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Power Grid Corp of India
Initiate at OW: Wiring India
PGCIL best positioned to benefit from two-fold growth in
sector capex by FY17; it has the lowest risk profile
FY11-13 EPS set to grow at 17% CAGR against 12.5% since
FY07; EPS growth likely to sustain until FY17 on strong capex
Initiate OW with INR130 TP; FY10 underperformance due to
lower increase in asset base but our project-wise analysis
suggests this will change in FY11-12
Power Grid Corp of India (PGCIL), the central transmission utility, is the best way
to play rising capex in the Indian power sector: We expect PGCIL to contribute 12% of
power sector capex of INR12trn (USD270bn) over the next seven years and 50% of the
total investment in the transmission segment.
Operational overhang led to sector underperformance: The power sector stocks have
underperformed in the last 12 months due to operational risks (fuel and SEB financial
health), as highlighted in our report Indian Power: Same problem, new execution risks,
4 October 2010. Among the major utilities, PGCIL is least exposed to operational risks and
offers a defensive play with high earnings growth, and is available at an attractive valuation.
Lower increase in asset base in FY10 led to underperformance; to change in FY11-12:
Our project level analysis suggests a higher proportion of transmission capacity will be
operational in the next seven years due to strong generation capacity additions driving capex
(USD31bn) and increasing the earning asset base (USD26bn) by 4.3x through FY17.
EPS to grow at 17% CAGR (FY11-13); capacity expansion key driver: We expect growth
to sustain until FY17 (15% FY11-17 CAGR). EPS grew 12.5% over the last four years.
Discount to sector peers not justified: PGCIL is trading at a 10-17% discount to the
large-cap generation peers, which we do not believe is justified. Our target price implies
2.3x PB, compared to the current 15-month forward PB multiple of 1.9x, at the lower end
of the last two years’ multiples (1.6-3x). It implies a target PE multiple of 16.8x, against
the current multiple of 14.4x (historical: 12-25x). We expect an increase in the earning
asset base in FY11-12 to be a key trigger for re-rating.
Initiate OW, 35% potential return: We use DCF to derive a fair value of INR130
(COE: 12%, terminal growth rate: 3%). Key risk: longer-than-expected delays in project
commissioning impacting earnings.
Investment summary
PGCIL, the central transmission utility company, is best positioned
to capture growth in power sector capex over FY11-17
High capex growth and increase in asset base facilitated by the
large IPP capacity expected over FY12-17
Initiate at OW with INR130 target price; we believe the market has
not yet factored in the positives, while the negatives are in the price;
key risk is project delays, resulting in lower-than-expected capacity
addition
Best positioned to capture the
benefit of the capex increase
PGCIL is the central transmission utility (CTU) in
India; as such, it has the sole responsibility of
planning and implementing interstate transmission
systems. It owns and operates more than 95% of
India’s interstate or regional transmission system,
and transmits c50% of the power in India.
We expect PGCIL to contribute 12% of the
overall power sector capex of INR12trn
(USD270bn) during FY11-17, which is more than
double the capex incurred in the last five years.
We expect its capex to accelerate from INR250bn
(FY08-10) to INR1,395bn over the next seven
years (FY11-17). Further, we expect the capex to
be capitalised much faster, translating into higher
earnings.
Lower asset base creation in
FY10 set to reverse
We believe the lower asset base creation in FY10
will reverse during FY11-17 for the following
reasons:
Our project-wise analysis suggests generation
capacity addition of more than 125GW during
FY11-17 (75% of existing capacity),
dominated by the independent power
producers (IPP) who seek to sell to the best
buyers, while the units are being planned
closer to the fuel centres (pit heads or ports).
Capex in generation should be matched by
similar capex in transmission and distribution.
PGCIL has planned capex for most of the
proposed projects.
PGCIL is unlikely to face any financial
constraint in meeting its equity contribution to
the capex plan until FY14-15, when we
expect it to raise capital through equity. We
believe this will be positive for the company
since it earns a post-tax ROE of c17% on the
equity invested in capital projects.
