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Tata Power Company share price fell 1 percent intraday Tuesday after Motilal Oswal has initiated coverage with sell rating on the stock, citing rich valuations.
"Valuations are rich because company's return on equity (RoE) is less than its cost of equity and growth is not RoE-accretive. We value the stock at 1x FY19E P/BV, with a target price of Rs 69 per share, implying 18 percent downside," the company explained.
The research house said the company's earnings would get a boost on sharp increase in thermal coal prices and inorganic growth but its RoE would still hover at around 11 percent over next three years, which is lower than its cost of equity.
Regulated business, which earns superior RoE, has many challenges and lacks material growth, it feels. Renewable energy is expected to drive capex and growth but it is unlikely to boost RoE due to high competition, it said.
The strategic engineering division has tailwinds in the form of high growth from defence opportunity, but it contributes just 1-2 percent of EBITDA.
The recent Supreme Court (SC) order has dashed the hope of compensatory tariff (CT) for CGPL Mundra, leading to losses. The declining structure of capacity charge and rising operation & maintenance costs would remain drags, Motilal Oswal said.
Coal prices are strong on supply-side discipline, which is a silver lining because of its net long position in mining assets in Indonesia. Coal prices and interest rates are the key sources of earnings volatility, which drives up cost of equity, it added.
The brokerage house said the pending sale of stake in the Arutmin coal mine, quoted investments and 1.65 percent stake in Tata Sons would be key toward value unlocking.
According to the house, key risks could be higher-than-estimated coal prices, resolution of capital under-recovery issue in Delhi, and the sale of non-core assets.
Tata Power is a leading private sector power supplier, with capacity of 10,477MW (71 percent thermal, around 7 percent hydro, around 10 percent wind, 9 percent solar and 3 percent waste heat recovery), largely in India. It is also engaged in electricity distribution in Mumbai/Delhi, and has stakes in coal mining assets in Indonesia and certain overseas power generation assets. It has consolidated its position in renewable energy, with the acquisition of Welspun's assets.
At 13:59 hours IST, the stock price was quoting at Rs 83.50, down Rs 0.65, or 0.77 percent on the BSE.
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