Power sector- A blip or early signs of troubles?:: ICICI Sec

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In Q2FY11, the I-Sec Power universe performed below expectations – adjusted
PAT was at Rs33bn (7% below I-Sec and 5% below Street expectations). During
the quarter, the financial clout of state electricity boards (SEBs) waned – as was
evident in weakened financials, fall in power demand YoY, load shedding when
power was available, not fully honouring short-term contracts, fall in merchant
rates and below-expectations profits.


The moot is if Q2FY11 was an aberration (given strong monsoons) or harbinger of
the chink in Power sector’s structure. Rise in SEB losses to Rs526bn in FY09,
continuous weakening of merchant rates (24% YoY in the past 12 months), low
power demand growth (6% YoY in October ’10) and consequent reduction in
power deficit to 6.4% in October ’10 (3% down YoY) reaffirm the latter. Key factors
to watch out for in the next six months are the extent of recovery in merchant
rates in the summers and pre-state elections (Tamil Nadu is due for polls in ’11).

􀁦 Weak core performance in Q2FY11, primarily owing to lower-than-expected
merchant realisations, higher coal cost, lower plant utilisation (owing to lack of
demand) and reduction in NTPC’s core RoE as it became a MAT company and
hence, was unable to retain income tax incentives.

􀁦 Power demand growth normal in October ’11 after a decline in Q2FY11. Power
demand growth has resumed normalcy – it grew 6.4% YoY after a decline in
Q2FY11. However, growth was lower than GDP growth and we believe that weak
structure of SEBs is a dampener for power demand growth and it is not gaining from
increased economic activity.

􀁦 Merchant rates continue to weaken YoY – on an average, they fell 24% in past
year. Rise in volumes in the short-term market and limited buyers with weak financial
health are leading to structural issues as regards merchant rates. Weak core
performance and operating environment are reflecting in the Street view and the
number of buy recommendations has fallen down in past three months.

􀁦 Balance sheet analysis – Capex on track. Balance sheet analysis indicates that
sectoral capex is on track and capex for I-Sec Power universe, excluding Reliance
Infrastructure (RInfra) has slightly come down to Rs132.6bn in H1FY11 versus
Rs146bn in H2FY10.

􀁦 Stock view. We prefer CESC among distribution companies as it is inexpensive
(adjusting for retail, FY12E P/B at 1.3x) despite superior financials and nil underrecovery.
We prefer RInfra given attractive valuations, improved profitability owing to
revised Mumbai tariff and improving EPC book. We maintain our negative stance on
merchant players such as JSW Energy (JSWEL) and Adani Power (APL). Despite
NTPC’s subdued performance and consequent earning downgrades (I-Sec
estimates 6-10% below Street’s) we maintain our neutral stance on the company
given improved execution pace and reasonable valuations. We maintain our neutral
stance on Tata Power (TPL) as our optimism on the coal business is offset by the
less profitable power business.