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Power Sector- Concerns over SEBs’ Financial Health
Overdone
We believe implementation of distribution reforms in the
power sector has been slow and if ignored could impact
companies that operate in generation and transmission
verticals. However, state electricity board (SEB)-wise
analysis reveals that barring Haryana, Madhya Pradesh,
Rajasthan and Uttar Pradesh, the 12 highest power
consuming states are carrying out meaningful distribution
reforms. Overall, as India’s power deficit is set to continue
and tripartite agreements remain valid till FY15E,
generation utilities would not face the risk of SEBs
defaulting or asking gencos to back down, and therefore,
NTPC, CESC and Tata Power will not be affected. Merchant
players could feel the heat of lower demand and realizations
depending on the state/region they are operating in and the
political activity there.
Tepid distribution reforms haunt power sector: Halfhearted
implementation of distribution sector reforms has
resulted in power sector stocks losing significant value
(many have declined 40% from their November 2010
levels). The concerns emanate from the fact that the SEB
level losses have registered 57% CAGR to Rs343bn over
FY07-09, which is due to a) AT&C losses at national level
remain high at 28.4% in FY09 (declined only 2.18PP
between FY07 and FY09), b) un-recovered subsidy bill has
increased from Rs7.5bn in FY07 to Rs113bn in FY09 and c)
ineffective state regulators.
Top power consuming states show improvement: We
concede that the pace of distribution reforms has been slow
and calls for immediate attention. However generalisation
would be incorrect as in pockets of the country distribution
reforms have taken off very well, Delhi and West Bengal
exemplify the same. Of the 12 major power-consuming
states in India, barring the Haryana and Madhya Pradesh
SEBs, all other SEBs have improved operationally and are
taking measures towards curtailing losses. While the
Rajasthan SEB, is improving operationally, it is suffering on
account of non fulfillment of subsidy obligations by the
state government and is thus facing systemic issues.
Merchant players may get affected, but selectively: As
we expect power deficit to prevail in India and the tripartite
agreements are valid till FY15E, utilities will not face any
backing down or default risks. However, merchant power
players could get impacted depending on the financial
condition and political activity in beneficiary state/region.
Impact on LITL and PTC: LITL will have 1,200MW of
merchant capacity by FY12E. Our realisation assumptions of
Rs3.5/unit and Rs3.3/unit for FY12E and FY13E, respectively,
are reasonable, as few states in the relevant regions have
assembly elections in FY12/13E. PTC too will not be affected
as the volume mix changes from current 38% to 85% in
FY15E in favour of long-term power.
Distribution reforms haunt power sector
As delicensing in 1991 failed to bring in private sector investments in power sector, the Electricity
Act 2003 was put in place. The Act guided for a slew of measures to revive the sector and make it
commercially viable. It aimed at making the sector more competitive and also included the setting
up of an autonomous regulator to free it from political hegemony. However, taking stock of the
progress made in the past few years, it is clear that implementation has not been uniform across
the states of India and is broadly in areas that are non-political in nature. In other words, while due
to unbundling of SEBs and arrangements like tripartite agreements generation and transmission
sector reforms have been carried out, implementation of distribution reforms, that desired more
political will and maturity at the state-level has been rather half-hearted.
What’s irking the market?
The recent practice of lower purchases by the SEBs and the slow implementation of distribution
reforms have suddenly attracted the attention of stakeholders in the sector. As a result, the power
sector stocks have taken a beating (down by ~40% from their Nov 2010 levels vs broad indices
which fell ~13% during the same period).
SEBs’ losses in FY09 are reported at Rs343bn. This was a similar situation in 2004, when the SEBs
losses stood at~Rs300bn and bonds were issued under OTSS (One Time Settlement Scheme) for
~Rs200bn to settle SEB dues. Considering the rise in cost of power, and assuming no major reform
taking shape in the distribution sector, SEB losses are expected to rise to Rs450bn in FY10 and
Rs680bn in FY11, translating into 45% CAGR. Further, in the absence of any significant reforms
being undertaken and due to increasing cost of power, losses are expected to breach the
Rs1,400bn mark by FY15E.
The primary reasons for distribution companies’ (DISCOM) poor financial health is (1) high AT&C
losses; (2) cross-subsidy and declining subsidy realizations; and (3) inability of state regulators to
undertake distribution reforms like issuing distribution tariffs, reduction in cross subsidies etc.
T&D losses
T&D losses in India are higher than most of the under-developed / developing countries. The
improvement over last few years too has been insignificant. The AT&C losses still remain high at
28.4% in FY09 vs the GoI’s target of reducing the AT&C losses to 15%. This is despite launching
APDRP, a program dedicated to reduction of AT&C losses.
So are we in a soup? Not really, SEB-wise analysis says so
We concede the pace of power distribution reforms has been slow and calls for immediate
attention. However, generalisation would be incorrect. While in some states, effective
reforms have been undertaken, in others reforms are in various stages of implementation.
