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Power Grid Corporation of India
▲Overweight
Previous: Neutral
PGRD.BO, PWGR IN
Safety in 'numbers', valuations hit a trough: Upgrade to OW
• Upgrade to OW from N, revised Dec-11 PT of Rs115, 17% upside. The
stock underperformed the Sensex by 29% in CY10. But we believe the
growth and risk profile will improve, and valuations are now attractive.
~80% of PGCIL’s 12th Plan (FY13-17) capex target of Rs1,050B is assured
of regulated returns, ahead of the shift to competitive bidding regime
starting 5th Jan. We forecast PAT CAGR of 18.5% (up 250bps) and
~160bps improvement in RoE to 14.9% through FY14 mainly due to- (A)
potential improvement in capitalization efficiency led by contractual
safeguards (B) strong execution skills (C) operating leverage arising out of
scale and (D) growth in high margin consultancy business. 1-yr fwd P/B of
2.1x is at a historical trough. PGCIL is a safe+stable growth story, in our
view, as compared to IPPs which face significantly higher uncertainty
around land, fuel, environmental clearances and merchant prices.
• PGCIL is largely hedged against impediments to growth through FY17.
Of PGCIL’s 12th Plan capex target, 55% is linked to private IPP projects,
15% to grid strengthening with no direct dependence on gencos; and
balance 30% to UMPP/central sector power projects. The relatively riskier
private IPP linked capex has contractual safeguards, which require the
beneficiary to pay regulated returns to PGCIL in the event the power project
is delayed and the transmission line is commissioned as per schedule.
• Model revisions- EPS up 2.4% in FY12E, 6% in FY13E: (A) Factoring
80% of 12th Plan target capex in est., (B) Capitalization of Rs450B assets
b/w FY11-14 (up ~10%), (C) Rollover PT to Dec-11 vs. Mar-11 earlier, (D)
30bps increase in risk free rate to 7.9%, WACC of ~9%. Upside from tower
leasing to telcos is a medium term catalyst- leasing 15% towers with a 2x
tenancy could potentially add Rs7.2B to PAT.
• Risks to our view and PT: Our Dec-11 PT of Rs115 is based on DCF
(WACC of 9%, terminal "g" of 2.5%). Hardening of bond rates (increases
WACC), prospect of weak growth in FY12 as mgmt has guided to Rs80-
90B of addition to GB next fiscal, 12% lower than FY11. Higher capex
without increase in capitalization efficiency is valuation destructive.
Revised Dec-11 PT of Rs115 (vs. Mar-11 PT of Rs100 earlier), offers
17% upside from current levels. The stock has underperformed the
Sensex by 29% in CY10, mainly ahead of FPO-cum-divestment
exercise in Nov-10. Our valuation is based on the DCF methodology
with a WACC of 8.95% and a terminal growth rate of 2.5% beyond
FY30. Terminal value contributes 73% to our enterprise value of
Rs873B.
Growth and risk profile expected to
improve, valuations attractive
We expect PGCIL’s growth and risk profile to improve over the medium term. We
believe the valuations are at a historical trough and provide an attractive entry
opportunity into the stable growth, low-beta, defensive stock.
We forecast PAT CAGR of 18.5% (up 250bps) and ~160bps improvement in RoE to
14.9% through FY14. There is safety in ‘numbers’ for the utility in comparison to
IPPs, which face several risks to execution and profitability.
Assured return model to continue thru high capex years
PGCIL has largely insulated itself from private sector competition through FY17.
Ahead of the impending cut-off date for shift to the competitive bidding regime for
implementing transmission projects, PGCIL has tied up ~80% of 12th Plan (FY13-
17) target of Rs1050B under the regulated return regime. This includes-
• 9 high capacity power transmission corridors (HCPTC) for evacuating
power generation from ~50GW of private IPP projects (see table 1).
According to management the transmission line/substation orders will be
awarded through FY12, and the execution period is expected to be ~30-36
months.
