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NTPC Ltd
(NTPC.BO / NATP IN)
Buy in the correction
■ Correction overdone. NTPC has corrected 12% over the past two months,
mainly on account of its poor 2Q FY11 results due to the loss of tax arbitrage
it earlier enjoyed. We believe the correction offers a buying opportunity.
■ Well placed on business model, fuel security. NTPC will continue to
follow its assured RoE business model for the 75GW capacity, expected to
be reached by FY20, which should protect it from the risks of the competitive
bidding models. Certainly, all utilities are exposed to risks from the widening
domestic fuel deficit. However, NTPC should be able to address this concern
to a large extent through its strategy to augment and diversify fuel supplies
from its captive mines, coal block acquisitions overseas, coal imports, and
fuel supply agreements with Coal India. Its regulated model allows it to passthrough fuel price risk. Also, with most of its projects located closer to their
fuel source, they are not exposed to transportation infrastructure issues.
■ Key catalysts – higher EPS growth and RoE; potential acquisitions.
Despite our conservative execution estimates, we expect a 27% rise in
NTPC’s capacity over FY11-12. This should result in a decline in its CWIP &
cash as percentage of its assets, leading to higher RoE and EPS growth.
Potential value creation from the deployment of surplus cash into core
assets, inorganic expansions, coal block acquisitions are other key catalysts.
■ Valuation. Our target price of Rs224 implies 17% potential upside. At our
target price, its surplus cash is valued at 1.5x, which is fair, in our view,
given the potential of this cash to generate higher returns. NTPC trades at 6-
9% discount to its historical P/E and P/B, despite a likely increase in
earnings and RoE. NTPC is attractively priced versus other regulated utilities
and average valuations of Indian utilities. NTPC is among the most preferred
on our CARV and FSI framework, implying it offers one of the best fuel
security and is relatively inexpensive versus peers.
Buy in the correction
Relatively well placed on fuel security
We expect India’s domestic coal deficit to widen going forward. Our sensitivity analysis
suggests for every 10% domestic coal deficit, earnings of a project will be impacted by 7%,
if coal were sourced through expensive imports, 9% if sourced from e-auction (spot) and
35%, if the project were to operate at lower utilisation for lack of fuel. We expect fuel deficit
to impact all utilities, including NTPC. However, the ability to pass on these cost pressures
will vary materially depending on a project’s business model.
NTPC’s assured RoE model exposes it to penalties for its inability to source requisite fuel
supplies but allows pass-through of fuel price risk, unlike other business models such as
Case I/II and merchant projects where both the risks are borne by the developer to a large
extent. NTPC is thus relatively well placed in terms of fuel security, in our view.
NTPC is better placed to address fuel supply risk, given its: 1) ability to acquire large coal
blocks led by its strong balance sheet and Maharatna status, 2) plans to commission large
captive coal blocks, 3) fuel supply agreements signed with Coal India (about 25GW) and
LoA awards recommended (about 18GW) and 4) strategy to import coal.
NTPC not exposed to merchant/competitive bidding
The National Tariff Policy 2006 mandates the replacement of the assured RoE business
model that NTPC follows with the competitive bidding models (Case I/Case II) from
January 2011 for public sector companies. Competitive bidding models expose developers
to various risks, unlike the assured RoE model, which allows pass-through of most costs.
In order to protect itself from the vulnerability of the competitive bidding models, NTPC
plans to enter into power purchase agreements for its 75GW capacity (expected to be
reached by FY20) before the January 2011 deadline. Also, it plans to have just 1.2% of its
capacity on merchant basis, implying it is not exposed to merchant price volatility.
