Why I am investing in Tata Power?

Tata Power Has 3 major business segments –

  1. Electricity generation via Coal
  2. T&D (Transmission & Distribution)
  3. Electricity generation (RE)- Wind and Solar

Additionally, it holds coal Mines to source Coal for Electricity Generation

Due to the nature of the business, Tata Power has strong and predictable cash flows on account of long-term PPAs with the Government and Commercial Customers.

Tata Power would not grow its Coal Electricity generation business organically and would not invest. This is a declining business with low ROE. The only CAPEX needed in this segment would be to maintain the existing assets.

Tata Power will invest into T&D business, as key participant in the governments objective to Partner with Private industry (including complete privatization) into these segments. Currently, these are loss generating businesses and offers huge incentives to govt. to privatize it . This segment typically provides 10-14% ROE (avg. 12% with D/E of 1)

The major growth segment is RE , where TATA has won major bids and is growing. This segment is generating avg. RoE of 9% currently.  Total Equity invested = 6000 cr. (D/E ~ 2)

Currently, the business generates predictable stable free cash flows of 1000 ~ (Rs. 3-4/share) and is available at E/P ratio of 8%-11% out of which 50% is paid back in dividends, hence dividend yield of 4.4%

Going Ahead, the company will reduce debt by –

  • Conservatively 10,000 crores and will increase FCF by approx.500 per year = Rs ~ 2/share by sale of assets. This would increase the E/P yield further and provide cash flow to fund CAPEX.  This would make total FCF = 5-7 Rs (eq E/P of 15%-20%)
  • Alternatively, company may raise additional equity which can dilute upto (25%) decreasing E/P to 6%-8% with dividend dilution to 3.3%

Total Equity = 22,000 crore

FCF = 1000

ROE = 4.5%

If you exclude Mundra (CGPL) Biz, FCF is 2100 crore with Equity of 17,000 generating ROE = 12.3%

To value the business, hence, the following must be considered

  • Other biz. Include T&D Business  – 1600 FCF with Equity of 11,500 (14%)
  • RE Biz – 500 FCF with 9% ROE on equity of 5,500 crore
  • CGPL Business – (1100) Crore FCF with equity of 5000 crore

Avg. ROE on additional capital invested – 12% (Range from 10%-14%)

No growth FCF = 1000 crore

No growth valuation = 37

Currently, Tata Power is fairly valued assuming that the current scenario continues forever.

(In 10 years, you can get money back)

  1. Growth is a margin of Safety
  2. Other Upsides-
  3. Mundra tariff resolution (~ Additional Upside of 500-600 cr FCF ie 10-15 Rs in valuation)
  4. Debt Reduction (10,000 crore reduction Can increase FCF by Rs 2 per year)

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