JSW Energy - cyclical utility - quant

JSW Energy (JSW IN) operates ~1,400 MW of merchant capacity from imported coal – the highest among peers. Given that ~54% of total capacity is from ST contracts, we expect high earnings volatility to continue. While global coal prices have corrected by 21% in US$ terms in the past year, benefits have been limited to only 16%, due to the depreciating rupee. As a sizeable portion of the fall in coal prices has already been factored into the CMP and capacity will remain at ~3,100 MW until FY15E, we initiate on JSW with a REDUCE rating and a SOTP-based PT of Rs65. Our sensitivity analysis shows PT in the range of Rs52-74 if merchant prices are in the band of Rs3.75-4.50/kwh.

Strong earnings volatility given high dependence on global coal and merchant prices: Merchant (or short-term) contracts made up ~54% of overall capacity for JSW in FY12. With merchant capacity being fully fuelled by imported coal, we believe it will face high earnings uncertainty. Our merchant price estimate is Rs4.20/kwh from FY13E.

Rupee a spoilsport in the global coal downtrend: International coal prices have fallen 21% y-y in the past year, primarily due to the slowdown in China and Europe and the availability of cheap gas in the US. While this bodes well for domestic importers, due to the rupee depreciation benefits have been limited for JSW. In our analysis, we assume global coal prices of US$85/MT and US$48/MT for 6,200 Kcal/kg and 4,200 Kcal/kg from FY13E. Our USD-INR rate is at Rs54.0 from FY13E.

No significant expansion in the near term: We expect JSW to become a 3,100-MW company in the next two quarters without any new capacity addition until FY15. Raj West Power, a 100% subsidiary, received a provisional tariff hike for its Barmer unit during November 2012, and we expect this to help it become profitable.

Valuation: We initiate on JSW with a REDUCE rating and a SOTP-based PT of Rs65. Power generation has been valued at Rs58 while investments in trading, transmission & coal are at Rs7.

Risks: Higher merchant prices leading to increased revenue, lower imported coal prices & rupee appreciation to reduce cost are key risks to our call and estimates.

Source : Equity Bulls

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