Expect higher earnings growth and RoE
We expect a 27% increase in NTPC’s installed capacity over FY11-12 as part of the about
18GW capacity currently under construction commissions. This is despite our conservative
assumption on execution and our expectation that NTPC will be able to meet only 57% of
its 11
th
Plan capacity addition target. Thus, we expect NTPC’s reported RoE to rise to
15.5% by FY13 from 14% currently, led by: 1) a decline in CWIP (generating no returns)
as a percentage of assets from 41% to 30% by FY13 on the commissioning of projects
and 2) a continued decline in the share of surplus cash and SEB bonds (generating low
treasury returns) on being deployed into the core business. We have not yet factored in
the potential value creation from the deployment of surplus cash into the core businesses.
Valuations are attractive
Our FCFE DCF provides a target price of Rs224, implying 17% potential upside. At our
target price, the implied value of its surplus cash of US$3 bn is 1.5x, which is fair, in our
view, as it could be deployed into core assets to generate higher returns. Viewed
differently, at our target price, about 23GW of capacity addition is priced in, of which
17.8GW is already under construction and another 7.1GW has all the regulatory approvals
in place. On 12-month forward P/E and P/B, NTPC trades at 6-9% discount to its historical
average, despite the likely increase in earnings growth and RoE. NTPC is attractively
priced versus other regulated utilities and the average valuations of Indian utilities. We
maintain an OUTPERFORM on Coal India as well as NTPC, as we believe both are
attractively priced. NTPC is among the most preferred on our CARV and FSI framework,
implying it offers one of the best fuel security and is relatively cheap versus its peers.
Relatively well placed on fuel
security
We expect India’s domestic coal deficit to widen going forward. Our sensitivity analysis
suggests for every 10% domestic coal deficit, earnings of a project will be impacted by 7%,
if coal were sourced through expensive imports, 9% if sourced from e-auction (spot) and
35%, if the project were to operate at lower utilisation for lack of fuel. We expect fuel deficit
to impact all utilities, including NTPC. However, the ability to pass on these cost pressures
will vary materially depending on a project’s business model.
NTPC’s assured RoE model exposes it to penalties for its inability to source requisite fuel
supplies but allows pass-through of fuel price risk, unlike other business models such as
Case I/II and merchant projects where both the risks are borne by the developer to a large
extent. NTPC is thus relatively well placed in terms of fuel security, in our view.
NTPC is better placed to address fuel supply risk, given its: 1) ability to acquire large coal
blocks led by its strong balance sheet and Maharatna status, 2) plans to commission large
captive coal blocks, 3) fuel supply agreements signed with Coal India (about 25GW) and
LoA awards recommended (about 18GW) and 4) strategy to import coal.
Fuel risk a key concern for utilities; NTPC well placed
India’s domestic coal deficit likely to widen over the next few years
We expect over 60% of India’s power capacity to be based on domestic coal by FY17. But,
we expect domestic coal deficit to widen going forward. Increase in high-cost imports
seems to be the only solution until the regulatory and infrastructure hurdles are removed.
But, fuel challenges could aggravate as power project equipment are designed to handle
only 15% variation in fuel mix, implying imports may not be able to resolve the issue
entirely.
Impact on utilities from fuel risk is high
Our sensitivity analysis suggests earnings for a typical 1GW power project will be
impacted by 3-15% for every 5% coal deficit. However, the ability to pass on these cost
pressures will vary materially by a project’s business model.
Inability to secure fuel supplies will impact returns even for NTPC
Under the assured RoE model applicable for NTPC’s projects, fixed costs are allowed to
pass through, if the project demonstrates 85% plant availability (PAF) every month. Plant
availability in turn is depends on the availability of fuel, among other factors. If the
developer fails to secure the fuel requirement for the project, its fixed costs (includes
assured RoE of 15.5%) are pro rated.
In addition, most of NTPC’s regulated projects have consistently generated a better-thanassured RoE of 15.5% through incentives permitted by the regulations to operate a project
at better than its prescribed norms. But in the event of lower fuel supply, these incentives
get impacted. The onus is thus on the developer to secure adequate fuel supplies.
