 MW and 6,600 MW in FY12 and FY13 respectively. This includes Mundra Project (four units, aggregating to 2,640MW) and Tiroda Project (Phase I & II aggregating to 1,980MW). By the end of FY15, the company expects to operate a power generation portfolio of 10,560MW.

APL to benefit from high Power deficit in Western India

: : : : : 21,800 192.17 4.09 73.50% 26.50% Adani Powers total planned capacity (9,240MW of 10,560MW) is being developed in Western region, which experiences highest power deficit in India. This is expected to benefit the company, as huge power generation shortfall will lead to demand for its power produced.

Indirect Control over Coal Assets through Parent

APL is a beneficiary of its parent Adani Enterprises (AEL) interest in coal assets of Bunyu coal mine in Indonesia with production capacity of 10MTPA. AEL also has a control over LINC Energy coal mines in Australia with production capacity of 30MTPA. Apart from the above, AEL has a coal purchase agreement with PT Bukit Assam, Indonesia State coal producer for a minimum quantity of 35MTPA taking its total linkage to 75MTPA.

Background: Adani Power (APL) is promoted by Adani Enterprises, which is the flagship company of Adani Group. APL has a capacity of 1,980 MW as on FY11 and is currently in the process of commissioning 6,600MW of power, which is in various stages of development. All of the Company's upcoming projects are coal-fired, with the 1,320MW Mundra-I project based on sub critical technology and the other projects based on supercritical technology. The Company is procuring equipment for its power plants from various Chinese manufacturers such as Dongfang and Shanghai Electric.

Plant Load Factor (PLF) above Industry Average

APL has been operating at high PLF of about 90% in FY10 and FY11 against the Industry average of about 77%. We have factored in a PLF of about 85% for FY12 & FY13 respectively.

Valuation & Outlook:

We estimate APL to report EPS of Rs.8.20 in FY12 and Rs.12.20 in FY13 respectively. Apart from aggressive capacity expansion plans, coal linkages, merchant exposure and strong PLF above industry average are the key drivers for the stock. The stock at the CMP of Rs.88.15 trades at 10.75X and 7.22X of its FY12E and FY13E EPS respectively. We have valued the stock at 8X its FY13 EPS with a Marketperformer rating and arrived at a target price of Rs.97 for the stock. We have assumed cost of Indonesian coal at USD 36 per ton. However, any decision by AEL to revise imported coal prices will ANALYST Vinayakam.P +91-44-30007361 vinayakamp@chola.murugappa.com adversely impact its profitability.

Attractively priced Indonesian coal

Through its wholly-owned subsidiary PT Adani Global, Adani Enterprises entered into agreements with holders of long-term exploration licenses to exclusively mine coal in Bunyu Island, Indonesia. These mines have an estimated reserve of 150mn tons, of which the company is currently extracting ~7mn tons per annum. It plans to increase output to ~8-11 Million Tonnes Per Annum (MTPA) to meet any deficiency caused by non-receipt of domestic coal. As per the agreement, Adani Enterprises will supply coal at USD36/ton (CIF Mundra), adjusted for coal quality, with escalation at the end of every five years from the commencement of operations of the project. The Free on Board (FOB) price of imported coal will be escalated by 10% every five years. APL also entered into an agreement with Mundra Port and SEZ (MPSEZ) to utilize their port and cargo handling services for which it will pay Rs300/ton towards port handling charges. These charges will increase at an inflationary rate every year.

Merchant sale and capacity addition are near-term earning drivers

APL's near-term earnings will remain buoyant on account of its accelerated capacity addition and higher merchant sale. We estimate APL to commission about 5,490 MW in FY12 and about 6,600 MW in FY13. We expect APL to derive around 33% and 26%of its FY12 and FY13 revenues from merchant power. With merchant rates remaining soft currently, we assume merchant tariff of Rs.4 Per unit for FY12 and FY13. APL has entered into a long term PPA of 25 years for all its projects. Capacity (MW) 1,320 1,320 1,980 1,980 1,320 1,320 PPA# (MW) 1,000 1,000 1,424 1,445 1,200 1,000 Levelized Tariff(Rs) 2.89 2.35 2.93 2.67 3.27 3.24

Plant Mundra I & II Mundra III Mundra IV Tiroda I & II Tiroda III Kawai

Utility Gujarat Urja Vikas Nigam Ltd Gujarat Urja Vikas Nigam Ltd Uttar Haryana Bijli Vitran Nigam Ltd & Dakshin Vitran Nigam Ltd Maharashtra State Electricity Distribution Company Ltd Maharashtra State Electricity Distribution Company Ltd JVVNL & AVVNL & JOVVNL*

*JVVNL Jaipur Vidyut Nigam Ltd; JOVVNL-Jodhpur Vidyut Vitran Nigam Ltd; AVVNL- Ajmer Vidyut Vitran Nigam Ltd; # PPA Power Purchase Agreement

Secured coal supply for most of its projects under development

The companys power generating portfolio comprises of all coal based capacities. Fuel requirement for Mundra Project, is fully tied up through 7 Million Tonnes Per Annum (MTPA) of coal from AEL and the balance through domestic linkages with coal India. Though, there are concerns over fuel linkage for Tiroda Projects balance coal requirement, We believe that the company is well placed to support its fuel requirement of all its projects due to strong backing from parent group.

