After giving tepid returns for four years ending 2020, Tata Power’s stock turned a corner and delivered over 3X returns in the past 21 months. This run-up of its stock is mainly due to the rapid ramp-up and the recent fundraising in its renewables business. The stock is currently trading at a TTM PE of around 35, which is above its five-year average PE.

But it’s not just the company’s renewables business that got investors’ attention. The company’s profitability has also improved over the past five quarters, and the recent Q1FY23 quarter was the eleventh consecutive quarter of YoY net profit growth.

This helped Tata Power to slowly improve its return on net worth over the past four years and in FY22, it shot up to 9.5% compared to 6% in FY21.

The company plans to double down on its renewables (solar and wind), engineering procurement and construction (EPC) businesses for power utilities, solar modules, and cell manufacturing, and chargers for electric vehicles, among others.

Even though the company recently laid out an expansive 2027 vision for its various businesses, the analyst consensus recommendation on the stock of ‘Hold’ must make investors wonder about what is in store for Tata Power.

Focus on margins, renewables, EV chargers, EPC business, and more

After bidding aggressively for various power projects in the past, Tata Power’s management now only wants to focus on projects that fetch it decent margins. “The message to my team is that we should not worry if we lose a bid, '' said CEO Praveer Sinha at the recent analysts’ day meet. “We should never compromise on our returns. Return is sacrosanct, come whatsoever.”

This is one of the reasons Tata Power managed to improve its return on net worth over the past few years. The company is taking a focused approach to investment in renewables under its subsidiary Tata Power Renewables (TPREL). This arm now houses Tata Power’s EPC and solar pumps businesses (Tata Power Solar Systems), utility-scale renewable generation projects, charging points for electric vehicles, manufacturing operations, etc. This comes after it inked an investment deal worth Rs 4,000 crore with a consortium of Blackrock and Mubadala. The company has already received the first tranche of Rs 2,000 crore.

The company is investing in a new plant to manufacture solar modules and cells with a capacity of 4GW each in Tamil Nadu at a cost of Rs 3,000 crore. The solar cells and module manufacturing unit will help the company cut costs on account of expensive imports due to the Centre’s imposition of duties on solar cells and modules. The solar module plant will be commissioned by June 2023 and the cells unit by November 2023.

Tata Power’s focus is now to expand on the gains it made over the past few years in the renewables business over the next five years.

It will use the funds it raised from the Blackstone-Mubadala consortium and double down on these renewable businesses over the next five years. This is expected to improve returns for investors and also entrench Tata Power in the renewable power ecosystem across India. Tata Power also hopes to gain from the Centre’s push to privatise the perennially loss-making state power distribution companies (discoms).

The company has set some aggressive targets for its various business, including renewables and power distribution. And it’s not like these targets are out of reach. For context, Tata Power’s rooftop solar business revenues rose 3.8X YoY to Rs 561 crore in Q1FY23, and revenues from solar pumps rose 70% YoY to Rs 241 crore. The company is inking new pacts with carmakers and real estate companies to set up EV chargers that are currently spread across 437 cities in India.

Legacy issues continue to linger, debt ratios rise marginally

No matter how hard Tata Power tries to move away from its conventional power business, it comes back to haunt it. The company continues to face legacy issues at its Mundra power plant which is constantly facing underrecovery. This is mainly due to delayed pass-through of higher coal costs.

Right now, the company is running three out of the five units (800 MW each) of the Mundra power plant under the Centre’s order in May to increase power availability due to the scorching summer heat wave. Operating under this order means the company will get to recover all of its increased costs on imported coal.

This came to effect from May 6 onwards and will continue till October 31. From April 1 to May 5 in Q1FY23, the Mundra power plant was operating without fully recovering the high costs of imported coal. The company is still discussing with various states changing its previous power purchase agreements to allow for recovery of higher fuel costs once the Centre’s order ceases to have an effect.

Even though Tata Power’s net debt ratios moderated over the past few quarters, the company’s focus on investment in its renewables business and Odisha discoms led to a slight increase in debt.

This led to a QoQ rise in its net debt-to-equity and net debt-to-underlying EBITDA ratios. Still, the company’s total debt-to-equity ratio continues to remain below 2:1 for the past five quarters, which is a good sign.

For now, the management is betting on the Centre’s willingness to settle the vexed issue of unpaid dues of state discoms. There is another scheme to clear pending payments underway and a push (through a bill in parliament) to nudge states to privatise their discoms. This is a huge opportunity, according to CEO Praveer Sinha.

The Tata Power stock price shows that any positives about the company’s future business prospects are completely priced in. This is probably why the street is in wait-and-watch mode