Figure 8 is an illustration of the impact on a assured RoE project’s earnings in the event of
fuel insufficiency. PAF over 85% generates availability-based incentives, while PAF below
85% attracts penalties (penalties are steep, should PAF drop to 70% or below).
NTPC’s Farakka and Kahalgaon projects – a case study
Coal India has identified dedicated mines for the supply of coal to NTPC’s 1.6GW Farakka
and 2.34GW Kahalgaon power projects. However, Coal India could not develop these
mines in time. In addition, inadequate railway infrastructure has been impacting supplies to
these projects.
Currently these projects are importing about 20% of their coal requirements at high landed
costs of about US$120/t versus the contracted coal supplies from Coal India estimated at
US$35/t.
Insufficient fuel has led to these projects operating at PAF below 85%. The deficit in fuel
requirements should have been met by NTPC through alternative coal sources (imports, eauction, etc.). However, NTPC could not bridge the coal supply deficit through imports
during FY10 and 1H FY11. While higher fuel costs are a pass-through, as these projects
operate on the regulated business model, lower than 85% availability has impacted the
projects’ incentives and assured RoE.
However, NTPC’s assured RoE model is relatively well placed against fuel risk
As detailed in our Quantifying Fuel Security’ report, published on 23 August 2010, we
believe the regulated business models are the best placed against fuel risk, as under
these models, the developer has the only responsibility to secure adequate fuel supplies,
but increase in fuel prices is a pass-through.
On the contrary, on arrangement of adequate fuel supplies, regulated projects’ incentives
increase, as they use higher-cost fuel. This is achieved as the regulations prescribe the
quantum of fuel to be consumed to generate one unit (kWh) of power. Fuel costs paid to
the regulated projects are determined based on the fuel consumption per unit of power
generated x cost of fuel. Typically, NTPC’s projects consume lower fuel per unit versus the
regulated norms, as they are being run efficiently.
NTPC working towards addressing fuel risk
As explained above, NTPC has to just ensure sufficient fuel availability to generate its
assured RoE and incentives. Unlike other business models, NTPC’s assured RoE model
enjoys pass-through of higher fuel costs. We highlight NTPC’s four-pronged strategy to
ensure sufficient fuel availability over the next few years.
Commissioning of captive coal mines
NTPC has been allocated eight captive coal blocks under the captive/government
dispensation route (of which two are in JV with Coal India), as illustrated in Figure 10.
NTPC’s total attributable mineable reserves from these mines are about 1.9 bn t.
NTPC recently appointed Thiess Minecs India (a subsidiary of Australia’s Leighton
Holdings) as the mine developer and operator (MDO) for its Pakri Barwadih mine in
Jharkhand. At peak capacity post the ramp-up after three years of the commencement of
mining (expected after two years), NTPC plans to mine about 15 mn tpa of coal from the
Pakri Barwadih mine and targets to mine about 56 mn tpa of captive coal from all the
mines being allocated by 2017. This production should be able to support 12-14GW (about
25% of its total coal capacity then) of NTPC’s coal-based capacity.
However, we do reckon that these targets are aggressive, as mines development has
been significantly delayed (over two years). Figure 11 outlines the status of its captive
mines. Citing delays in mines development, the Ministry of Coal has issued show cause
notices (like they did to other allottees of captive coal blocks) to NTPC, asking why these
allocations should not be cancelled. However, we believe, the mine allocations for NTPC
are unlikely to be cancelled, given it is working towards getting these mines operational.
Coal block acquisitions abroad – surplus cash and Maharatna status key positives
NTPC has formed a JV, International Coal Ventures, for acquiring coal blocks overseas.
The company is evaluating coal blocks in Indonesia, Australia and Mozambique.
While most Indian utilities are planning to acquire coal blocks overseas, we believe NTPC
is better placed in terms of its ability to make large coal block acquisitions, as: 1) its
Maharatna status allows investment of Rs50 bn/acquisition and 2) it has the financial
muscle, given its strong balance sheet – cash balance of US$3 bn and is under-leveraged
(net gearing of just 0.5x versus 2.3x permitted for regulated projects).