• Proposed 4GW UMPPs in Orissa and Chhattisgarh, entailing an investment
of ~Rs105B.
• According to management, private sector will have to show an
implementation track record in transmission, hitherto absent. Private sector
transmission projects commissioned so-far have been in JV with PGCIL.
contractual safeguards
We define capitalization rate as [Net addition to GB/ (CWIP in previous year +
capex in current year)]. Higher efficiency of capitalization (or higher capitalization
rate) implies that a higher equity base of commissioned projects is entitled to assured
regulated returns and incentives. We expect the capex mix in 12th Plan to support
improvement in this metric and hence aid PAT growth.
• Of PGCIL’s 12th Plan capex target, 55% is linked to private IPP projects,
15% to grid strengthening with no direct dependence on gencos; and
balance 30% to UMPP/central sector power projects. The relatively riskier
private IPP linked capex has contractual safeguards which require the
beneficiary (the SEBs if they have been identified or else the generation
company which has entered into an agreement with PGCIL for Long-term
open access) to pay regulated returns to PGCIL in the event the power
project is delayed and the transmission line is commissioned as per
schedule.
• In a separate order in Sep-10, CERC approved CoD for a portion of
transmission system associated with the Kudankulam atomic power project
prior to it entering regular service where the delay was caused by the
postponed commissioning of the generation project. The precedent has
positive implications for improvement in PGCIL’s capitalization efficiency
if it can demonstrate to CERC that the transmission system is ready for
regular service but is so prevented for reasons not attributable to itself, or its
contractors/suppliers.
Superior execution skills, contribution of incentives to
boost RoE
PGCIL has a strong execution track record and invested ~85% of planned capex (of
Rs214B) during Xth Plan and execution is tracking at 84% vs. MoU targets in XIth
plan so far. This is in stark contrast to generation utilities where slippages over plan
targets have ranged have usually been 50% historically. Till Sep-10, PGCIL has
invested 53% of XIth Plan capex; in contrast IPPs have managed to commission only
24GW thru Nov-10, vs. original target of 78GW and scaled down target of 62GW.
Superior execution skills should manifest in earnings and RoE improvements on
account of- (A) Ability to meet capex targets, we est. 80% of 12th Plan target capex
of Rs1050B is met, (B) We forecast ability to commission projects on time will earn
PGCIL 50bps additional RoE. We est. that 40% of incremental equity investments
are in projects that get commissioned as per schedule, and (C) Network availability
linked incentives @ 1% of transmission equity for availability beyond 98%. We
estimate that these incentives (Rs1.75B in FY12) will account for ~7% of FY12
PAT.
High growth potential in healthy margin consultancy
business
PGCIL's vast experience in developing HV transmission network in India
(~79,556ckm of transmission lines set up by PGCIL carry 51% of total power
generated in the country as on Sep 30, 2010) places it in a comfortable position to
steer growth of the consultancy business. Consultancy revenues grew 25% in FY10
and 58.4% in 1HFY11. Absence of capital requirements for consultancy makes the
income stream highly lucrative. PGCIL does not employ people separately for
consulting and utilizes its existing experienced manpower. Assuming no interest
FY10 consultancy EBIT of Rs1.45B was 5.5% of PGCIL’s PBT, we estimate it to be
10.7% of PGCIL's PBT by end of FY12.
PGCIL provides consultancy services in 3 broad categories-
• Electricity distribution strengthening schemes and rural electrification
• The execution of transmission and communication system related projects
on a turnkey basis
• Engineering and consulting assignments for Indian and overseas utilities.
PGCIL is currently undertaking international consultancy assignments in
Afghanistan, Bangladesh, Sri Lanka, Bhutan, Nepal, Nigeria and UAE.
Increase in private sector participation in transmission in India would also provide
growth opportunities to PGCIL’s consultancy business. We model a 15% growth
CAGR in PGCIL’s consultancy revenues through FY17, a 20% CAGR would
increase PGCIL’s equity by ~Rs6/share.