Out of the 12 major power-consuming states in India, barring the Haryana and Madhya
Pradesh SEBs, all other SEBs have improved operationally and are taking measures towards
curtailing losses. The Uttar Pradesh SEB though has shown operational improvements, is
still suffering from enormous AT&C losses (40.3% in FY09) and has not been filing for
distribution tariff orders with the regulator. Similarly, the Rajasthan SEB, while
operationally improving, is suffering on account of non fulfillment of subsidy obligations by
the state government and is thus facing systemic issues. If reforms, both political and
distribution, are delayed further the condition of these four SEBs (Haryana, Madhya
Pradesh, Rajasthan and Uttar Pradesh) would deteriorate further and would impact the
players operating in other verticals (generation and transmission) of the sector.
AT&C losses
Reduction of AT&C losses is crucial to long-term financial viability of SEBs. Therefore, the GoI
launched the APDRP and R-APDRP with an objective of bringing down the AT&C losses to 15%.
The progress on this front has been rather disappointing. All-India AT&C losses have declined by
just 2.18 percentage points (PP) to 28.4% in FY09 from FY07. However, the reduction in AT&C
losses has not been uniform through out the country.
Amongst the 12 highest power consuming states in the country, that consume 85% of total
power, 8 have registered consistent and significant decline in AT&C losses. West Bengal, Delhi,
Punjab, Gujarat, Andhra Pradesh and Karnataka have registered AT&C loss reduction of 7.93 PP,
16.35PP, 3.58PP, 1.55PP, 4.89PP and 7.08PP, respectively to bring the AT&C losses below the
national average of 28.4%, while AT&C losses of Rajasthan and Uttar Pradesh though remain
above the national average have registered significant reduction of 6.22PP and 3.93PP between
FY07 and FY09. It is on account of high and in some cases increasing AT&C losses in states like
Madhya Pradesh (61.1% AT&C loss and consumes 4.2% of total power), Maharashtra (31.2% AT&C
loss and consumes 12% of total power) and Haryana (33.3% AT&C losses and consumes 4.1% of
total power) that the national average remains high at 28.4%. Excluding these three states, the
FY09 AT&C losses for the country stand at ~20%. Thus, while there are more efforts required on
this front, situation is improving in most of the cases.
Cross-subsidy
Power is a highly politicized commodity in India, and is often used by political parties/ state
governments while doling out populist policies. Thus, to completely corporatise SEBs, the
Electricity Act 2003, guided that the state governments should provide for the subsidies they
announce, and subsidies for no segment should be more than 50% of the cost of supply. Looking
at the political environment prevailing in the country, we do not see the agriculture/BPL subsidies
getting rolled back or agricultural power metering being pursued aggressively in the near future.
Thus, we do not expect cross-subsidies to reduce. However, if the subsidy is offset by the industrial
revenues or is paid in full by the respective state governments, cross-subsidy is not a problem for
SEBs in the near-term. We have observed that with the increase in cost of power in general and
SEBs buying more power from the short-term market, the subsidy booked by SEBs has increased
at a 2 year CAGR of 47% to Rs297bn in FY09, which, owing to further increase in fuel cost and
higher short-term power purchases, is expected to be even higher in FY10 and FY11E. However,
what is more worrying is that the gap between subsidy booked and subsidy received has widened
from Rs7.5bn in FY07 to Rs112.8bn in FY09, implying that the state governments are not
honouring their power-subsidy obligations. But again, 67% of this gap due to the Jharkhand,
Rajasthan and governments, that have been under-paying subsidies for past three years.
Effectiveness of state regulators
We believe under-performance of regulators is the biggest concern of the three parameters
highlighted in this report, which leads to static revenues against rising costs. As per PFC’s report
on SEBs’ Financial Health, though 23 of total 30 SEBs have state regulators operational, only 9
have issued distribution tariff orders till April 2010. As per the same report out of the top 12 power
consuming states in India, 7 have been issuing MYTs. However, burdened by increasing cost of
power supply and stagnant revenues, recently Tamil Nadu SEB has filed for distribution tariff
increase to the regulator after a gap of seven years. Punjab SEB too is now in the process of issuing
MYT distribution tariff. Though these SEBs have been issuing MYTs, the accumulated losses of
previous years continue to remain in the balance sheets of SEBs, which will be realized or written
off over a period of time. That leaves behind the states of Uttar Pradesh and Haryana, amongst the
top 12 power consuming states of India, wherein the regulators are though operational but have
not issued MYTs/Distribution Tariff Orders.
Key Observations on top 12 power consuming states in India
We have observed that the West Bengal, New Delhi and Gujarat SEBs have made progress by
reducing AT&C losses significantly and turning profitable (post subsidy). In a recent
development, the Delhi Electricity Regulatory Commission had taken stance against the state
government and implemented reforms.
In the Southern Region, AT&C losses have come down by 3.78pp to 17.4% in FY09. However,
Tamil Nadu which already had low AT&C losses, at 18.5%, hasn’t registered an improvement
in AT&C loss, but has started taking measures by filing for tariff order with the SERC after 7
years. Similarly, the Karnataka SEB has brought down its AT&C losses by 7PP and at the same
has been filing for distribution tariffs on a regular basis. Andhra Pradesh SEB too has seen
significant improvement in AT&C Losses, which have come down from 17.9% in FY07 to 13%
in FY09. While operationally the SEB is improving, the concern here is on the state
government not honouring their subsidy bills. As per AP Electricity Regulatory Commission,
the DISCOMs are now allowed to raise loans against the dues and carrying cost is also payable
by the government. However, we see this practice of raising loans to fulfill subsidy obligation
as a systemic issue and needs a sustainable solution.
