Recall our earlier thesis that high interest rates and capital cost escalations will adversely affect Reliance Power’s (RPower) planned projects.
Since then, because of an economic downturn, central banks globally cut interest rates and infused liquidity into the banking system. We believe this monetary easing will help RPower arrange debt at cheaper rates.
We accordingly assume a lower domestic interest rate of 12% vs 13.25% earlier. We also assume a lower cost of foreign debt of LIBOR + 350bp vs the earlier LIBOR + 675bp.
Also, commodity prices have cooled down significantly. Price of steel, which accounts for 45-50% of total capital cost of a power plant, has come down by 49% from its peak in August 2008. We now no longer assume the 15% capital cost escalation for RPower’s projects.
Tata Power has petitioned the Delhi High Court challenging the government’s decision to allow RPower to use surplus coal from the Sasan Project’s captive coal blocks for RPower’s other power projects.
Tata Power has claimed that initial bid documents did not contain such a provision and the change in the project structure after the Sasan Project was awarded to RPower was arbitrary and illegal.
We believe that this case could delay the implementation of RPower’s Sasan and Chitrangi (erstwhile MP Power) projects.
We factor in these risks by assuming lower probabilities for Sasan and Chitrangi in our probability based valuation. We now estimate the combined value of these projects will be Rs25/share compared to Rs54/share previously.
We reiterate our REDUCE recommendation and lower our target price to Rs105 from Rs136 valuing RPower’s projects using our proprietary probabilitybased valuation model.
We estimate an upside of Rs15/share to our target price if its gas dispute with RIL is resolved at a price of $5.20/ mmbtu. We also estimate an upside of Rs37 per share to our target price if RPower is able to execute both Sasan and Chitrangi projects.
The company currently has no operating income and only generates interest on the cash it raised in its IPO last year. We reduce our other income estimate on expectations of lower interest rates in second half of FY09.