Structural Advantage
Adani Power enjoys location advantage for most of its power projects as it derives benefits, such as, easy access to fuel & water and proximity to power deficit areas due to favourable location. Its Mundra Project is located close to the Mundra Port which is owned and operated by Mundra Port and Special Economic Zone Limited (MPSEZ), a promoter group company. Also, the company is positioning itself to cater to the need of a region with high power demand. It is evident from the fact, that 88% of its total planned capacity (9,240MW of 10,560MW) is being developed in Western India, which according to Central Electricity Authority (CEA), experiences highest power deficit in India. CEA does not anticipate power deficit situation in this region to improve below 11% in FY12.

Control over transmission assets for merchant power

Adani Power has dedicated transmission lines to connect its Mundra Project and Tiroda Project to State & Central government substations for power evacuation. Adani Power has already developed and commissioned 400 Kilovolts (KV) Direct Current (D/C) dedicated Mundra - Dehgam transmission line of 430kms. The company is also setting up another 1,000 kilometers (km) 500KV High Voltage Direct Current (HVDC) transmission system for supply of power to Haryana Power Generation Corporation Ltd (HPGCL). Along with this, the company is also developing a dedicated 50km 400KV Mohindergarh-Bhiwani transmission line for supply of power to HPGCL. Adani Power Maharashtra Limited (APML), a subsidiary of Adani Power, is developing a 221km 400 kV TirodaWarora transmission line as an Intra-state transmission licensee to evacuate power from APMLs Tiroda Power Project.

Cancellation of Lohara Coal-blocks for Tiroda Project

APL had been allocated coal blocks at Lohara West and Lohara Extension for the Tiroda project. However, the allocation got cancelled by the Ministry of Environment & Forest (MoEF), citing its proximity to the tiger reserve. However, the company has got a tapering linkage in lieu of the cancelled coal block allocation in the interim period and is expected to be allotted another coal mine in lieu of the Lohara mine.

PPA with GUVNL for Mundra Phase-II hangs in balance

APL has entered into a 25-year Power Purchase Agreement (PPA) for supply of 1,000MW of power from its 1,320MW Phase-II capacity in Mundra for a flat rate of Rs. 2.35 per unit. As the Mogra-II coal block has been designated as a No-Go Area by the Ministry of Environment and Forest (MoEF). APL intends to terminate the PPA and sell them in the short term market. The Gujarat Electricity Regulatory Commission (GERC) ruled against APL on its plea to terminate the PPA and APL has challenged this ruling with the Appellate Authority. The Appellate Authority has upheld the order of GERC and APL is likely to appeal in the supreme court.APL will have to use its imported coal from Indonesia to fire this unit which affects its margins. We believe that it would be very difficult for APL to get a ruling in its favour in this case as the onus of fuel availability lies with APL and has therefore factored in a rate of Rs.2.35 per unit in our estimates.

7,069 MW tied up to long term PPAs exposed to Fuel risk

APL has entered into a 25 year PPA for almost 7,069 MW i.e. 77% of its 2014 capacity of about 9,240 MW. However, bulk of these PPAs - i.e. 4,744MW at Mundra and Tiroda I & II - which come into effect from FY13 onwards, are Case I bids. In Case I bids any risk of increase in costs for these projects will have to be borne by APL, which exposes its profitability risk. PPA's for Mundra I & II, Mundra IV and Tiroda I & II factor in a nominal increase of 2.1%, 2.6% and 2.0% CAGR respectively in energy charge over the 25 year tariff period. PPAs for Tiroda III and Kawai (1,200MW each) have fuel and transportation cost escalation clauses in place, thereby protecting its earnings to that extent.

Ramp up in Coal India's production is vital for APL

Coal Indias FY11 production remained flat at 431mn tons over FY10. However, this was significantly lower than its target of 461mn tons. Further Coal India has reduced its FY12 production target to 452mn tons from over 485mn tons earlier. Mahanadi Coal (MCL) which is viewed as Coal India's best performing subsidiary in terms of output reported a decline in production during FY11. This was due to recurrent strikes by villagers and lack of law and order in Talcher Coalfields. Hence, if Coal India or its subsidiaries production falls short going forward, APL's cost dynamics will change significantly.