Operating leverage owing to scale
Margin improvement led by employee cost savings are expected to continue as scale
of operations increases. As per our current capex and capitalization assumptions,
PGCIL's gross block will increase 3.15x over FY10 levels by FY17.
Medium term catalyst: Upside from telecom tower leasing
business
In FY10, PGCIL's board had approved a plan to diversify into the business of leasing
towers to independent tower firms and telecom service providers. According to
PGCIL, ~15% of towers of 15000 towers are technically feasible for leasing.
PGCIL has invited bids for selection of telecom tower infrastructure providers to
utilize its transmission towers in the states of Punjab, Haryana, Himachal Pradesh
and Jammu & Kashmir.
Assuming a tenancy of 2.0x operators per tower, and average monthly rental of
Rs20000/player, over the medium term the business has a revenue potential of upto
~Rs7.2B. Since the business does not entail any incremental capex by PGCIL, there
will be a flow-through of revenue to earnings. As of now, we do not factor this
income stream in our model and await finalization of contracts.
Investment negatives, risks to our view
What could cause underperformance to continue?
• Power Grid has an inverse correlation with bond yields. Regulated utilities
tend to underperform in a rising rate environment.
• We expect EPS growth in FY12 to be weak (~7%), ~2.7% below consensus.
Management recently has guided to Rs80-90B of addition to GB next fiscal,
12% lower than FY11. This may result in muted PAT growth in FY12.
Trough valuations provide attractive entry
point into stock, in our view
PGCIL has underperformed the Sensex by 29% in CY10, mainly ahead of FPO-cumdivestment exercise in Nov-10. 1H earnings growth has been quite strong at 34.6%
YoY.
1-yr fwd P/B of 2.1x is at a historical trough.
PGCIL is a safe+stable growth story, in our view, as compared to IPPs which face
significantly higher uncertainty around land, fuel, environmental clearances and
merchant prices.
We expect PGCIL’s growth cum risk profile to improve over the medium term. We
forecast PAT CAGR of 18.5% (up 250bps) and ~160bps improvement in RoE to
14.9% through FY14. There is safety in ‘numbers’ for the utility in comparison to
IPPs which face several risks to execution and profitability. See table on comparison
of average LT term RoE and FY12 P/B for IPPs and PGCIL below.
Key model revisions
Owing to higher capex through 12th Plan, improved capitalization efficiency
outlook, gains from incentives and operating leverage, we have revised our EPS est.
up from 2.4% to 14.6% thru FY17 (see table 7). Specific changes are mentioned
below-
• Factoring 80% of 12th Plan target capex in est. (Rs840B vs. Rs630B
earlier).
• Capitalization of Rs450B assets b/w FY11-14 (up ~10%). Factoring
management guidance of Rs100B addition to GB in FY11 and ~Rs90B in
FY12. Expect capitalization rate to improve to 32% b/w FY12-17 vs. our
est. of 30% earlier.
• Rollover PT to Dec-11 vs. Mar-11 earlier
• 30bps increase in risk free rate to 7.9% (in-line with increase in 10-yr G-Sec
rate), WACC of ~9%
Revised Dec-11 PT of Rs115, 17% upside to CMP
We upgrade to OW from N and revise Dec-11 PT (vs. Mar-11 earlier) of Rs115 (vs.
Rs100 earlier), which offers 17% upside from current levels. See summary of our
DCF valuation and WACC assumptions in Table 8 and 9 respectively.
Note that PGCIL becomes FCF positive in FY18E, as the capex intensity comes
down to 77% of sales. It tapers to 62% of sales by FY21E and thereafter, we equate
capex to depreciation. The D/E inches up from 1.86x to 2.26x by FY17E in our base
case capex assumptions (Rs840B thru FY13-FY17). However, D/E would still be in
control and below the threshold of 70:30, which could trigger equity dilution.
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