Analyst Corner: Maintain ‘buy’ on Tata Power with increased TP of Rs 73

By HSBC Global Research

Even with an elusive Mundra resolution, low coal prices and deleveraging should make this pain inconsequential. Hiving off the renewable portfolio will unlock value, reducing the leverage overhang, and drive stock performance near term. Maintain Buy; increase target price to INR73 (from INR66) with further upside contingent on firm execution.

The journey so far. The company has continued to sell non-core assets, further facilitated by the promoter group’s preferential equity allotment. It has reduced net debt by INR72bn (17%) over the last four quarters, to INR368bn (not counting perpetual debt and lease liabilities). The key Mundra issue remains unresolved.

We don’t see a potential resolution in the near term, especially as governments are busy handling Covid-19. However, low coal prices have significantly reduced the pain and cash profit at the integrated coal business level has now become positive. Further debt reduction should make it easier to service debt on Mundra.

De-leveraging troubles and simplifying the structure: We believe there are INR20bn worth of non-core, low ROE assets which can be sold, and another INR28bn of net debt reduction to be accrued from past sales (including INR10bn from the SED sale, which is just completed, with the balance coming from Arutmin). Beyond this, the firm is divesting its renewable business (INR185bn as per HSBC’s valuation) which will release capital. The company is also merging its solar EPC and Mundra asset with its parent entity which should lead to huge tax benefits. This should reduce the number of subsidiaries and simplify its business model to regulated distribution businesses, legacy coal production, related infra and thermal power, and solar EPC with equity investments in renewable InVit. These should allow the company to focus on growth.

Execution is key to unlocking value. On our sum-of-the-parts valuation, our current fair value TP is INR73 (implying 22% upside) but contingent on the company executing its stated strategy.

We believe there could be upside of an additional INR34 per share (further 47% upside from our TP; total 79% upside from the CMP) (see details on page 8-9). However, we worry about the following impact on ESG attractiveness of the separation of renewable business, potential rise in coal prices which can hurt Mundra, risk of another round of multiple small investments taking away management’s bandwidth (see company’s comments and our thoughts on page 9).