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Power Utilities
2011 outlook is bullish; performance to be driven largely by robust
sector earnings growth (25%+)
Acceleration of new capacity addition (to 18GW in FY12), rise in
capex and high power prices to improve earnings visibility
Concerns (project execution, coal supply, financial health of
distribution co.s) to persist, but are priced in. PTC is our top pick
2011 sector outlook
We expect strong performance from Utility stocks
in 2011, fuelled by a) acceleration of power
capacity addition (18GW in FY12 versus 31GW
commissioned over the last four years), which we
forecast will drive 25% earnings growth, and b)
high sector capex during FY12 (the last year of
the 11th five-year plan), which implies strong
earnings in the coming years (utility sector returns
in India are regulated largely as a function of
equity employed).
The sector will, admittedly, continue to face an
overhang of investor concerns regarding project
execution, fuel availability and financial health of
state owned distribution companies (discoms);
however, we believe these factors a) do not
represent any meaningful short-mid term earnings
risk, and b) are already adequately discounted in
valuations (sector PB multiples have contracted
from 2.5x to 2x during 2010 on these concerns).
Notably, we also believe that the new capacities
do not constitute an excess supply situation, and
we expect long-term contracted power prices to
continue to increase on the back of increasing fuel
costs, albeit merchant power rates may correct to
narrow the gap between long-term power and
short-term merchant power (built into estimates).
Power Trading Corporation (PTC) is the top pick
from our coverage, given its expected growth and
stability in power trade as well as increasing
margins in addition to value unlocking potential.
Highest annual capacity and capex. Our project
level tracking indicates that 18GW of new
capacity will be added in FY12, which is the
highest ever capacity addition in a single year. In
addition, we estimate large capex in the
transmission sector led by PGCIL (INR160bn).
These will be further supplemented by a capex of
INR220bn in the distribution sector under the R
APDRP and RGGVY projects alone. We believe
that additional capacity and high capex infusion
will push sector income to grow at 25%+, which
we expect will be positive for the stocks.
Long-term prices to increase as merchant
prices moderate. We do not expect base load
surplus in power supply, given a large deficit in
existing supply. However, we do expect the peak
merchant price to contract from the highest levels,
since reasonable new merchant power capacity is
expected in FY11/12 (c4GW, about c80% of
existing merchant capacity). That said, increasing
coal costs and supply pressures will result in
higher long-term contracted prices under case 1
bids (already evident in the last few bids). We
expect bid prices to be in the range of INR3.50 to
INR4.25 during FY12.
Fuel and discoms’ financial health are key
concerns. Understandably, investor concerns
pertaining to operational risks, like availability of
coal and payment risk from state distribution
companies, are likely to persist. The shortfall in
domestic coal supplies is expected to increase to
120Mt in FY12 (2x FY10 levels) and potentially
can impact both plant load factor and margins.
That said, our forecasts do anticipate increased
coal imports and higher prices as a result.
Separately, losses at the state-owned distribution
companies are anticipated to increase to
INR800bn in FY12 (+17%). However, while this
may result in transient payment delays, we do not
foresee any default risk (we expect governments
to fund the shortfall).
Importantly, not all utility companies are equally
exposed to the above risks, and therefore exposure
to these risks can be diversified away through
stock selection.
Utilities powered by growth to outperform the
market. Indian Utilities have underperformed the
market in the last 12 months (-18% versus the
Sensex), primarily due to growing investor
concerns on implementation delays and operation
issues; most stocks are now trading at forward PB
of around 2x, which is close to historic lows.
While we do not expect these multiples to
improve meaningfully in the near term, we do still
expect strong sector performance, driven largely
by earnings growth. Furthermore, shares of
companies whose capacity is likely to come
onstream and show earnings growth should
perform better.
2011 top pick
PTC, OW(V), TP INR161
We prefer companies with a strong growth
outlook and minimum exposure to fuel and
pricing risk. PTC is our top pick as we expect it to
benefit from increased trading volumes (from new
capacity) and resultant margin expansion.
PTC has entered into long-term PSAs
(c5500MW) and PPAs (16000MW), which we
believe will reduce the volatility of its trading
business. Potential listing of its subsidiary, PTC
Financial Services, in CY2011 and a 48%
earnings CAGR over the next two years will
likely be positive stock catalysts.
Our 12-month target price of INR161, which
implies a forward PE of c15.9x (currently 18.7x)
is based on a sum-of-parts valuation (trading
business – INR66, investment in
subsidiaries/associates – INR50 and remainder
value from unutilized cash of INR10bn).