Financial Overview
Revenues to grow due to Capacity Additions
APL in FY11 has an installed capacity of 1,980 MW and is likely to increase its capacity to 5,940 MW in FY12 and 6,600 MW in FY13. APL revenues are likely to increase to Rs. 72,820mn and Rs. 1,27,187mn in FY12 and FY13 respectively as against Rs. 21,352mn during FY11. We have assumed merchant power rates to be Rs.4 per unit in FY12 and FY13. Unit Mundra I & II Mundra III Unit-1 Unit-2 Mundra IV Unit-1 Unit-2 Unit-3 Tiroda I & II Unit-1 Unit-2 Unit-3 MW 1320 660 660 660 660 660 660 660 660 Expected Commissioning Date Commissioned Commissioned Nov-11 Jun-11 Sep-11 Nov-11 Sep-11 Dec-11 Jun-12

Source: CSEC Research

EBITDA margins cushioned by coal supply agreement with AEL

Coal which is the major raw material for any power company has seen a phenomenal rise in the recent period with prices in the spot market hovering around $120 per MT. However, APL is in a sweet spot on account of its tie up with AEL to supply coal from its Indonesian coal fields at USD 36/ton. APLs EBITDA in FY12 and FY13 are likely to be around Rs. 42,073mn and Rs. 65,103mn as against Rs. 12,205mn in FY11. APL had reported EBITDA margins in FY11 at 57.20% and is likely to report EBITDA margins of 57.8% and 51.2% in FY12 and FY13.

EBITDA Margins
59.00% 57.00% 55.00% 53.00% 51.00% 49.00% 47.00% 45.00% 2010 2011
EBITDA Margins

2012E

2013E

Source: CSEC Research

PAT growth backed by strong Capacity Additions and Merchant Exposure

We estimate APLs net profit Rs.19,862mn and Rs. 29,172mn in FY12 and FY13 respectively as against Rs. 5,131mn in FY11 .PAT growth is driven by strong capacity additions and merchant exposure.

Valuation & Outlook:

We estimate APL to report EPS of Rs.8.20 in FY12 and Rs.12.20 in FY13 respectively. Apart from aggressive capacity expansion plans, coal linkages, merchant exposure and strong PLF above industry average are the key drivers for the stock. The stock at the CMP of Rs.88.15 trades at 10.75X and 7.22X of its FY12E and FY13E EPS respectively. We have valued the stock at 8X its FY13 EPS with a Marketperformer rating and arrived at a target price of Rs.97 for the stock. We have assumed cost of Indonesian coal at USD 36 per ton. However, any decision by AEL to revise imported coal prices will adversely impact its profitability.

Key Risks
Fuel Shortages
APL has entered into fuel supply agreement (FSA) with Coal India for its upcoming projects. Any shortfall in supply of coal by coal India will result in the company purchasing coal from the spot market which would put pressure on its margins.

Increase in Coal Cost

APL has tied up with AEL for 7 MTPA of coal which was supplied at USD 36/ton. However, the Indonesian Government has recently enhanced Indonesian coal prices to about USD 65 per ton though APL claims to have fuel supply agreement to supply coal at USD 36/ton. However, this would result in AEL taking a hit on its financials which may eventually end up in AEL revisiting its fuel supply agreement. Any move by AEL to raise coal cost to about USD50/ton or USD 65/ton will impact APLs EBITDA margins. We have created three scenarios for supply of coal at USD 36/ton, 50/ton and 65/ton given below. Year Coal Cost USD 36/ton USD 50/ton USD 65/ton
Source: CSEC Research

2012E EPS 8.3 6.8 5.1

2013E EPS 12.2 10.7 9.0

Financial Statement Income Statement Particulars Net Sales Other Income Total Income EBITDA Interest Depreciation PBT Tax PAT (Rs. Million) FY12E FY13E 72,820 127,187 1,238 2,162 74,058 129,349 42,073 65,103 8,514 17,028 8,664 11,854 26,134 38,383 6,272 9,212 19,862 29,171 Cash flow Statement Particulars Net Cash from Operations Net Cash from Investments Net Cash from Financing Net Flow Opening Balance of Cash Closing Balance of Cash Ratios Particulars OPM% EBIDTA% EBIT Margin% PBT Margin % NPM % Debt-Equity Ratio EPS (Rs.) (Rs. Million) FY12E FY13E 24,725 -87,370 87,363 24,718 12,551 37,268 38,644 -44,038 29,172 23,778 37,268 61,047

FY11 21,352 363 24,982 12,204 2,550 1,886 8,131 3,000 5,131

FY11 30,369 -170,689 141,217 897 11,654 12,551

Balance Sheet Particulars Share Capital Reserves & Surplus Equity Application Money Total Debts Deferred Tax Liability (Net) Minority Interest Total Source of Funds Net Block CWIP Investments Net Current Asset Net Deffered Tax Misc.Exp not W/O Total Application of Funds

FY11 21,800 41,073 9 245,027 3,120 5,663 316,692 87,472 236,909 100 -7,789 0 0 316,692

(Rs. Million) FY12E FY13E 23,932 23,932 66,071 95,242 9 9 333,635 379,835 3,120 3,120 5,663 5,663 432,430 507,801 234,199 174,084 100 24,047 0 0 432,430 317,016 134,808 100 55,877 0 0 507,801

FY11 58.9% 57.2% 50.0% 38.1% 24.1% 3.70 2.4

FY12E 59.5% 57.8% 47.6% 35.9% 27.3% 3.30 8.3

FY13E 52.9% 51.2% 43.6% 30.2% 22.9% 2.70 12.2

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STOCK RATINGS : Outperformer:>15% upside over the next 12 months; Marketperformer: trade within a +/-15% range over the next 12 months; underperformer:>15% downside over the next 12 months.