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India Utilities
Q3FY11 earnings preview
Earnings growth to be driven by increase in generation,
largely due to capacity additions over the past year
The underperformance of the last few quarters offers an
investment opportunity; stock prices may react positively to
any improved outlook for capacity additions
In terms of active ratings, PTC (OW(V)) and CESC (OW) are
our preferred stocks, while we are most negative on Lanco
UW(V)
3Q earnings preview: We expect earnings growth in 3Q FY11 to remain strong driven
largely by continued capacity additions. Within our sector coverage universe, we estimate
companies will report net profit growth of 15% yoy on average with PTC (+48% yoy) and
Tata Power (+44% yoy) reporting strong growth (see details on page 3).
Sector outlook: The last two quarters have seen a correction in short-term merchant
power prices and pressure on the coal supply for select units though the aggregate stock
position of coal at power plants was marginally higher at the end of last quarter. While
contracted PPA prices remain above INR3.50 we reaffirm our view that the gap between
long-term PPA prices and merchant rates will continue to narrow, falling to less than
INR1/unit over the next 2-3 years. We continue to prefer companies which sell more than
70% through long-term PPAs and have clear visibility on fuel supply.
Sector underperformance provides investment opportunity: The Power index has
underperformed the Sensex by 9% over the last quarter on concerns related to project
execution, fuel availability, the financial health of state owned distribution companies and
lower merchant prices. However, we believe the long-term underlying trends for the
sector are still positive, despite teething problems on the operational front, and that the
above-mentioned concerns are already adequately discounted in valuations (sector PB
multiples currently stand at 2.0x vs the historical range of 2.0-2.5x).
How to play the sector: Our key conviction idea is PTC, as we expect it to benefit from
increased trading volumes (from new capacity) and resultant margin expansion, as well as
the unlocking of value from the potential listing of its subsidiary, PTC Financial Services.
We also like CESC for its growth potential and expected reduction in retail losses and are
Overweight on Tata Power given its low fuel risk and future growth potential – to 3x the
current capacity by FY14e. We are Neutral on NTPC as we expect its capacity additions
to fall short of the company’s target.
3QFY11 earnings preview – company-specific comments
PTC: We expect trading volumes to grow 10% yoy and input costs to fall (-9% yoy); we forecast revenue
growth of 1% yoy. We expect margins to improve by 22% yoy to INR5 paise/unit resulting in EBITDA
growth of 71% yoy and PAT of INR235m, up 48% yoy. We expect investors to focus on the volume outlook
and the margin increase and to look for further clarity on the projects in which PTC has made an equity
investment. Potential deployment of surplus cash of INR10-12bn will likely be another concern of investors.
Tata Power: We expect strong revenue and EBIT growth in both the power (up 19% and 19% yoy,
respectively) and the coal businesses (up 20% and 47% yoy, respectively). We expect firm realisations
(USD65/ton) as well as volumes (17.5mn tons) in the coal business. While in the immediate term we expect
investors to focus on progress of the projects under construction at Mundra (4GW) and Maithon (1GW), in the
longer term investors will likely be keen to know more about the future growth drivers for the company.
CESC: We expect generation (up 25% yoy) to improve on the back of capacity additions (+26% yoy), as well
the increase in the tariff (+11% yoy), resulting in revenue growth of 37% yoy and PAT growth of 21% yoy.
We expect investors to focus on progress at the Haldia and Chandrapur power project as well as further
reductions of the retail losses. Investors will likely also be keen to see if the company provides any guidance on
other issues such as potential capital raisings and progress on proposed projects in Jharkhand and Orissa.
NTPC: We expect improved generation (up 3.5% yoy) on the back of capacity additions (+3% yoy), as well
the increase in the tariff due to input cost increases (up 28% yoy), to result in revenue growth of 23% yoy and
PAT growth of 7% yoy. We expect investors to focus on the extent of progress towards the capacity addition
target of 4.2GW in FY11 (1.5GW has been added to date and we expect another 1.5GW in 4Q) as well as the
applicability of MAT in FY11 and going forward. Investors will also likely focus on the direction NTPC
provides for future projects after having signed PPAs for 94GW to meet the 5 January 2011 deadline for price-
based competitive bidding.
Reliance Infrastructure: We expect revenue to grow at 21% qoq to INR49bn largely driven by execution in
its EPC business (+140% qoq) resulting in PAT growth of 32% qoq to INR4.7bn. The company began
reporting consolidated numbers only in Q1 FY11 and hence yoy comparisons are not available. We expect
investors to focus on the growth and margins in the EPC business and progress at the various infrastructure
projects (six infrastructure projects worth cUSD1.9bn) expected to be commissioned in FY11.
Lanco Infrastructure: We expect revenue to grow at 55% yoy on the back of growth in the EPC division
(+14% yoy) as well the Power division (+182% yoy) business. The growth in the power business will be driven
by the capacity addition of c1.3GW (up 180% yoy). Accordingly, we expect PAT growth of 74% yoy. We
expect investors to focus on a) pricing in regard to its merchant capacity of c1GW out of 2.1GW and b)
progress on projects under construction and in the pipeline such as the Anpara (1.2GW), Amarkantak 3&4
(1.32GW), Babandh (1.32GW) and Vidarbha (1.32GW) power projects.
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