Fuel supply agreements signed with Coal India, unlike most peers
NTPC has signed 20-year fuel supply agreements (FSAs) with Coal India that ensures
about 90% of the fuel requirements for its coal projects commissioned till March 2009
(about 25GW). While we do reckon the risk of Coal India’s supplies falling below the
assured volumes, a contractual FSA with a penalty structure (for lower supplies by Coal
India), should ensure Coal India’s supply commitment. On the other hand, most of its
peers either have Letter of Assurances (LoAs) or have just signed MoUs with Coal India
for fuel supplies, either of which is not legally binding.
In addition, NTPC has already been recommended for a Letter of Assurance (LoA) for
granting long-term/tapering linkages for about 18.2GW of its capacity.
In the next round of domestic coal linkage recommendation expected within a few months,
we expect NTPC to be granted LoAs for further 7.9GW of capacity based on its projects
faring well on the CEA’s point grading system.
NTPC is also setting up coal-fired plants closer to the source of fuel to avoid transportation
related delays. Currently about 80% of NTPC’s coal-fired capacities are located at or near
the pit head – unique positioning versus most of its peers.
Coal imports bridging the gap, NTPC to start importing coal directly from FY12/13
NTPC plans to import 16 mn t of coal during FY11. Of this, Coal India will import 4 mn t of
coal (on nomination basis) and NTPC has already issued a letter of intent (LoI) to the
State Trading Corporation (STC) for importing 12 mn t of coal. In addition, from FY12/13
onwards, NTPC is planning to import coal directly.
Gas supplies have improved
NTPC’s gas projects of 3,955MW achieved the highest ever generation of 27.6 bn kWh at
a PLF of 78.4% in FY10 versus 67.0% during FY09, driven mainly by improved gas
supplies. NTPC received 13.9 mmscmd of gas/RLNG in FY10 versus 10.8 mmscmd in
FY09. This also led to an increase in the average availability for its gas-based projects to
93.1% versus 86.7% in FY09.
During FY10, NTPC renewed its APM gas supply agreements up to 2021 and PMT gas
supply agreements up to 2019. It has also signed long-term contract for 2 mmscmd RLNG
supply on firm basis and 0.5 mmscmd on fallback basis with GAIL for a period of 10 years
for its NCR-based gas stations totalling 2.3GW. In addition, the government has allocated
4.46 mmscmd of gas from Reliance’s KG-D6 basin.
NTPC plans to implement another 2.6GW of gas-based capacity at Kawas and Gandhar in
Gujarat, if it succeeds in procuring 12 mmscmd of gas from Reliance (currently subjudice).
We have not factored in these capacities in our assumptions, which could pose potential
upside risks to our estimates.
NTPC offers one of the best fuel security
Based on our fuel security index, we believe NTPC offers one of the best fuel security
among its peers, as: 1) it has already signed fuel supply agreements for its projects set up
till March 2009, 2) it has access to large captive coal mines, 3) its strategy for coal imports,
4) its plans to acquire coal mines now at advanced stages and 5) the majority of its
capacity is based on the regulated business model.
NTPC not exposed to merchant or
competitive bidding
The National Tariff Policy 2006 mandates the replacement of the assured RoE business
model that NTPC follows with the competitive bidding models (Case I/Case II) from
January 2011 for public sector companies. Competitive bidding models expose developers
to various risks, unlike the assured RoE model, which allows pass-through of most costs.
In order to protect itself from the vulnerability of the competitive bidding models, NTPC
plans to enter into power purchase agreements for its 75GW capacity (expected to be
reached by FY20) before the January 2011 deadline. Also, it plans to have just 1.2% of its
capacity on merchant basis, implying it is not exposed to merchant price volatility.
