JP’s electric run

Jaiprakash Hydro-Power (JP Hydro), a subsidiary of Jaiprakash Associates, owns and operates the 300 MW Baspa-II hydroelectric project in Himachal Pradesh. What, though, brings attention to this company is that its stock has risen by 42.6% in the last five trading sessions - it has almost doubled since August to Rs 76.80 now.

Among key reasons, market experts say, is the increase in interest, especially by FIIs. Since coal, gas and crude prices have moved up, the market seems to be willing to give a premium to producers of cheap power, especially non-hydrocarbon energy stocks.

Gaurang Shah, head of research, KR Choksey Shares & Securities said, “the power purchase agreement of JP Hydro (signed in 1992) is also favourable as it offers around 16% return on investment. For the first ten years from commencement of operations (viz. 2003-04), the agreement offers a 6% increase in tariffs.”

Meanwhile, the domestic power utility sector has also seen some re-rating in the recent past. And for this relatively small counter, a presence in the derivatives segment also seems to be a reason, albeit marginally, for it to have gained the market’s attention. The trading pattern shows that volumes have picked up since July, 2007.

Among other notably reasons for the recent jump in JP Hydro’s share price seems to be the Indian government’s initiative to set up a task force on hydropower development and a separate sub-committee on financing issues. The committee will study and help resolve all issues pertaining to clearances for environment issues and development of projects and allocation of sites. In short, it aims to smoothen to process for companies willing to take up the viable projects. Says Gaurang, “if that happens, it will be something similar to what the government has done in the case of ultra-mega power projects.”

Analysts maintain that a larger role of the private sector in the power space bodes well for all power companies. The market has obviously perceived these developments as positive.

The market also believes there is scope for players like JP Hydro in the hydropower space to gain from carbon credits. Companies that generate lesser emissions (below permissible limits) typically are eligible to earn carbon credits, which they can also sell to others for a price.

The stock has outperformed BSE Sensex since July this year. JP Hydro’s EPS for 2007-08 is estimated at Rs 4.50-5.00. While the industry PE is between 15 and 20 times the estimated earnings, for JP Hydro, assuming a PE of 17 times, its value works out to Rs 85.

On a replacement basis, assuming an optimistic capital cost of Rs 10 crore per mega watt (for setting up a hydro project), JP Hydro’s enterprise value should be about Rs 3,000 crore as compared to Rs 4,700 crore currently.

To sum up, the upside seems limited for now. However, analysts continue to be positive on the stock with a one-year view.

A risky subject

For a stock that has risen almost five-fold in the last nine months, a drop of 5% in a few days is not unusual. Notwithstanding analyst projections of strong growth in topline, bottomline and stable margins, the stock of Educomp Solutions, India’s largest educational service provider for kindergarten to class 12 students in IT and IT enabled environment, has fallen on account of increased prospects of being downgraded to ‘sell’.

Hitesh Shah, Surendra Goyal, and Vishal Agarwal of Citigroup have already recommended a ‘sell’ on September 25, with a price target of Rs 2,380, even as they foresee topline to grow at a compounded annual rate of 102% and EPS by 95% over FY 2007 and 2010.

According to the analysts, Educomp has issued about 625,000 stock options to employees at a strike price of Rs 125, wherein the company has taken the fair value, to expense the option in the profit & loss account, at Rs 834. This fair value is a third of the current price.

Hence, by taking a lower value, the EPS gets inflated. Further, Educomp has accelerated the vesting of these options while the cost will be written off over a few years. The analysts feel that these moves could inflate EPS by Rs 51 and Rs 21 over the next two years.

Another concern pertains to the high price paid by Educomp to the promoters for acquiring majority stake in two start-ups, viz. Edu-Infra and Edu-Manage, the subsidiaries engaged in creation of educational infrastructure and school management (pre-school to 12th standard viz. K-12).

Against the total of Rs 20 lakh that the promoters invested last year into these two companies, Educomp will pay Rs 55 crore for a stake of 68-69% each in the two companies.

The analysts said, “We remain skeptical about Educomp paying 100-120x the original price for newly incorporated companies with no revenue / operating profits.”

They also see a regulatory risk in the company’s attempt to set up “for-profit” primary and high schools, which is not permitted under Indian regulations.

On July 30, when Educomp was at Rs 2,321, Anindya Chatterjee of Jefferies & Co Inc. (another research house) had also raised concerns with regarding the company’s foray into K-12.

“In our view, Educomp’s foray into the business of ‘brick-n-mortar’ schools is risky, and value depletive - triggering our downgrade to underperform.

Divergence from the core business of providing and managing classroom educational content could erode margins, and hurt profitability. Cost stickiness, amid suboptimal school enrollments, could burn cash in coming quarters,” said Chatterjee.

“We find that the cost assumptions are unrealistic, and that the revenue assumptions are equally aggressive leading to inflated profitability guidance.”

On the other hand, while some other analysts don’t have concerns with the company’s business model or growth prospects, their worry is regards the high valuation, given that the stock is quoting at a price to earnings (PE) ratio of 70 times its estimated 2007-08 earnings and 40 times based on its 2008-09 earnings.

At a current price of Rs 2,725, Educomp, which closed last fiscal with revenues of Rs 110 crore, is valued at almost Rs 5,000 crore (on fully diluted equity). To sum up, at these levels, the risk-reward ratio is tilted in favour of risk.