Indian renewables - The state of play
Monday, January 16, 2012 | Posted by: Grant Thornton
Categories:
India,
India Watch Issue 15
| Tags: energy,
india,
private equity,
renewable energy,
capital,
fuel,
valuations,
renewable independent power producers,
IPPS,
coal,
electricity,
power,
indian renewables,
renewable companies
Power in India is a commodity in demand – mainly sourced by coal. India has the third-largest hard coal reserve in the world, however, the quality is relatively poor due to its low sulphur and high ash content. Additionally, supply is constrained to a small number of inefficient state-owned companies and India’s Ministry of Coal estimates that the demand will increase significantly in 2012. All these factors are attracting domestic and international private investment to the renewables sector.
Anyone that has travelled to India is likely to have experienced a power outage at some point during their stay. This is not uncommon given that the country operates at a peak energy shortage of 12%. Moreover, its per capita consumption of power is amongst the lowest of the BRIC nations, and below the world average (some 300 million Indian citizens still have no direct access to electricity).
Power in India is therefore a commodity in demand. A bottleneck in the value chain is the supply of fuel – coal being the dominant fuel source. Despite having the third-largest hard coal reserve in the world (after the United States and China) the quality is relatively poor due to its low sulphur and high ash content. Supply is also constrained to a small number of inefficient state-owned companies; India’s Ministry of Coal estimate that the demand-supply gap will increase to 106MT in 2012 from 74MT in 2011. There is now a growing import market of coal from Indonesia.
These issues are two of the key drivers for the rise of renewable independent power producers (IPPs). Private investment into the sector has been encouraged by the government through preferential power-purchase agreements and the introduction of a Renewable Energy Certificate market. As a result many projects (at the moment mainly hydro, biomass and wind) are generating leveraged IRRs in the late teens.
Such returns have attracted domestic and international institutional capital. Over the last year private equity investment into Indian renewable companies increased five-fold from US$100 million to US$522 million. This takes the total private equity investment to over US$1 billion since 2006. Indian IPPs on London’s AIM market have also been successful in raising capital, in 2010 we estimate £120 million was raised which grew to nearly £190 million in 2011. We expect this to continue to grow as we estimate the capacity for renewable energy in India is some 69GW. This does not include solar assets, which is only recently begun to attract investment as a result of the recent state and national auctions.
It is natural to assume the sector is a defensive play given that government reforms in the renewable and wider power market should protect IPPs from global and national economic headwinds. However over the last 12 months the value of pure-play public Indian renewable companies (listed in London and in Bombay) has fallen by 22% on average. This has performed in line with the overall market (the BSE Sensex falling by 23% over the same period).
We believe one of the reasons for this could be due to the increases in debt financing costs caused from inflationary pressures. The Indian central bank has increased interest rates 13 times over the past two years; taking it from 5% in 2009 to 8.5% in 2011. Despite the central bank deciding to not raise rates last month, and some early signs of easing inflationary pressure, we believe it is still unclear if rates will fall in the short term.
Another reason for the fall in valuations could also be due to a lack of well-established companies in the sector. We estimate there are only six pure-play renewable energy generators in India that are listed. Only three of which have a market capitalisation of over £100m, and five have a combined installed capacity of less than 800MW. Such small/mid-cap stocks often have poor liquidity which typically obscures valuations, particularly during flight to quality periods.
These factors, in the backdrop of political unrest due to the recent corruption scandals, may still be in-play during the early part of 2012. However a strong catalyst for improvement in stock valuations is through commissioning assets. For example a typical wind asset should generate over US$200,000 in EBITDA per MW once in operation; a decent sized wind site could therefore make a dramatic difference to the financials of a small-cap stock. We are therefore most bullish on those stocks with a management team that has a strong track record, and a fully funded pipeline of assets which are expected to be commissioned in the short term. Such stocks have mitigated risk profiles given financial closure is complete (a significant hurdle for any infrastructure related company), and also offer good upside as the market typically does not price in pipeline projects.
Gurpreet Gujral
Director, Research – Cleantech
Brewin Dolphin
E: Gurpreet.gujral@brewin.co.uk
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