NTPC has circumvented competitive bidding model
Assured RoE model expected to be replaced with competitive bidding models…
The National Tariff Policy 2006 mandates transition from the regulated cost-plus-assured
RoE model (that NTPC follows) to the competitive bidding models for private sector
companies from January 2006 and for public sector companies from January 2011. Even
the central regulator, Central Electricity Regulatory Commission, favours the transition to
the competitive bidding regime from the assured RoE model. Going forward, the tariff for
contracted projects (excluding merchant projects) will be determined by the competitive
bidding Case I/Case II revenue models.
…competitive bidding models expose developers to several risks
The competitive bidding models require developers to assume various risks, such as
project cost overruns from execution delays, volatility in interest rates, and potential
increase in fuel costs hurting the non-escalable portion of energy costs, unlike the costplus-assured RoE model, which allows a complete pass-through of these costs, if they
were within the regulatory norms.
But, NTPC not exposed to competitive bidding models for 75GW capacity
In order to protect itself from the vulnerability of Case I/ Case II projects, NTPC has
already entered into power purchase agreements (PPAs) for about 70GW of capacity with
various SEBs and plans to enter into PPAs for a total of about 75GW before the National
Tariff Policy deadline of Jan 2011 becomes effective for the company.
We expect NTPC to reach an installed capacity of 75GW by FY20, implying NTPC is not
exposed to the competitive bidding models. However, NTPC may opt to participate in
some projects based on the competitive bidding models, over and above its 75GW
capacity target, which are currently not part of our estimates/valuations.
Exposure to merchant business model negligible
NTPC is not exposed to the volatility in merchant prices, as it has just 1.2% of its about
76GW of planned capacity under the merchant route. We do not expect NTPC’s share in
merchant to rise above 2-3%, given that the Ministry of Power is not in favour of a public
sector company generating excess profit through the merchant route on current demandsupply imbalance and the conservative strategy of NTPC.
Expect higher EPS growth and RoE
We expect a 27% increase in NTPC’s installed capacity over FY11-12 as part of the about
18GW capacity currently under construction commissions. This is despite our conservative
assumption on execution and our expectation that NTPC will be able to meet only 57% of
its 11
th
Plan capacity addition target. Thus, we expect NTPC’s reported RoE to rise to
15.5% by FY13 from 14% currently, led by: 1) a decline in CWIP (generating no returns)
as a percentage of assets from 41% to 30% by FY13 on the commissioning of projects
and 2) a continued decline in the share of surplus cash and SEB bonds (generating low
treasury returns) on being deployed into the core business. We have not yet factored in
the potential value creation from the deployment of surplus cash into the core businesses.
Expect capacity increase by 27% over FY11-12E…
We expect a substantial ramp-up in capacity at NTPC over the next four years on the
commissioning of 18GW capacity under construction and another 7.1GW of capacity for
which equipment ordering is at the final stage and have just started construction.
Over the near term (FY11-12), we expect a 27% increase in its installed capacity, led by
8.5GW of capacity addition during this period, taking its total capacity to 40.2GW. Of this,
the company has already added about 1.5GW YTD FY11.
…despite our estimate that it will meet only 57% of its 11th Plan capacity addition target
This ramp-up in capacity is despite our conservative estimates on its capacity addition
plans, in line with the slippages witnessed by NTPC in the past. The company plans to add
about 18.3GW over FY11-12E, to reach an installed capacity of 50GW by FY12.
Expect improvement in reported RoE…
We expect reported/overall RoE for NTPC to improve over FY12-13 from 14% to 15.5%,
led by: as 1) a decline in CWIP (generating no returns) as a percentage of total assets
from 41% in FY11 to 30% by FY13 on the commissioning of projects and 2) a continued
decline in surplus cash and SEB bonds (generating low treasury returns) as a percentage
of total assets on being deployed into the core business.
