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Power Grid Corporation of India
Not sexy, but has a nice personality
Event
PWGR has announced the pricing for its follow-on public offer (FPO) at a
price range of Rs.85-90/share, reflecting an FY12 PER of 13.5x-14.4x and
FY12 P/BV of 1.8x. This looks compelling in our view and we’d recommend
investors to buy into the FPO. We don’t see the stock doubling in the next 1-
2yrs (not sexy), although it is a strong defensive exposure to Indian Power.
Impact
Power Grid – poor performer… since May, the stock has underperformed
the market by 28% - a typical outcome of a regulated utility vs. a bull market.
Our Underperform call has been driven by valuation as the stock been trading
on above-peer and market multiples.
But FPO pricing looks compelling: with an implied FY12 PER of 13.5x-
14.3x and FY12 P/BV at 1.7x-1.8x, below both peers and historical averages.
Improvement in liquidity from FPO: following the FPO and fresh equity
issue, the free-float of the stock will increase substantially, which in our view
demands a reduction in its cost of equity as liquidity improves.
Best defensive pick in the space at FPO price: qualitatively, the risks to
PWGR’s earnings appear relatively low with the current regulatory period
extending to FY14. Perhaps most importantly, however, due to the Tripartite
Agreement between the Government of India, SEB’s and Central Sector
Utilities, we believe PWGR’s counterparty risk is far lower than the IPP’s.
Earnings and target price revision
We are raising our price target to Rs100 from Rs91.
Price catalyst
12-month price target: Rs100.00 based on a Sum of Parts methodology.
Catalyst: FPO and fresh equity issue as liquidity boost during the month.
Action and recommendation
On the back of the fallen share price and stronger anticipated liquidity from
the FPO, we upgrade our recommendation from Underperform to Neutral and
upgrade our price target from Rs.91/share to Rs.100/share.
Buy into Follow-on Public Offer: 13.5x-14.4x FY12 PER, 1.8x book
Power Grid Corporation of India (PWGR IN) has set the Price Band for its Follow-on Offer at
Rs.85/share – Rs.90/share. A further 5% discount will be available to Retail investors and eligible
employees. We would recommend investors to buy into the FPO, which offers a potential 10%-
15% upside to our price target of Rs.100/share.
Trading lower than historical average: we see limited downside
The FPO pricing is towards the low-end of its historic range, which has averaged 21.5x on a 1yrfwd
PER and 2.7x on a 1yr-fwd P/BV over the past three years. Over the past year this has come
down to 19.8x and 2.3x respectively, which are both below the implied FPO price
Improved liquidity: free float more than double from 14% to 31% post FPO
Following the FPO and fresh equity issue, PWGR’s free float would more than double. With
Government ownership below 75% post issue, it reduces the likelihood of ongoing FPOs in our
view, where we see greater overhang risk for stocks with higher Government exposure such as
NTPC (NATP IN, Rs193.00, Outperform, TP: Rs248.00).
As flagged by PWGR, the combined FPO/fresh equity issue is the fifth largest equity issue in India
behind Coal India, Reliance Power, NMDC and NTPC. Post the issue, we would expect PWGR’s
liquidity to improve significantly, which should draw more institutional interest.
And bond rates have tightened, reducing downward pressure from here
Since we initiated with an Underperform, 10yr bond rates have also strengthened and Macquarie
sees little upside from current levels. Regulated utilities tend to underperform in periods of bond
yield strength, as shown below, so this trigger for underperformance has reduced.
The fundamentals don’t say ‘Buy’ at current market price
During recent presentations, management noted that whatever it has commissioned over the past
few years, it expects to double in FY11 and suggested that every three years it delivers a
‘quantum jump’ in project commissioning. We have already assumed bullish capitalisation
forecasts (a three fold increase in FY11).
But a safer thematic play than IPPs: SEB loss + fuel risk protection
Greater protection from SEB losses: the ‘elephant in the room’ in the Indian power sector in our
view is the increasing financial losses being endured by the State Electricity Boards (the buyers of
both power generation and transmission). A recent Government report highlighted that losses from
State T+D losses in FY15 could amount to US$26bn. As a guide of relativity, this is greater than
the combined forecasts of all Central Government Subsidies (for food, petrol, fertiliser, etc) in
FY15.
Under the Tripartite Agreement entered into between the Government of India, the State Electricity
Boards (SEB’s) and Central Sector Power Utilities (including Power Grid), if payment is not made
to Power Grid beyond 90 days, the Government of India is required to pay the outstanding
amounts to Power Grid from the concerned state’s account balance with the Reserve Bank of
India (RBI). That’s a luxury that Independent Power Producers (IPPs) don’t have.
Not directly hampered by fuel: the widening fuel supply gap from Coal India vs. demand for coal
from the power sector is widening. In our view, this will create greater operational risk for power
generators, who, independent on the method of their power sales, have earnings dependent on
availability/plant load factors.
Power Grid, however, gets paid purely on availability and therefore independent on whether power
is flowing down its lines - if the network is available, the user has to pay. This significantly lowers
operational risk by Power Grid and therefore gives greater transparency around its ROE.
Where fuel supply shortages could affect Power Grid is via the delay on new power projects,
which in turn delay transmission project capex. We attempt to capture this in our capex forecasts
above.
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