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Power Utilities
2011 outlook is bullish; performance to be driven largely by robust
sector earnings growth (25%+)
Acceleration of new capacity addition (to 18GW in FY12), rise in
capex and high power prices to improve earnings visibility
Concerns (project execution, coal supply, financial health of
distribution co.s) to persist, but are priced in. PTC is our top pick
2011 sector outlook
We expect strong performance from Utility stocks
in 2011, fuelled by a) acceleration of power
capacity addition (18GW in FY12 versus 31GW
commissioned over the last four years), which we
forecast will drive 25% earnings growth, and b)
high sector capex during FY12 (the last year of
the 11th five-year plan), which implies strong
earnings in the coming years (utility sector returns
in India are regulated largely as a function of
equity employed).
The sector will, admittedly, continue to face an
overhang of investor concerns regarding project
execution, fuel availability and financial health of
state owned distribution companies (discoms);
however, we believe these factors a) do not
represent any meaningful short-mid term earnings
risk, and b) are already adequately discounted in
valuations (sector PB multiples have contracted
from 2.5x to 2x during 2010 on these concerns).
Notably, we also believe that the new capacities
do not constitute an excess supply situation, and
we expect long-term contracted power prices to
continue to increase on the back of increasing fuel
costs, albeit merchant power rates may correct to
narrow the gap between long-term power and
short-term merchant power (built into estimates).
Power Trading Corporation (PTC) is the top pick
from our coverage, given its expected growth and
stability in power trade as well as increasing
margins in addition to value unlocking potential.
Highest annual capacity and capex. Our project
level tracking indicates that 18GW of new
capacity will be added in FY12, which is the
highest ever capacity addition in a single year. In
addition, we estimate large capex in the
transmission sector led by PGCIL (INR160bn).
These will be further supplemented by a capex of
INR220bn in the distribution sector under the R
APDRP and RGGVY projects alone. We believe
that additional capacity and high capex infusion
will push sector income to grow at 25%+, which
we expect will be positive for the stocks.
Long-term prices to increase as merchant
prices moderate. We do not expect base load
surplus in power supply, given a large deficit in
existing supply. However, we do expect the peak
merchant price to contract from the highest levels,
since reasonable new merchant power capacity is
expected in FY11/12 (c4GW, about c80% of
existing merchant capacity). That said, increasing
coal costs and supply pressures will result in
higher long-term contracted prices under case 1
bids (already evident in the last few bids). We
expect bid prices to be in the range of INR3.50 to
INR4.25 during FY12.
Fuel and discoms’ financial health are key
concerns. Understandably, investor concerns
pertaining to operational risks, like availability of
coal and payment risk from state distribution
companies, are likely to persist. The shortfall in
domestic coal supplies is expected to increase to
120Mt in FY12 (2x FY10 levels) and potentially
can impact both plant load factor and margins.
That said, our forecasts do anticipate increased
coal imports and higher prices as a result.
Separately, losses at the state-owned distribution
companies are anticipated to increase to
INR800bn in FY12 (+17%). However, while this
may result in transient payment delays, we do not
foresee any default risk (we expect governments
to fund the shortfall).
Importantly, not all utility companies are equally
exposed to the above risks, and therefore exposure
to these risks can be diversified away through
stock selection.
Utilities powered by growth to outperform the
market. Indian Utilities have underperformed the
market in the last 12 months (-18% versus the
Sensex), primarily due to growing investor
concerns on implementation delays and operation
issues; most stocks are now trading at forward PB
of around 2x, which is close to historic lows.
While we do not expect these multiples to
improve meaningfully in the near term, we do still
expect strong sector performance, driven largely
by earnings growth. Furthermore, shares of
companies whose capacity is likely to come
onstream and show earnings growth should
perform better.
2011 top pick
PTC, OW(V), TP INR161
We prefer companies with a strong growth
outlook and minimum exposure to fuel and
pricing risk. PTC is our top pick as we expect it to
benefit from increased trading volumes (from new
capacity) and resultant margin expansion.
PTC has entered into long-term PSAs
(c5500MW) and PPAs (16000MW), which we
believe will reduce the volatility of its trading
business. Potential listing of its subsidiary, PTC
Financial Services, in CY2011 and a 48%
earnings CAGR over the next two years will
likely be positive stock catalysts.
Our 12-month target price of INR161, which
implies a forward PE of c15.9x (currently 18.7x)
is based on a sum-of-parts valuation (trading
business – INR66, investment in
subsidiaries/associates – INR50 and remainder
value from unutilized cash of INR10bn).
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