Price-based bidding unlikely
to slow down PGCIL capex in
the next four years
The central government, on the advice of the
Central Electricity Regulatory Commission
(CERC), announced that price-based bidding will
be applicable to all public sector undertakings
(PSU), including the central utility, from 5
January 2011. Price-based bidding can potentially
increase competition and lower returns. However,
since PGCIL has a strong project pipeline, we do
not expect it to immediately see any deceleration
in capex.
Predetermined ROE
PGCIL works in a regulated environment. Its
projects earn a 15.5% (post-tax) ROE on the
investments in the transmission business (92% of
overall revenue). This is stable and predictable,
with minimal downside risks. Additionally, it
earns returns (1-1.5% ROE) for maintaining the
transmission network availability at more than
98% (99% in the last 6-7 years).
Capacity addition directly flows into
earnings
PGCIL assets start to generate earnings when
transmission lines become operational. We expect
its regulated equity to grow at a 22% CAGR over
FY11-13, driving an earnings CAGR of 17%
during the same period.
Negligible operational risks, unlike
generation companies
As PGCIL is a “wire” company, there are rare
instances of operational disruptions. Hence, unlike
generation companies, the negative impact from
disruptions on PGCIL’s earnings is limited.
Generation companies face fuel availability and
price risks (coal & gas) and possible nonscheduling
of their plants, which impacts their
capacity utilisation.
Key concerns
Delay in project expansion
PGCIL’s projects typically have a gestation
period of 18-36 months. In the past, the company
has faced delays of 3-18 months. The projects
linked to new power generation plants can face
additional delays, caused by factors beyond the
company’s control. Right of way requiring forest
clearance is another challenge. We have factored
in an overall average execution period of 21
months (including 3-6 month delays) in the
Twelfth Five-Year Plan.
Our analysis suggests that a further execution delay
of six months on average could lead to a 5-6%
decline in EPS and a 4% decline in target price.
Funding concerns
We do not foresee any funding concerns for
PGCIL for FY11-12. However, our analysis
suggests that the company will have to raise
cINR107bn during the Twelfth Five-Year Plan
period and may need to raise capital in FY14-15.
Possible risk from default by stateowned
distribution companies?
The state-owned distribution companies, PGCIL’s
major customers, are not in the best of financial
health. We expect their losses to increase to
INR800bn in FY12 from INR526bn in FY09.
However, although we may see transient payment
delays, we do not expect any default risk (as we
expect the government to fund the shortfall).
Other risks
Reduction in ROE from 15.5% (post-tax)
currently – during FY05-09, the CERC cut
ROE from 16% to 14%.
Capital benchmarking – in determining the
tariff, the regulator may approve capex lower
than actual capex incurred, which is
benchmarked against an acceptable capex
amount, as per the new CERC regulations,
resulting in lower earnings.
EPS to grow at 17% CAGR
over FY11-13 and sustain
until FY17
We estimate PGCIL’s regulated equity base
to increase two-fold, from INR106bn in FY10
to INR210bn in FY13, due to the INR345bn
increase in asset base.
The increased equity base will help PGCIL
grow its revenue at an estimated 19.5%
CAGR over FY11-13. We expect EBIDTA
margin to remain at 81%.
This should result in EPS growing at a 17%
CAGR (FY11-13), which is slightly below
revenue and EBITDA growth due to equity
dilution post the follow-on public offering in
November 2010.
This is higher than the 12.5% growth seen in
the last four years. We expect growth to
sustain until FY17 (15% EPS CAGR) due to
heavy capex.
How do we fare versus consensus?
Our FY11-13 EPS estimates are largely in line
with consensus.
DCF-based TP of INR130;
initiate at OW
We use DCF methodology to value PGCIL, given
the stable cash profile of its business. We have an
explicit forecast until FY17 (end of the Twelfth
Plan), fading out capex until FY22 (end of the
Thirteenth Plan), and a terminal growth rate of 3%
thereafter. We discount each cash flow assuming
a COE of 12% to arrive at a fair value of INR130.
