Tata Power's Q1FY19 results (Upgrade to Outperformer) - Sale of non-core assets gain momentum

Q1FY19 consolidated result highlights

• Tata Power’s non-core assets sale has gained momentum. During 1QFY19, it concluded the share purchase agreement with Tata Sons for selling its stake in Tata Communications at a value of Rs21.5bn. Board has also approved the sale of Strategic Engineering Division. In addition, Tata Projects sale is likely to be concluded over next six to eight quarters. Further, Arutmin sale proceeds of USD280m are likely to be realised over next few quarters. The proceeds will be used to reduce debt. We estimate this to reduce the leverage to  from 3.2x (end FY18) to 2.2x (end FY20)
• Mundra reported an under recovery of Rs0.92 per unit in Q1FY19 (vs Rs0.93 per unit in Q1FY18). Mundra availability was 68% in Q1FY19 (normative of 80%). As a result, Mundra UMPP’s reported an adjusted loss of Rs3.3bn in Q1FY19 (vs loss of Rs3.1bn in Q1FY18). 
• Domestic market obligations (25% to be sold to domestic power producers at capped prices) set by Indonesia has led to decline in gross profits in Q1FY19. As a result, despite increase in coal prices, profit contribution from mines was Rs2.5bn in Q1FY19 (vs Rs2.9bn in Q1FY18). Gross spread (realisation minus cash cost) decreased to USD 20 per ton in Q1FY19 (vs USD23 per ton in Q1FY18)
• Standalone EBITDA/ adj. profit was Rs5.7bn/Rs1.7bn. Cons. profit of Rs2.8bn  (adj. for exceptional item) for Q1FY19 was below estimate of Rs3.7bn. Profit has been adj. for exceptional gain of Rs14bn  (adjusted for tax) recognised for the sale of  stake in Tata Communications 

Key positives: Concrete steps to divest Telecom, Defence and other non core businesses; Mumbai PPA rolled over till FY19

Key Negatives: Coal Supply at discounted prices under Indonesian domestic market obligation (Total impact of USD20m per annum)

Impact on financials:  Reduce our earnings estimates for FY19E/FY20E by 22%/8% to account for domestic market obligations

Valuations & view

Tata Power efforts to deleverage the balance sheet by selling its non core assets have started bearing fruit. After successful sale of stake in Telecom, sale of strategic electronics division and Tata Projects is likely to happen over next six to eight quarters. The proceeds are being used to deleverage the balance sheet. Despite downgrade of earnings in Fy19 and FY20, stock has corrected 25% since January 2018 and trading cheaply at 1.0x FY20 P/B and 11x FY20 P/E.  As a result, we upgrade the stock to Outperformer with a revised target price of Rs88/share (revised on DMO obligations) on back of deleveraging efforts and comfortable valuations.