CORRECTION: It has come to our attention that our original article, dated 25 Oct 2012, contained certain inaccuracies. We would like to correct those in the following revised article, below:
Reliance Power Limited is one of India’s largest power generating companies, but it’s in the headlines for all the wrong reasons these days, including controversy over some key coal supply contracts. Together with its heavy debt load, this puts the quality of its profits into question.
Anyone who followed the drama following the 2002 death of the founder of Reliance Industries Dhirubhai Ambani, might have hoped that after his widow, Kokilaben Ambani, divided the group’s assets between their two feuding sons, life would proceed more calmly and the business outlook for both would look more upbeat. But at least in the case of Reliance Power Ltd. (RPWR.IN) a division of Reliance Group (RPOL.NS) headed by Anil Ambani, the company seems to have sailed into choppy waters.
Indeed, Reliance Power’s array of projects both at home in India and overseas are encountering an array of problems. Its construction of a coal mine in Indonesia has fallen behind schedule. Chitrangi pace of development is tied to shortages of coal supplies from the Sasan mines. (We’ll get to the root of that problem, which stems from a contract issue, shortly.) The company’s Samalkot gas-fueled power plant also is likely to be delayed by at least two years as it scrambles to finalize gas supply issues with the government. The project is awaiting allocation of domestic natural gas from the government.
Overall, Reliance’s relationship with the Indian government is coming under a lot of additional scrutiny. Since the 2011 scandal surrounding the licensing of 2G wireless spectrum in India, amid accusations of bribery that followed revelations that some of these spectrum contracts were offered at discounts, any bids by any company for any state-owned resource have attracted a heightened degree of oversight. Reliance Group’s activities, in particular, seem to have run afoul of best practices. It won government approval to develop three blocks of coal reserves near a 4,000 megawatt power plant it was developing (the Sasan mines and project), but the government went further, allowing it use the surplus coal from Sasan to supply the Chitrangi power project. Since Chitrangi would be supplying power to the power grid at a higher tariff than the Sasan project, Reliance Power was able to capture the difference in the form of profit. An Indian federal government auditor calculated in a recent report that the government cost the country some $33 billion of lost revenues by allocating coal reserves and at a fraction of their real market price, although the auditor does exclude the Sasan coal blocks from the presumptive loss to the country . The report has caused an uproar in the Indian parliament, with accusations of illegal transactions flying fast and furious, and the risk of litigation is likely to hang over the industry for some time to come.
While the company’s projects are running into trouble, the cost of paying for them has been rising steadily. As you can see in the chart below on the left, capital spending by Reliance Power has been rising steadily for the last five years, to reach a whopping 108 billion rupees ($2 billion) in the year ended March 31, 2012. As a result, the company’s cash flow position is poor, with negative free cash flow of -$2 billion for the year ending March 2012. These aren’t automatically a reason to worry: if the company’s new projects come online in a timely manner and deliver revenues and earnings as anticipated, the financial picture will improve. If these projects are delayed, as seems possible, the consequences are worrying.
Reliance Power’s long-term debt has ballooned to more than $2.5 billion as of March 2012, from just $300 million three years ago. As interest payments on these loans increase, the pressure on the company to bring its projects online in a timely manner so that it has the cash flow to service those payments will only increase. Over the longer run, this kind of capital spending/cash flow trend is not sustainable and the company’s inability to deliver strong cash flow to back up any earnings will call into question the sustainability of those profits.
Across the board, Reliance Power’s financial metrics appear to be deteriorating. Its margins continue to fall, with net profit margins tumbling from 72% a year ago to 43% today. Operating profit margins also have decreased, from 95% a year ago to 70% today.
These trends explain why Reliance Power scores a mere 4 out of a possible 100 on the StarMine EQ model. That signals that its earnings already are appear to be unsustainable, a conclusion that, given the company’s high debt and rising interest expenses, is a worrying one for investors to ponder.
Analysts continue to cut their estimates for both Reliance Power’s revenues and its profits for the current fiscal year (ending March 2013), and for the following year as well, as can be seen in the chart below. That explains why the company earns a score of only 8 of a possible 100 on the StarMine Analyst Revisions Model, a low ranking that also signals analysts are likely to continue those downward earnings revisions.
As if Reliance Power isn’t in enough hot water with its finances and its operations, the upcoming elections in 2014 may bring to power a new government that may well decide, as a matter of policy, to review any existing contracts. Government contracts to develop coal mines and build and operate coal-fired generating plants may have been lucrative for Reliance Power in the past, but they are likely to be a source of concern and uncertainty going forward, given the company’s several government contracts that enable it to acquire the coal and natural gas it needs to fire up its power plants.
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