Stock Name: MUDAJYA
Company Name: MUDAJAYA GROUP BHD
Company Name: MUDAJAYA GROUP BHD
| Research House: OSK | Price Call: HOLD | Target Price: 2.66 |
THE BUZZ
The Wall Street Journal reported that Coal India Ltd's (CIL)board of directors has finally given the green light for the company to signFuel Supply Agreements (FSAs) with power producers in India. This comes after apresidential directive issued by India's government to the state-owned companyto sign the accords after CIL missed the initial deadline of 31 March. Weunderstand that the FSAs will be signed within the next 3 days before 20 April.
OUR TAKE
What happened back then? 90% owned by the state government,CIL is the largest coal producer in the world in terms of capacity. Itcontributes to some 90% of coal production in India. InFY03/11, CIL produced 436m tonnes ofcoal, missing the government's previous target of 447m tonnes as heavy rainfall hit operations. Consequently,several power stations had to stop or cut production late last year due to fuelshortages, leading to blackouts in some parts of the country. To ensuresufficient coal supply going forward, India's Prime Minister Officeadministration has set an initial deadline of 31 March for CIL to enter intoFSAs with power producers. Nonetheless, the deadline was not met, promptingPrime Minister Manmohan Singh's administration to issue a presidentialdirective on 5 April to ensure that CIL sign the accords within the next 15 days.
Deceivingly positive.At first glance, the announcement seems positive with the FSAs between CIL andpower producers finally being sorted out to ensure sufficient coal supply tomeet fuel requirements. The long-awaited agreement is expected to benefit power plants with anestimated capacity of 50kMW with the nation now sitting on total 193kMWof installed capacity. Nonetheless, after counterchecking with other media sources from India, we found outthat CIL has set itself a lower penalty (to be paid to power producers) if it failsto meet the minimum supply obligations, which we deem a negative surprise.
Lower penalty putsconviction in doubt. Under the FSAs as approved by CIL's board, should thecompany fail to supply at least 80% of the contracted coal to the new power stations,it would only have to pay 0.01% of the value of the shortfall as the penalty asopposed to the 10% stipulated previously. And again to the disadvantage of the power producers in India, the penaltyclause will only be triggered afterthree years from the date of signing the FSAs. In our view, the FSAs havenearly wiped off all the liabilities that CIL will have to bear arising from a potential default in case of a coal supply shortfall. This puts its commitment towards ensuring sufficientfuel requirements in doubt and leads us to believe that there is increasingrisk of shortages in fuel supply, which could jeopardize the entire powerindustry in India.
Nothing is certain inIndia. Although Mudajaya's management confirmed that its 26%-owned associateRKM Powergen has secured a backup coal supply in India amounting to 99m tonnes which will meet the fuel requirements for its 4x360MW power plant in Chhattisgarhfor over 15 years, we are increasinglyconcerned over the flip-flopping of policiesby India's existing administration. A few recent examples include the ban oncotton exports, introduction of a provision that allows India to tax foreigntakeover of Indian assets retroactively to 1962, cancellation of telecom licences issued previously to some foreign telco operators, revocation of its approval to allowforeign supermarkets to enter India as well as suspension of South Koreansteelmaker Posco's plans to build a USD12bn steel mill in India. This latestpiece of announcement aggravates our concerns further as we deem the loweredpenalty a lower commitment from CIL to honour the FSAs and we also do notdiscount the possibility of the Indian government taking back its words on the allocatedbackup coal supply. There is mounting pressure from opposition parties which questionthe huge 50%-60% discount attached to the contracted coal supply pricing, whichreportedly translates into a loss of national income of over INR10tn.
Imported coal not aviable option for now. Should the local coal supply fall short, RKM Powergenwould likely have to source its fuel requirements in the international coalmarket as the last resort. Currently, imported coal is trading atUSD90-110/tonne vis-''-vis RKM Powergen's coal linkages with the Indian Government atan effective price of USD40-50/tonne. Nonetheless, we understand that the existing fuel cost pass-through formula doesnot explicitly incorporate a potential hike in operating expenses should RKM Powergen source its coal requirements fromoutside of India. Given the political ruckus that is created every time a stateelectricity board contemplates a tariff hike, we think a revision in itsexisting fuel cost pass-through formula is rather unlikely at this juncture andhence, imported coal does not look like a viable option in the near term.
Risks of Chattisgarhbeing left idle increase. RKMPowergen's power plant in Chhattisgarh is scheduled to commence operations by4Q12 with the first unit likely to do so by the end of this year, while the 3remaining will go on stream on a staggered basis, i.e. every 3 monthsthereafter. With this latest development, we see increasing risks of its plantbeing left idle upon completion, as witnessed in the current scenario for someof the Independent Power Producers in India, as CIL have removed most of itsliabilities in the event of coal production shortfall. On the other hand, thepossibility of utilizing imported coal,which is a lot pricier, seems unlikely for now until the state electricityboard gives its nod on the revision of electricity tariffs.
Downgrade to NEUTRAL. We are downgrading our call on Mudajaya fromBuy to NEUTRAL in view of the potential risks arising from a potential shortfall in coal supply to meet its fuel requirements. By the same token, our FV is now revised downto RM2.66, after attaching a steeperdiscount of 50% (from 30% previously).While some may argue that our FV now implies a rather appealing 6x FY12PER being pegged to Mudajaya's construction earnings sans any contribution from its Chhattisgarh power venture, our cautious stance is warranted by potentialwrite-offs in its books (in the form of writing down its investment in RKMPowergen which stood at RM431m as well as its outstanding receivables ofRM683m) should the Chhattisgarh venture turn sour. Do note that as of Dec 2011,its remaining works on Chhattisgarh amounted to RM1.8bn, making up close to 50%of its outstanding orderbook.
Source: OSK188
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