Tata Power: Transition should lead to improvement in return ratios

We take a closer look at TPWR and its globally integrated utility peers on various fundamental and valuation metrics. A decisive action plan has been initiated, and execution holds the key. This transition should lead to stronger focus on specific businesses and improvement in return ratios.

Global comparisons: We find it of interest that global utilities focused on a single line of business tend to trade at higher and better multiples as they are easier to understand and often have stronger return ratios. In addition, investors tend to look upon global integrated utilities that are undergoing transition more favourably. We think TPWR 2.0, an integrated utility, is attractively valued compared to global peers against the backdrop of its business transition plan that is underway.

TPWR 2.0 – The plan: As TPWR completes its business restructuring (sale of non-core businesses, reduction of net debt, and creating a capital refinancing vehicle for the Invit renewable business), we think this should lead to a healthier balance sheet and stronger return ratios. The focus

is on increasing exposure in the regulated business (T&D), ramping up the asset-light consumer-facing businesses, and growing the renewable platform by recycling capital. Imported spot coal businesses, such as the Mundra plant and coal assets in Indonesia, have been a drag on overall ROCE. We believe TPWR’s exposure to coal-facing businesses will keep coming down incrementally. If its foray into some complementary consumer-facing businesses is successful, it could present interesting long-term monetisation opportunities, in our view.

What are investors looking for incrementally? The narrative had been anchored on earnings progression/disappointment below ebitda, and now has shifted to earnings progression above ebitda. We think TPWR management will have to demonstrate consistency in its thought process, strong execution of its stated strategy, regular communication about medium-term milestones (growth aspirations, return ratios, leverage, etc.) and clarity on its long-term dividend payout policy.

What’s changed? We raise our PT from Rs 62 to Rs 72 on the back of increased earnings forecasts driven by Mundra (Q1 earnings, lower international spot coal), lower debt and interest burdens following the equity infusion by promoter group, and stronger capex in regulated T&D business.