We do not believe PB or PE on FY12-13 earnings
can capture the growth potential expected over the
next seven years.
Our target price of INR130 implies a potential
return of 35%, which is above the Neutral band;
thus, we initiate with an Overweight rating.
PGCIL attractive among peers
PGCIL is trading at 1.9x PB, at a 10-17%
discount to its peers, which is at the lower end of
the multiples it traded at over the last two years
(2-3x PB). The stock has underperformed the
Power Index by 3% in the last year. We believe
this is on account of investor concerns on the pace
of project execution and lower capitalisation in
FY10. Our target price implies PGCIL will trade
at 2.3x FY13 book. On PE, our target implies a
multiple of 16.8x compared to the current 15-month
forward multiple of 14.4x (historical 18-24x PE).
We believe this is justifiable, given strong earning
expectations and the company’s lower risk profile.
Strong capacity addition in FY11-12 will be the
key re-rating trigger.
PGCIL, the central
transmission utility
PGCIL’s high transmission capex of INR1,395bn (FY11-17) is
likely to continue, following large generation capacity adds in India
Lack of transmission capacity could become the biggest
bottleneck for development of an efficient power market in India
Its key role is to provide and maintain a long-distance
transmission network, wheeling of power and load management
Strong generation capacity
addition to drive transmission
capex
Under the Electricity Act 2003, PGCIL was
appointed as the nodal CTU. We expect more than
125GW of new generation capacity addition in
India during FY11-17 (75% of existing capacity).
Every rupee spent on generation needs to be
matched by another in transmission and
distribution. In the past, transmission capacity
expansion in India could not keep pace with
generation — this is reflected in the recent CERC
report which stated that two main exchanges
could not sell 7-16% of the power demanded in
October due to congestion in the system.
We expect that the current phase of accelerated
investment in transmission, started and led by
PGCIL since FY08, will continue at CAGR of
17% during FY11-17.
PGCIL to dominate
transmission capex
We expect PGCIL to achieve c95% of capex
during the current Five-Year Plan (FY08-12),
against a proposed outlay of INR550bn. Since
PGCIL has in place a capex plan of INR1.2trn for
the Twelfth Plan (FY13-17), we believe it is likely
to continue to incur capex at an accelerated rate,
even after the expiry of the current plan period;
we expect capex of INR1,395bn between FY11
and FY17.
PGCIL is likely to contribute more than half of
the total transmission capex in India, since most
state transmission companies have limited ability
due to the poor financial health of the state power
sector and as private transmission projects are still
small.
Price-based bidding unlikely
to slow down PGCIL’s capex
in the next four years
Based on the CERC’s advice, the central
government announced the implementation of
price-based bidding for awarding new
transmission projects. The bidding mechanism
became applicable to all PSUs, including the
CTU, from 5 January 2011. However, given that
PGCIL already has a large project pipeline, we do
not expect project capex to decelerate in the near
term.
Mature power markets require
redundancy in transmission
capacity
We believe that a successful power market in
India can develop only if the IPPs, which are in
the process of setting up large capacities, as well
as state generation companies are able to freely
transmit and wheel power. We believe that
redundancy in the transmission system is a
necessary pre-condition, since the generation
capacities are mostly coming up around the coal
pit heads or at ports to facilitate fuel supply to the
power projects, which are a distance from the
current load centres (see map below). PGCIL has
been mandated to create this capacity — it is now
in the process of creating a national grid as well as
strengthening the grid’s transmission capacity.
While we expect c100GW generation capacity
from the IPPs by FY17, matching it in terms of
transmission capacity will be critical for the
success of new generation projects.
PGCIL’s role
PGCIL’s role as the CTU is defined by the
Electricity Act 2003. Its key business is the
interstate transmission of high voltage power and
providing and maintaining a transmission system
for the wheeling of power and load management.
