Watch out for those drowning in debt

Brushing aside their significantly leveraged balance sheets, stocks of Jaiprakash Power Ventures (JP Ventures), Adani Power, Lanco Infratech and KSK Energy Ventures have shot up 42-86 per cent from September 2013 lows. Apart from expectations of interest rate cuts, hopes that these companies will be able to make asset sales to reduce the debt on their balance sheets have driven stock prices. Recent deals such as JP Ventures’ proposed sale of its entire portfolio of operational hydro power projects of 1,791 MW to Reliance Power fuelled such hopes. But it may be too early to bet on such a trend.

Take the JP Ventures-Reliance Power deal. If it goes through, it may value JP Ventures’ power assets at over ₹10,000 crore, bringing in cash that will no doubt come in handy for the de-leveraging of the group balance sheet. But it is clear that JP Ventures has been forced to give up its primary cash cow to de-leverage the group’s balance sheet.

The sale of these facilities is likely to deprive it of a sizable portion of its current revenues and cash flows. The three hydro power projects on the block generated revenues of about ₹1,900 crore, three-fourths of the company’s revenue in 2012-13.

After the asset sale, JP Ventures will be left with one operating coal-based 500 MW power plant until it commissions 600 MW of its Nigrie Super Thermal Power Project some time in August.

Also, the deal values the JP Ventures’ hydro power assets at about ₹5.6 crore/MW, which is a tad lower than the market valuation for peers such as NHPC. Thissuggests a going rate of about ₹6.3 crore/MW. For Reliance Power though, this appears to be a sweet deal. It will be able to acquire operational hydro power plants at a reasonable valuation. It currently runs a coal-based generation capacity of 4,440 MW and does not have any operational hydro power capacity.

For investors in power generation companies, what this deal signals is that while asset sales may pick up from here, it’s going to be a long, arduous road for some of the more leveraged groups to resolve debt problems.

Take Lanco Infratech, for instance, now in the midst of debt restructuring. It had a debt to equity ratio (DER) of almost 24 times as of March 2014. Others such as Adani Power and KSK Energy Ventures are significantly leveraged with DER of six times and 4.5 times, respectively, and can best be avoided. The two also have poor interest coverage (earnings before interest and tax/ interest) ratios of less than one time, indicating that they can also be pressured by liquidity problems.

However, there are players within the sector with more moderate levels of debt who can fight their way back to health. Companies such as Reliance Power, Torrent Power and JSW Energy are more moderately leveraged (each with a DER of 1.4 times) to begin with.

While Tata Power too had a high DER of 3.3 times (consolidated debt of ₹35,197 crore) as of March 2014, some recent moves offer hope on de-leveraging and make it worth betting on.

One, the company raised ₹1,993 crore through a rights issue in April this year, helping it bring down its DER to 2.8 times. Apart from this, in July, the company signed option agreements to sell a 5 per cent stake in the Indonesian coal company PT Kaltim Prima Coal (KPC) for $250 million and its entire 30 per cent stake in KPC related power infrastructure companies. Earlier, in January, it entered into an agreement to sell its 30 per cent stake in PT Arutmin Indonesia and associated companies for $500 million. But it is the state-owned NTPC with a DER of 0.9 times that is an investor’s best bet if he/she wants to play it safe.