We have not yet factored into our estimates the potential deployment of cash into: 1)
captive mine development, 2) plans to set up projects overseas, such as Nigeria, and Sri
Lanka, 3) diversification into new businesses, such as equipment manufacturing, 4) coal
block acquisitions and 5) potential acquisitions of projects. Once implemented, this should
address one of the key concerns about the stock that surplus cash depresses NTPC’s
reported RoE, as it is deployed into low-return treasury investments versus its potential
RoE on being deployed into core businesses.
…despite our conservative estimates on core RoE
The CERC’s regulated norms allow incentives in the tariff structure to promote efficient
operations. NTPC has consistently used the efficiency-led incentives to its advantage and
has garnered a much higher RoE than its assured RoE of 14%/15.5%. We expect NTPC
to continue benefiting, mainly from thermal efficiency, UI charges and availability-based
incentives. Led by these incentives, we expect NTPC to generate a core business RoE of
20-21% over FY11-FY13.
This is despite our conservative assumption that incentives will fall over time led by
regulations possibly becoming stringent as more utilities become efficient. We expect core
business RoE to taper off over time to a sustainable RoE of 19%, but still higher than the
contracted RoE of 15.5%
Collection efficiency remains strong
SEB financials continue to deteriorate. This raises a key counterparty/receivable risk for
generation utilities. However, NTPC has been able to realise 100% of its billing for seven
consecutive years, since the signing of the tripartite agreement in FY04 – one of the initial
ills of the power generation sector (NTPC’s collection was 76%, as of FY02).
As per the tripartite agreement, all NTPC customers maintain 105% of their average
monthly billing with NTPC via Letters of Credit (LCs). Besides, in the event of a default,
NTPC has the first right on states’ finances through the RBI and can progressively curtail
power supply to the defaulting states.
This arrangement has ensured strong collection efficiency for NTPC. In fact, the company
realises about 70% of the bills raised within a week of its presentation – rebates are
offered on payments made via LCs at 2.5% until FY09 and 2% from FY10 onwards.
Extremely well placed to finance growth plans
NTPC is extremely well placed to fund its growth plans, given its: 1) under-geared balance
sheet (gearing of 2.3x allowed for regulated utilities), 2) stable cash flows led by the
regulated business, 3) high debt service capability (FY12E interest coverage at 4.6x) and
4) cost pass-through mechanisms.
Earnings cut by 4-5% for FY11-12E
NTPC has earned incentives through tax arbitrage during FY10/1Q FY11, as it used to pay
20-22% effective tax rate but received the pass-through of full effective tax rate at 33.2%.
However, with the commissioning of new projects that enjoy 80-IA tax benefits, which
requires the project to pay only the MAT rate during the tax holiday of 10 years, its
portfolio of projects is moving towards low tax rates. This trend is likely to continue, given
the expected strong project commissioning over the next few years.
This means that the company will be a net loser, as it will pay taxes in the range of 21-
22% (expected to rise progressively) but will enjoy only the pass-through of the effective
MAT rate of 19.9%. We cut our earnings for FY11E by 4.4% and FY12E by 4.9% mainly
on account of the reversal of tax arbitrage. Thus, we lower our target price for the stock by
1.3% to Rs224 (from Rs227). We also introduce our estimates for FY13.
Valuations are attractive
Our FCFE DCF provides a target price of Rs224, implying 17% potential upside. At our
target price, the implied value of its surplus cash of US$3 bn is 1.5x, which is fair, in our
view, as it could be deployed into core assets to generate higher returns. Viewed
differently, at our target price, about 23GW of capacity addition is priced in, of which
17.8GW is already under construction and another 7.1GW has all the regulatory approvals
in place. On 12-month forward P/E and P/B, NTPC trades at 6-9% discount to its historical
average, despite the likely increase in earnings growth and RoE. NTPC is attractively
priced versus other regulated utilities and the average valuations of Indian utilities. We
maintain an OUTPERFORM on Coal India as well as NTPC, as we believe both are
attractively priced. NTPC is among the most preferred on our CARV and FSI framework,
implying it offers one of the best fuel security and is relatively cheap versus its peers.