Provision for long-distance transmission and
wheeling of power is the key role of the wire
companies, i.e. PGCIL at the central level and
state transmission companies at the state level. At
the same time, it is important to provide free
transmission capacity to both generators as well as
demand centres even at a short notice, by building
in redundancy in the capacity, which is currently
not available.
The Act provides for the creation of a National
Load Despatch Centre (NLDC) to act as a centre
at the national level, for optimum scheduling and
despatch of electricity among the Regional Load
Despatch Centres (RLDC) and State Load
Despatch Centres (SLDC). The NLDC and RLDC
are managed by PGCIL, via its fully owned
subsidiaries.
Transmission planning now adopts an integrated approach
Old approach
Transmission system planning in the country
was primarily focused on generation evacuation
and transmission system was configured such
as to be able to evacuate power without any
load-shading or rescheduling. This approach did
not take into account the spatial distribution of
the load and hence was not in a position to
respond to changes in supply or demand
pattern.
New Approach
This is the integrated system planning approach
which does not look at point to point planning for
the supply and demand centers. The new
approach takes into account that a large part of
power will be generated at fuel sources while the
demand centers will be spread across the
country with variations across the day or year.
Source: Ministry of Power (MOP), GOI
Electricity Act 2003 definition of transmission line and
wheeling
Act defines “transmission lines" as all high
pressure cables and overhead lines (not being
an essential part of the distribution system of a
licensee) transmitting electricity from a
generating station to another generating station
or a substation, together with any step-up and
step-down transformers, switch-gear and other
works necessary to and used for the control of
such cables or overhead lines, and such
buildings or part thereof as may be required to
accommodate such transformers, switch-gear
and other works.
Act defines "wheeling" as the operation whereby
the distribution system and associated facilities
of a transmission licensee or distribution
licensee, as the case may be, are used by
another person for the conveyance of electricity
on payment of charges to be determined under
section 62.
Source: The Electricity Act 20
National Grid — What is it?
PGCIL is working towards achieving its mission of establishment and operation of Regional and National Power Grids to
facilitate transfer of power within and across the regions with reliability, security and economy, on sound commercial
principles.
The exploitable energy resources in our country are unevenly distributed, like Coal resources are abundant in
Bihar/Jharkhand, Orissa, West Bengal and Hydro Resources are mainly concentrated in Northern and North-Eastern
Regions. As a result, some regions do not have adequate natural resources for setting power plants to meet their future
requirements whereas others have abundant natural resources. Demand for power continues to grow unabated. This
calls for optimal utilization of generating resources for sustainable development. Thus, formation of National Power Grid
is an effective tool to achieve this as various countries have adopted the model of interconnecting power grid not only at
national level but also at international level.
Further, acquiring Right of Way (ROW) for constructing transmission lines is getting increasingly difficult, especially in
eco-sensitive areas like North-Eastern Region, Chicken neck area, hilly areas in Jammu & Kashmir and Himachal
Pradesh. At the same time, these areas are also endowed with major hydro potential of the country. This necessitates
creation of Transmission Super Highways, so that in future, constraints in ROW do not cause bottleneck in harnessing
generating resources. Inter-connection of these highways from different part of the country would ultimately lead to
formation of a high capacity National Power Grid.
Thus, developments in power sector emphasize the need for accelerated implementation of National Power Grid on
priority to enable scheduled/unscheduled exchange of power as well as for providing open access to encourage
competition in power market. Formation of such a National Power Grid is being implemented by PGCIL in a phased
manner.
Initially, considering wide variations in electrical parameters in the regional grids, primarily HVDC interconnections were
established between the regions. This was completed in the year 2002, thereby achieving inter-regional power transfer
capacity of 5000 MW.
