GVK Power & Infrastructure: Avoid

GVK Power & Infrastructure: Avoid


INVESTORS can give this IPO from GVK Power & Infrastructure (GVK Power) the go-by. The proceeds of the offer will not be used to create any productive assets directly. The money will be used to invest in subsidiaries that are setting up thermal power plants. As such, the expected returns from this investment do not appear good enough to justify the offer price of Rs 260-310 per share.

Holding company


GVK Power plans to use the funds from this public offer to increase its stake in a group company, Gautami Power (GPL), and to repay loans borrowed to invest in the equity of the same company **earlier. GVK Power will become the holding company once the group restructuring, of which this offer is a part, is put through. It will hold interests in two subsidiaries that generate thermal power — GPL and GVK Industries (GIL).

GIL operates a 216 MW mixed fuel power plant at Jegurupadu, Andhra Pradesh. It is now on the verge of commissioning phase II of this project — a 220 MW dual fuel combined cycle power plant — at an approved cost of Rs 720 crore. GVK Power holds a 53.96 per cent stake in this company, originally a joint venture between the GVK group and CMS Energy of the U.S.

GPL is implementing a 464 MW dual fuel combined cycle power project at Peddapuram at an approved cost of Rs 1,450 crore. This plant is likely to commence operations from September this year. GVK Power, which now holds 45.33 per cent stake in GPL, will use the proceeds of this offer to hike its stake to 51 per cent in the company.

Revenue model


GVK Power's revenue model does not appear very robust. It will mainly consist of fees for operation and maintenance (O&M) of the power plants owned by the subsidiaries and dividends received from them. There will also be incentive fees based on the operational levels of the power plants. The audited financial statements for the year-ended March 31, 2005 show operating fees of Rs 3.86 crore and total turnover of Rs 7.45 crore, including expenses reimbursable by the subsidiary. On this revenue, the company posted earnings of Rs 1.76 crore, lower than the Rs 2.54 crore it earned in 2003-04.

The financial statements of the first half show a jump in revenues and earnings to Rs 11.72 crore and Rs 4.22 crore respectively, but that includes a hefty `other income' of Rs 5.13 crore which may not be sustainable. GVK Power's fortunes directly depend on that of its subsidiaries. Buoyancy in revenues can come only from higher operating levels at the power plants as this will bring in higher incentive income.

Dividend income is again a factor of the operating efficiencies of the power plant as earnings would be dependent on that. The full benefit of dividend income on GVK Power's earnings are likely to be felt only in 2007-08 or later as GPL's project is likely to go on stream only by December this year.

Operational risks


The new plants being commissioned would start with a disadvantage as gas availability in Andhra Pradesh is not adequate to service the requirements of the power stations in the State. GAIL, which is the supplier of gas to GIL and GPL, has already indicated that it may not be able to supply the agreed quantum of gas.

The options are to either run the plant at low capacity levels or make up the shortfall with high-speed diesel. Running the stations at low plant load factor will result in loss of revenues as the AP distribution companies have signed an agreement with GIL and GPL to not pay the capacity charge till the end of 2006 for the unused capacity.

Using high-speed diesel may push up the tariff and make the power produced uncompetitive.

The Phase I of GIL's 216 MW plant could operate only at 75 and 80 per cent PLF in 2004-05 and 2003-04 respectively due to the inadequate gas supplies. Gas availability is unlikely to improve dramatically at least for the next three years until the gas discovered in the KG Basin deep waters is brought to shore by Reliance and/or ONGC.

With the cheapest power likely to be picked up first under the merit order despatch norms, the new projects of GIL and GPL, with their high fixed cost component in the tariff, are likely to find themselves out in the cold.

Another factor to be taken into account is that reservoirs in the State have record storage levels which means that the option of tapping hydel power, which is cheap compared to gas or liquid fuel-based power, will be attractive for the discoms. Given the above, the visibility on the earnings front appears a little clouded at this point in time especially for the subsidiaries, GIL and GPL.

Not a power play


It would be wrong to consider GVK Power as a play on the power sector for investment. It is more a services company deriving bulk of its income from maintaining the power plants of its subsidiaries. As such, the scope for buoyancy in revenue and earnings appears limited.

The restructuring activities of the group and the presence of innumerable group companies, mostly held privately by the promoters, for similar businesses including power generation, dims the picture on the corporate governance front. Investors can avoid this public offer.


Source : Hindu Business Line