Our DCF-based valuation suggests 17% potential upside
Our FCFE DCF-based valuation for NTPC suggests a 12-month target price of Rs224,
implying 17% potential upside. We assume a cost of equity of 13% and a terminal growth
rate of 4%.
Our target price implies surplus cash value at 1.5x – fair considering growth options
NTPC has about US$3 bn in surplus cash, representing about 10% of its total balance
sheet size. This cash has the potential of generating a core business RoE of 17-18% on a
sustainable basis versus the post-tax returns of 5-6% generated on it currently.
We highlight NTPC’s valuation will change materially based on how fast one assumes the
conversion of this cash into core businesses. The most conservative scenario is to
assume that no surplus cash gets deployed into core businesses – valuing cash at just 1x.
While the most optimistic scenario is to assume that all the surplus cash is deployed
in core businesses – cash generating 3x its value (18% return potential versus 6%
currently).
Our target price of Rs224 implies NTPC’s surplus cash will be valued at 1.5x. We arrive at
this estimate by valuing the core power business using our DCF valuation methodology,
assuming a cost of equity of 13% and a terminal growth rate of 4% (the same assumptions
were used for arriving at our target price for NTPC). Further, we value the one-time
settlement of SEB bonds (OTSS bonds) at its book value.
Based on this calculation, we believe NTPC’s surplus cash is fairly valued, considering its
deployment potential into acquiring coal assets overseas, diversification into new
businesses, such as equipment manufacturing, and plans to diversify into new
geographies, such as Sri Lanka and Nigeria.
Our target price implies 23GW capacity addition – most of this has visibility
Our replacement cost-based analysis for NTPC suggests our target price implies 23GW of
new capacity. We see high visibility for NTPC to be able to implement this capacity, given:
1) about 18GW of capacity is under construction, 2) another 7.1GW of capacity is planned
to start construction soon, with most of the regulatory approvals in place, 2) NTPC’s strong
balance sheet to support its expansion plans and 4) the majority of the capacity is
brownfield expansion that is faster to implement.
We arrive at this estimate by valuing NTPC’s current attributable installed capacity (about
32.2GW) at a replacement cost of Rs37 mn EV/MW, at a 30% discount to the current
replacement cost, given its ageing existing plants. We would have to value another 23GW
of capacity addition to meet our target price for NTPC.
NTPC trades at 6-9% discount to its historical average
NTPC is trading at 6-9% discount to its average one-year forward P/E and P/B. We expect
NTPC’s valuations expand on the back of a 13% EPS CAGR over FY11-13E, led by a
strong ramp-up in capacity adds.
NTPC and Coal India both appear attractive
As highlighted by our Coal India analyst, Neelkanth Mishra, in his initiation report
published on 3 November, Cost-plus means more value, NTPC is a better benchmark for
Coal India than global coal peers for valuation comparison, as both these companies are
in the business of thermal power, largely work on a cost-plus model, have large market
caps, are majority government owned, and are low free float companies with similar
regulatory risks.
At Coal India’s IPO offer price of Rs245/share, Neelkanth had argued that the valuation
gap between NTPC and Coal India should narrow. However, post the 31% increase in
Coal India stock price since listing, we believe most of this rerating has already been done.
While we do reckon compared with NTPC, Coal India has an asset light business, which
allows it to enjoy higher asset turns and thereby higher RoE, we note Coal India also
enjoys a premium P/B versus NTPC.
Overall, we continue to prefer Coal India and NTPC, given their growth potential,
defensive characteristics, higher predictability of earnings and cash flows, regulated/nearregulated business models, strong balance sheets, superior core RoE and sound
corporate governance.
NTPC well priced among other listed regulated utilities
Regulated utilities such as GIPCL and Neyveli Lignite have much lower earnings/EBITDA
growth over the next few years versus NTPC. Besides, for regulated utilities such as
NHPC, Neyveli Lignite and GIPCL, capacity adds are lumpy, leading to volatile growth
versus NTPC’s relatively stable earnings growth.