In the current phase, inter-regional connectivity is planned to be strengthened with hybrid system consisting of high
capacity EHV/UHV AC and HVDC links. Such a National Power Grid is envisaged to disperse power not only from Mega
sized generation projects but also to enable transfer of bulk power from one part of the country to another in different
operational scenarios say, in varying climatic conditions across the country: Commissioning of links under this phase
has commenced with the commissioning of 2000 MW Talcher-II HVDC Bipole, Raipur Rourkela 400kV D/C AC
transmission line having series compensation, augmentation of Gazuwaka HVDC (500MW) back to back link and Tala
transmission system. The inter-regional transfer capacity of 22,400MW is available as of March 2010. Further
strengthening of National Power Grid is being implemented through high capacity AC EHV lines, 765 kV UHV AC lines/
HVDC lines. This phase is planned to be implemented by 2012 when inter-regional power transfer capacity will be
enhanced to about 37,700 MW by the end of XI Plan, depending upon planned growth of generation capacity.
Source: Ministry of Power
Similar to NTPC? Not
really
PGCIL and NTPC have similar business models (cost plus ROE),
but different risk-return profiles
PGCIL has a lower return profile than NTPC, but carries limited
operational risks (fuel availability and scheduling), which may hurt
generation companies going forward
PGCIL should trade at similar levels to NTPC, or even at a premium
Regulated business models
with different risk-return
profiles
NTPC (NATP IN, Neutral, CMP INR190, TP
INR225), the largest power generator, and PGCIL
have similar business models (cost plus ROE),
although this is likely to change after FY17.
However, their implementation and operational
risks profiles differ.
PGCIL has lower return profile
but limited operational risks
While both PGCIL and NTPC are entitled to
15.5% (post-tax) ROE, the scope for additional
returns is c5-7% higher for NTPC than for
PGCIL. However, PGCIL’s earnings do not carry
any operation-related risks, while NTPC faces
risks in terms of fuel availability (coal & gas) and
prices. These may lead to non-scheduling of its
plants, and impact its plant load factor (PLF).
NTPC projects face higher risks of time and cost
overruns than PGCIL’s projects.
PGCIL’s discount not justified
PGCIL is trading at a 10-20% discount to NTPC,
mainly due to investor concerns on the IPP
capacity addition and lower capitalisation in
FY10. We do not believe this is justified for three
reasons:
PGCIL is likely to see stronger earnings
growth (17% FY11-13 CAGR) than NTPC
(11.6% CAGR), due to higher capitalisation.
PGCIL is appointed as CTU as per the
Electricity Act 2003. Hence, it will continue
to play this role, despite the implementation
of price-based bidding from 5 January 2011.
We believe the new process is less likely to
impact PGCIL than it is likely to impact
NTPC — NTPC is on a par with other private
sector utilities in India.
PGCIL’s stock is more liquid than NTPC’s
(30% free float vs. 15%).
Earnings forecasts
PGCIL to continue strong capacity addition, accelerating its
capitalisation, resulting in 3.7x increase in asset base and 4.3x
increase in regulated equity (FY11-17)
Earnings to grow at 17% CAGR (FY11-13) and sustain till FY17
versus 12.5% over the last four years
Existing cash flows to meet funding requirements for budgeted
capex in Eleventh Plan, but Twelfth Plan capex will require further
equity dilution by FY15, albeit positive for the stock
PGCIL to see strong capex
during FY11-17
As discussed previously, we expect PGCIL to
continue recording accelerated growth in capex
and hence higher capacity addition till FY17. We
expect this to directly impact earnings (which are
linked to its capacity addition) as it increases its
regulated equity base (see chart on page 21 for
determination of tariff).
In our view, the company will meet c95% of its
planned capex target of INR550bn during the
Eleventh FYP (FY07-12) since it has sufficient
projects lined up to be completed over the next
three years. PGCIL incurred cINR254bn capex as
of FY10 (46% of planned). It has earmarked
capex of INR119bn for FY11 and INR160bn for
FY12. The company exceeded its annual capex
target in the last three years. However, it is likely
to fall marginally short of the target this year due
to delays in some of the evacuation projects. The
current plan capex has been distributed 60% for
grid strengthening projects and 40% for power
evacuation projects.
The capex plan for the Twelfth Plan (FY13-18) is
in place (118% increase over previous plan). This
will be equally distributed between grid
strengthening and generation evacuation projects.
