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PGCIL

Core ROE of 22.5% offered at 1.5x; No brainer; subscribe

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CMP: Rs 98                                       Price Band: Rs 85-90

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n     FY10 actual core ROE of 21.3% - (1)18.9% from regulated business, (2) 1.1% from STOA, (3) 1.3% from consultancy and (4) -1.7% reduced by deferred tax accounting

n     Core ROE to increase by 1% to about 22.5% in next two years led by Short Term Open Access volumes; Potential of further 1% ROE upside if assume likely numbers on volumes

n     FPO at 1.5xFY13E Book, cheap on absolute basis with core ROE of 22.5% and relative basis – NTPC core ROE at 24% (including 3% from UI) and P/BV at 2.1x

n     Operating cash flow yield of 16% in FY12E; November 11 target of Rs128/Share; Sure Shot returns; Subscribe    

Core ROE of 21.3% in FY10, helped by regulated equity calculations on

gross block and negative working capital

PGCIL’s core ROE jumped from 17.5% in FY09 to 21.3% in FY10. This was mainly

because of (1) change in regulated ROE from 14% to 15.5%/16.0%, (2) change in other

norms, (3) 0.7% increase due to STOA and (4) 0.3% increase due to consultancy. The

core ROE (21.3%) is higher than regulated ROE (17.0%) in case of PGCIL due to (1)

regulated equity calculations on gross block and actual equity calculations on net block

and (2) negative working capital. Further on reported basis the core ROE appears lower

because of deferred tax accounting eating away 1.7%. Seeing the capex quantum, we

believe that PGCIL is likely to remain under MAT for the foreseeable future and the

deferred tax liabilities created, practically are not likely to result in actual tax payments.

Assuming half of the volumes expected in short term market - core ROE

to further increase by 1% led by STOA

PGCIL has earned its share of gross income of Rs1.2bn from STOA in FY10. This

resulted in ROE upside of about 1.1%. Based on our analysis of upcoming short term

capacities and assuming only half of the volumes, this income would increase

significantly. We expect a ROE contribution of 2.1% from this source in FY13E. Again

highlight that if we consider all the likely volumes, the ROE upside would be further 1%.

FPO at 1.5x FY13E book; cheap on absolute as well as relative basis

At higher band of Rs90/Share, the PGCIL FPO is valued at 1.5x FY13E Book. This is

cheap looking at core ROE of ~22.5% in FY13E. Also PGCIL FPO is significantly

undervalued compared with the current valuations of other regulated utilities like NTPC.

NTPC is trading at 2.1xFY13E Book value with core ROE of 24%. However we highlight

that 3% of NTPC’s core ROE is from UI which is linked to short term prices. Whereas in

case of power grid, the core ROE of 22.5% is totally dependent on volumes and not on

prices.

With (1) Operating cash flow yield of 16% in FY12E, (2) regulated monopoly business

with certainty of numbers, (3) execution track record of nearly 100% and (4) further

potential of 1% REO upside from STOA - we see PGCIL as a much better investment

option.

We have valued PGCIL on SoTP of its core Book and cash and investments. The (1)

regulated equity of Rs182bn at the end of FY13E is valued at 2.5x and (2) equity funded

cash and investments are valued at 1x (no option value considered). We recommend

subscribe to the FPO with November 11 price target of Rs128/Share. We even remain

positive on the stock at CMP of Rs98/Share at which the stock trades at 1.7x FY13E

Book.

Earnings growth momentum clearly picking up

The company is on the path to step up its earnings growth for next 4-5years to 25% from

19% during FY06-FY10. During Q2FY11 and H1FY11, it has commissioned projects of

whopping Rs39bn (Rs10bn in Q2FY10) and Rs51bn (Rs24bn in H1FY10). This has

reflected in 35% (after one time adjustment - 25%) earnings growth in H1FY11.

A look at its plan wise Capex and profits reveal very interesting trends:

n 10th plan capex doubled (implied CAGR of 14%) from 9th plan but profits grew by 1.4x or

6% CAGR only – this is because generation capacities linked were mostly Govt. and

most of it commissioned in the last year of the plan indicating recovery of transmission

charges also getting delayed.

n 11th plan capex is tripling (implied CAGR of 24%) from 10th plan and PAT is also tripling

– (1) partly due to new regulations, (2) partly due to huge backlog of generation

capacities from 10th plan and (3) partly due to expected acceleration in generation

capacities in last two years of 11th plan, also visible in commissioning pattern of PGCIL

lines as highlighted above.

n 12th plan capex is again likely to triple (implied CAGR of 25%) – important to note is

major capacities are coming from private players thus no bunching up in the last year of

the plan – commissioning to be front loaded.