NTPC fares well on our P/B versus RoE model among its peers (regulated utilities). We
note while the assured RoE of 15.5% is same for the transmission business (Powergrid)
as well as the generation business (NTPC), regulations leave limited room for
transmission utilities to generate higher RoE through incentives versus power generation
NTPC also has a superior balance sheet than Powergrid, given its low net gearing and
superior cash flow generation profile.
Also, while the assured RoE of 15.5% is same for thermal (NTPC) and hydro generation
projects (NHPC), hydro projects have longer implementation timelines and execution risks
that result in higher proportion of assets getting blocked in CWIP that generates no
returns. Our study of the regulations suggests the opportunity to generate higher returns
through incentives is superior for thermal projects versus hydro projects.
Besides, we note among the regulated utilities, NTPC maintains one of the highest
dividend payout ratios of 39% to maintain an optimal capital structure. This results in
NTPC having one of the highest dividend yields among the regulated utilities (ex. GIPCL).
NTPC best placed on our CARV and FSI framework
NTPC is also placed in the most preferred zone on our CARV (capacity adjusted relative
valuation) and FSI (fuel security index) framework, implying the company offers one of the
best fuel security and is the cheapest among its peers.
NTPC well priced versus Indian utilities
NTPC is trading in line or at a discount to the average valuations of Indian utilities based
on the most conventional valuation metrics, despite its superior RoE and dividend yield.
However, we believe NTPC deserves a premium to Indian utilities, given its: 1) relatively
high fuel security, 2) stronger balance sheet, 3) high core business ROE led by efficient
operations, 4) high earnings visibility led by regulated business operations, 5) well-charted
growth plans and 6) scale of operations.
Key investment risks and concerns
Regulatory risk
The business operations of NTPC are highly regulated. The regulator may adopt certain
measures in the interest of power consumers, fuel suppliers, etc., that might be
detrimental to NTPC’s profitability. For example, the regulator might reduce its assured
RoE, lower UI charges, etc. However, we believe it is unlikely over the medium term for
the regulator to curtail NTPC’s profit/returns significantly, as India requires massive
investments in the power sector. However, we see a key risk for merchant power plants to
get regulated in India, given the excess profiteering being planned by its developers citing
power deficit.
Surplus cash depresses returns
We expect NTPC to have 16.6% of its balance sheet size in cash and OTSS bonds during
FY11E, which yields lower returns than its core businesses. In line with the trend over the
past three years, we estimate its cash surplus as a percentage of assets to fall over time
(11.6% by FY13E), as cash is being deployed into its core business activities. We believe
this is possible for NTPC, given its massive capex plans. However, any slippages on this
front will dilute earnings and RoE.
Risk of fuel supplies
NTPC is in a massive investment mode. Inability to secure fuel supplies will impact the
assured RoE and incentives for the company. Though NTPC has been able to largely
meet its requirements through imported coal, going forward, it could be an issue, should
NTPC fail to secure its fuel supply requirements.
Sustaining efficient operations
NTPC has demonstrated its ability to run its power plants very efficiently, resulting in
higher-than-contracted RoE. Going forward, we expect NTPC to be able to generate these
incentives, as the company continues to run its plants efficiently. Any slippages in
achieving this will impact its earnings, returns and thereby valuations.
Outcome of ongoing litigation on gas supplies
NTPC’s agreement for the supply and pricing of 12 mmscmd of gas from Reliance’s KG
basin is under litigation. The outcome of this litigation will impact NTPC’s stock price
performance. However, we have not factored in any capacity additions based on these
supplies.
Rising interest rates
Utility stocks have high negative correlation with interest rates, as it impacts the cost of
discounting its cash flows as well as provides an alternative investment opportunity in
high-yielding government securities.
Execution risk
A significant delay in executing planned capex on account of delays in land acquisition,
procuring clearances, equipment, etc., will impact its earnings and RoE.
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