The current project plan submitted by PGCIL
indicates that a major part of the nine highcapacity
transmission projects will be executed by
FY15. However, we expect time overrun due to
delays in some of the IPP projects and expect this
capex to spill over to FY16-17.
Earnings growth driven by
capex and CWIP
capitalisation
PGCIL starts earning revenue only after it completes
the projects and capitalises the capex incurred as
approved by the regulator. Typically, a transmission
project takes 18-36 months for completion
depending on the type and complexity of the project.
Generation-linked projects are additionally
dependant on the completion of the power plants by
the IPPs as compared to grid strengthening projects,
which are relatively independent of external factors.
Over the past five years, the conversion of capital
works in progress (CWIP) into gross block has been
around c55%, which dipped to c22% in FY10. This
was mainly due to large capex incurred in FY09-10
to the tune of INR195bn for some of the large
projects (for instance, atomic projects INR24bn,
WRSS INR25bn) expected to be completed over
FY11-13.
We expect that the conversion of CWIP to assets
will improve as the projects near completion. Based
on the current project status, we expect PGCIL to
capitalise INR328bn (INR82bn in FY11 and
INR105bn in FY12). We expect the company to
capitalise cINR964bn during the Twelfth Plan.
Overall, we expect PGCIL’s fixed asset base to
increase 3.7x, resulting in its regulated equity base
increasing 4.3x (from cINR106bn in FY10 to
INR455bn in FY17), driving strong earnings growth.
Strong revenue and EPS
growth (FY11-13e)
Revenue to grow at 19.5% CAGR
over FY11-13e
Since we expect the company to capitalise
INR345bn during FY11-13, we estimate a twofold
increase in the regulated equity base during
that period (INR106bn to INR210bn). The
increased equity base will help PGCIL grow its
revenue at a 19.5% CAGR during FY11-13.
The key components of revenue growth are 20%
CAGR growth in its transmission business (93%
of its revenue), 10% CAGR growth in its
consultancy and telecom business and 23%
CAGR growth of its revenue from short-term
open access charges.
Maintain 81% EBITDA margin
We expect PGCIL to retain its high EBITDA
margin of 81% and hence grow EBITDA at a
19.4% CAGR during FY11-13.
EPS growth at 17%
We estimate PGCIL’s EPS to grow at a 17%
CAGR during FY11-13. This is slightly lower
than its revenue and EBITDA growth due to the
increase in the number of shares after the followon
public offering in November 2010. This
compares to 12.5% growth seen in the last four
years. We expect growth to sustain until FY17
(15% EPS CAGR) due to strong capex.
Large CWIP suppresses ROE
While the company earns c16% ROE on its core
regulated equity base, the actual reported ROE is
12-13% due to large CWIP, as the company does
not earn any return on this.
Funding in place for 11th Plan
post FPO, but will need to
raise equity for 12th Plan
Eleventh Plan: We estimate PGCIL will incur
capex of cINR270bn during FY11-12, which is
marginally lower than the company’s own
projection of INR278bn during the same period.
This translates into equity requirements of
INR81bn (70:30 debt:equity). Currently, the
company has cash and cash equivalents of
INR35bn and cash raised from the FPO to the
tune of INR38bn.We also expect the company to
generate free cash flows of INR46bn over the next
two years, which should take care of funding for
the capex as envisaged by the company.
Twelfth Plan: We expect the company to incur
capex of INR1.1trn during FY13-18, implying an
equity requirement of cINR337bn. Based on our
analysis and cash flow estimates, we expect the
company to generate free cash flows of INR195bn
during the plan period and opening cash balance
of cINR35bn. We expect the company’s equity to
fall short by cINR107bn during the Twelfth Plan.
Hence, we expect it to raise capital either in FY14
or FY15. Therefore, there will be further dilution
depending on the pace of the projects’ execution.
We believe this will be positive as PGCIL earns a
post-tax return of 16% on its equity employed in
the business.
