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India Equity Research Reports, IPO and Stock News
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Utilities and the three demons: Sector Outlook
We continue to have an underweight position on power utilities into the next quarterly results
3Q11 due to ongoing pressure on merchant power prices, tight fuel supplies and rising
inflation. We therefore prefer a more defensive stance, opting for exposure to Tata Power and
NTPC for outperformance over the next few months. We also like Adani Power due to its
stronger fuel position.
Throughout the first quarter of FY12 we expect the merchant power price scenario to improve
due to tight fuel supplies. Therefore we would be poised to buy merchant power exposures
with competitive fuel positions post the 3Q11 results that have been sold on the back of
merchant power weakness, such as Jindal Steel and Power and Adani Power. We are still
wary of those open to both merchant and fuel risk, such as JSW Energy.
Rising inflation and bond rate pressure
Rising inflation is a headwind for most equities, but especially regulated earnings with subsector
growth, such as NTPC and Power Grid. As shown below, any climb in the long-term
bond rate translates to underperformance from utilities with long-tail cash flows that have
valuations (more than other stocks).
Fuel supply: CIL could further disappoint, while import prices go through the roof
We expect the Indian thermal coal scenario to further tighten. As at 31 December 2010, the
Central Electricity Authority (CEA) expects a total of 30GW of new power plant capacity to be
added by the end of FY12. Of this, around 15.6GW will rely on linkage coal (this doesn’t
include some imported or captive coal-based plant that claim to have tapering linkages with
CIL). If these capacities come in, we’d expect a further supply shortfall of 42mt for the power
sector based on our forecast of CIL production.
Even if we assume 50% of the state and central plants don’t get commissioned in this timeframe
(although this will just be a delay), there will still be a further supply gap of at least
13mt.
In our view, those plants dependant on linkages and with PPA’s that don’t allow cost passthrough
could suffer margin loss. Therefore we prefer those with competitive fuel positions
(Jindal Steel and Power, Adani Power) or those who have the ability to pass through higher
fuel costs (NTPC, Tata Power).
Power Prices: monsoon pessimism
3Q11 results are likely to again reflect soft merchant power prices and therefore we don’t
suggest playing any merchant rebound until post the results. The current forward curve
implies pricing of between Rs.4.00-4.50/kWh over the next few months in line with guidance
from the listed power companies.
However into 1Q12 we see power prices strengthening. The recent weakness in pricing has
been driven purely by weakening demand (supply is only up ~5% yoy – similar to the
previous year), as the northern region states of Rajasthan and Haryana have procured
significantly less volume via bilateral contracts than in the previous year. However, we are
already seeing sizeable volumes coming from the southern states of Tamil Nadu (upcoming
state election in FY12) and Karnataka vs. this time last year – more relevant for merchant
demand over the next six months.
Also, in an environment of rising coal prices, imported-based coal-fired plant remains the
marginal cost generator, setting a longer-term base (over the next year or two) for merchant
power prices. The impact of higher coal prices on power prices are shown below and also
support power prices in the Rs.4.00-4.50/kWh range.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Utilities and the three demons: Sector Outlook
We continue to have an underweight position on power utilities into the next quarterly results
3Q11 due to ongoing pressure on merchant power prices, tight fuel supplies and rising
inflation. We therefore prefer a more defensive stance, opting for exposure to Tata Power and
NTPC for outperformance over the next few months. We also like Adani Power due to its
stronger fuel position.
Throughout the first quarter of FY12 we expect the merchant power price scenario to improve
due to tight fuel supplies. Therefore we would be poised to buy merchant power exposures
with competitive fuel positions post the 3Q11 results that have been sold on the back of
merchant power weakness, such as Jindal Steel and Power and Adani Power. We are still
wary of those open to both merchant and fuel risk, such as JSW Energy.
Rising inflation and bond rate pressure
Rising inflation is a headwind for most equities, but especially regulated earnings with subsector
growth, such as NTPC and Power Grid. As shown below, any climb in the long-term
bond rate translates to underperformance from utilities with long-tail cash flows that have
valuations (more than other stocks).
Fuel supply: CIL could further disappoint, while import prices go through the roof
We expect the Indian thermal coal scenario to further tighten. As at 31 December 2010, the
Central Electricity Authority (CEA) expects a total of 30GW of new power plant capacity to be
added by the end of FY12. Of this, around 15.6GW will rely on linkage coal (this doesn’t
include some imported or captive coal-based plant that claim to have tapering linkages with
CIL). If these capacities come in, we’d expect a further supply shortfall of 42mt for the power
sector based on our forecast of CIL production.
Even if we assume 50% of the state and central plants don’t get commissioned in this timeframe
(although this will just be a delay), there will still be a further supply gap of at least
13mt.
In our view, those plants dependant on linkages and with PPA’s that don’t allow cost passthrough
could suffer margin loss. Therefore we prefer those with competitive fuel positions
(Jindal Steel and Power, Adani Power) or those who have the ability to pass through higher
fuel costs (NTPC, Tata Power).
Power Prices: monsoon pessimism
3Q11 results are likely to again reflect soft merchant power prices and therefore we don’t
suggest playing any merchant rebound until post the results. The current forward curve
implies pricing of between Rs.4.00-4.50/kWh over the next few months in line with guidance
from the listed power companies.
However into 1Q12 we see power prices strengthening. The recent weakness in pricing has
been driven purely by weakening demand (supply is only up ~5% yoy – similar to the
previous year), as the northern region states of Rajasthan and Haryana have procured
significantly less volume via bilateral contracts than in the previous year. However, we are
already seeing sizeable volumes coming from the southern states of Tamil Nadu (upcoming
state election in FY12) and Karnataka vs. this time last year – more relevant for merchant
demand over the next six months.
Also, in an environment of rising coal prices, imported-based coal-fired plant remains the
marginal cost generator, setting a longer-term base (over the next year or two) for merchant
power prices. The impact of higher coal prices on power prices are shown below and also
support power prices in the Rs.4.00-4.50/kWh range.
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