PGCIL revenue determination according to CERC norms
As per CERC regulations, PGCIL is paid a return on equity in a transmission project only after the commencement
of commercial operation of that project. In the event of a time overrun for a project in which company is investing,
returns on investment in that project will be postponed during the delay.
PGCIL’s charges for transmission customers are governed by tariff norms determined by the Central Electricity
Regulatory Commission (CERC) pursuant to central government tariff policy and legislation.
Under the tariff regulations applicable for the tariff Block 2009-14, PGCIL is permitted to charge its customers
transmission charges for recovery of annual fixed cost (“AFC”) consisting of components.
Return on Equity,
Interest on outstanding debt,
Depreciation,
Operation and maintenance expenditure and
Interest on working capital
From the tariff Block 2009-2014, the Return on equity shall be computed on pre-tax basis, at the base rate of 15.5%
by grossing up the base rate for the tax factor.
Depreciation shall be calculated annually based on Straight Line Method at 5.28% for transmission systems etc
Operation and maintenance expenditure is based on the number of kilometers of transmission lines and the
number of bays in substations multiplied by normative rates specified in the Fiscal 2010-2014 Regulations.
The transmission charge (inclusive of incentive) payable for a calendar month for a transmission system or part
thereof is as per the following:
AFC x ( NDM / NDY ) x ( TAFM / NATAF ) where
1. AFC = Annual fixed cost specified for the year, in Rupees
2. NATAF = Normative annual transmission availability factor, in per cent
3. NDM = Number of days in the month
4. NDY = Number of days in the year
5. TAFM = Transmission system availability factor for the month, in Percent.
Source: CERC
Valuation and risks
We use DCF to derive a fair value of PGCIL to capture strong and
stable cash flow generation
PGCIL trades at a discount to large Indian power generation
companies despite having a better earnings profile
Initiate as OW with TP of INR130. Key risks are delays in project
execution resulting in lower-than-expected capitalisation and
consequently earnings
PB or PE approaches may not
fully capture strong growth in
equity base
While PB is a good measure to use to arrive at the
fair valuation for a company like PGCIL, we do
not believe it can capture the strong growth that is
expected over the next five years. We also do not
think that a target multiple on FY12 EPS will be
able to truly capture the full growth potential of
the company.
We use DCF-based valuation
In our view, given the stable cash profile of the
business, we prefer to use DCF to value PGCIL.
We have made explicit forecasts until FY17 (end
of Twelfth Plan), fading out until FY22 (end of
Thirteenth Plan), and then assume a terminal
growth rate of 3% thereafter.
We then discount each cash flow assuming COE
of 12% to arrive at a fair value of INR130 per
share for PGCIL.
PGCIL attractive among peers
PGCIL is trading at 1.9x PB, at a 10-17%
discount to its peers and at the lower end of the
multiples it has traded at in the last two years (2-
3x PB). The stock has underperformed the Power
Index by 3% in the last year. We believe this is on
account of investor concerns on the pace of
execution of projects and lower capitalisation in
FY10. Our target price implies 2.3x FY13e book.
We believe this is justifiable given strong earnings
expectations and PGCIL’s lower risk profile.
We expect strong capitalisation in FY11-12 to be
key triggers for a re-rating of the stock.
Initiate as OW for 35%
potential return
Under our research model, for stocks without a
volatility indicator, the Neutral band is 5
percentage points above and below the hurdle rate
for Indian stocks of 11%. For PGCIL, this
translates into a Neutral band of 6-16% around the
current share price.
Our target price of INR130 implies 35% potential
return, which is above the Neutral band. Thus, we
initiate with an Overweight rating on the stock.
Sensitivity to key operational
assumptions
Delay in commissioning: Our analysis suggests
that a further delay of six months in execution on
average could lead to a 5-6% decline in EPS and
4% in target price.
Lower capex: Our analysis suggests that even if
the company is unable to meet its capex guidance
of INR1.2trn by 38%, EPS declines 6-8% and the
target price declines 4%.
Risks
Delay in expansion of projects
PGCIL’s projects typically have a 18-36 month
gestation period. In the past, it has faced delays of
8-18 months. Projects linked to new power
generation plants can face additional delays,
which are outside the control of the company.
Right of way due to forest clearance is another
issue faced by the company. We have factored in
overall average execution period of 21 months in
the Twelfth Plan, factoring in c3-6 months of
delays.
Our analysis suggests that a further delay of six
months in execution could lead to a 5-6% fall in
EPS and 4% in target price.
Funding concerns
We do not foresee any funding concerns for
PGCIL in meeting its capex guidance for FY11-
12. However, based on our analysis, the company
will need to fill a gap of cINR107bn of equity
during the Twelfth Plan. Hence, it will need to
raise equity either in FY14 or FY15 depending on
the pace of the projects’ execution. This will
result in further equity dilution.
Possible SEB payment delays
The company’s major customers are state-owned
distribution companies, whose financial health is
not good. Losses at the state-owned distribution
companies are anticipated to increase to
INR800bn in FY12. While this may result in
transient payment delays, we do not foresee any
default risk (we expect state governments to fund
the shortfall).
Other probable risks
Fall in ROE from the existing 15.5% (posttax):
The CERC decreased ROE from 16% to
14% during FY05-09.
Capital benchmarking: According to new
CERC orders (released in 2010), the actual
capex used in the development of a project
will be benchmarked against an acceptable
amount of capex in order to determine
whether the actual expenditure incurred was
reasonable. This could result in approved
capex for determining tariffs being lower than
the actual capex, resulting in loss of revenues
and earnings for the company.
Company profile
PGCIL is a CTU, as per the Electricity Act 2003
It is the single-largest transmission company in India, with a
transmission network of c80,000km transmission lines and 132
sub-stations
It has a strong network (99.5% network availability) and transmits
c50% of the total power generated in India
Transmits c50% of the power
generated in India
PGCIL is the largest transmission company in
India, with a transmission network of c80,000km
electrical transmission lines and 132 electrical
sub-stations, as of September 2010, with a
transformation capacity of 89,170 MVA. The
company was ranked No. 3 transmission utility
globally (World Bank, January 2009). It currently
owns and operates more than 95% of India’s
interstate and inter-regional electric power
transmission systems. It also transmits c50% of
the power generated in India.
In the last 6-7 years, it has consistently maintained
transmission network availability at more than 99%,
higher than the targeted system availability (98%),
facilitating incremental profits through incentives.
Further, the company has received the highest
annual performance rating of ‘Excellent’ from the
Government of India every year since FY94
The company commenced operations in FY92 as
part of a government initiative to consolidate all the
interstate and inter-regional electric power
transmission assets of the country in a single entity.
Consultancy business – 4% of
FY10 revenue
Since FY95, the consultancy division has
provided transmission-related consultancy
services to over 115 clients in over 330 domestic
and international projects. Consultancy income
mainly consists of fees from Rajiv Gandhi
Grameen Vidyutikaran Yojana, the execution of
transmission and communication system-related
projects on a turnkey basis, and technical
consulting assignments for Indian state utilities
and utilities in other countries.
Telecom business – 2% of
FY10 revenue
PGCIL diversified into the telecom business in
2001, utilising its nationwide transmission system
to create an overhead fibre-optic telecom cable
network using optical ground wire on power
transmission lines. As of 30 September 2010, the
network was 20,733km and connected 129 Indian
cities, including all major metropolitan areas.
Revenue from the telecom business is mainly on
account of leasing bandwidth of its fibre optic
lines to various customers. The company leases
bandwidth on this network to more than 70
customers, including Bharti Airtel, Bharat
Sanchar Nigam Ltd, National Informatics Centre,
Dishnet Wireless, and Tata Communications.
Joint ventures yet to fructify
PGCIL has investments in nine public-private
joint ventures, which have been established to
develop certain new transmission lines and
systems with private parties. These, however, are
yet to yield results.
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