Amongst the states in the Northern Region, the condition of Rajasthan and Uttar Pradesh
SEBs is a cause for concern. In the case of Rajasthan, though the AT&C losses have dropped
by 6.2PP since FY07 to 29.5%, the issue here is the non-payment of the high subsidy bill by
the state government. The state government has been under-paying the subsidy bill, and unrecovered
subsidy at the SEB end reached 86.3% in FY09 from 34% in FY07. The Uttar
Pradesh SEB is plagued by whopping AT&C losses of 40%. Though the losses are on a
declining trend, but in comparison to the magnitude of loss, the reduction of 3.9PP in two
years is on the lower side. Considering this and the fact that state regulator has been
ineffective, we do not see the SEB achieving fiscal discipline in the near future.
We believe that the condition of Madhya Pradesh SEBs is critical primarily on account of
exceptionally high AT&C loss of 61%, despite the state regulator issuing ARR for distribution
companies.
We concede that the distribution reforms in India seriously lag behind the expectations and
benchmarks set and in absence of political will to implement reforms in distribution sector, other
verticals of the sector would get impacted in future. However, we also realise that of the 12 major
power-consuming states in India, barring Haryana, Madhya Pradesh, Rajasthan and Uttar Pradesh
SEB, the condition of all other SEBs has improved.
Utilities are safe, merchant players can get affected
While we maintain our view on the demand-supply scenario in the country that we
highlighted in our report dated 23 Dec 2010, an SEB-wise study reveals that the Haryana,
Madhya Pradesh, Rajasthan and Uttar Pradesh SEBs are more troubled. As the power deficit
will prevail in India and tripartite agreements are valid till FY15E, utilities do not be face any
backing down risk or default risk. However, merchant power player might potentially get
affected depending on the financial health of beneficiary state and the political activity
therein.
Maintain our view on Power Scenario in India:
Power Sector Update, Dated 23 Dec 2010 - “A detailed analysis of the demand-supply situation
indicates that the power deficit in India would decline from 10% to ~4.5% in FY13E, as strong
capacity addition (13% CAGR over FY11-13E) would outstrip the growth in demand (assumed at
6.5% annually). However, as state electricity boards (SEBs) are facing severe financial burden, they
are tempted to buy less power, thus resulting in a superficial reduction in demand growth (3.6%
reported by CEA for the current year till October vs GDP growth of ~9%). Going forward, such
practices along with events like elections or any other populist policies/measures would impact
reported demand number, and also momentarily swing merchant rates either ways. Excluding
such scenarios, a declining deficit scenario would cause merchant power rates to fall from their
high of Rs6/unit in FY10 to Rs3.3/unit in FY13E, at par with long-term PPA rates. “
Impact of SEB financial health on players in other verticals:
Deteriorating financial health of SEBs/DISCOMs affects the players operating in other verticals of
power value chain in two ways: a) Default risk b) Suppressed demand representation by SEBs.
While the escrow mechanism ensures that the SEBs/DISCOMs do not default, in the last two
quarters we have seen the SEBs demanding less power. This was reflected in the lower merchant
power realizations and lower PLF of utilities (as they too were asked to back-down). While the
financial constraints of SEBs lead to lower merchant power demand and hence the rates went
down, a good monsoon which resulted in lower power-demand from irrigation sector and higher
than average hydel generation prompted SEB to ask even the utilities too to back down. However
unless in case of similar eventuality, utilities like NTPC, CESC and Tata Power, will remain largely
unaffected by the risk of lower demand by the SEBs. Concerns are more tangible for players
operating in short-term power markets and players dealing with the troubled SEBs. Prima facie, of
the companied under our coverage, Lanco Infratech and PTC India potentially may get impacted
due to the SEB financial health.
Lanco Infratech Ltd
Lanco Infratech Ltd (LITL) is perceived to get affected due to its exposure to structurally weak SEBs
and high merchant power capacity.
Impact due to higher merchant capacity: By FY16E LITL will have ~30% of its generation
exposed to short-term power market. This capacity will cater to northern and southern
regions, that are major power consuming regions and have huge deficits. In the immediate
future, LITL will bring ~1200MW of merchant power capacity on board. In view of the fact that
few states in the respective regions are having state assembly elections, we find our
assumption of Rs3.5/unit for FY12E and Rs3.3/unit for FY13E realisations reasonable.
Impact due to exposure to vulnerable beneficiary states: LITL has tied up ~ 5.8GW of
generation capacity under long-term PPA. The major beneficiary states are Andhra Pradesh,
Tamil Nadu, Karnataka, Uttar Pradesh and Maharashtra. As mentioned earlier in the report, we
do not see any default or lower off-take risk for the tied-up capacity in the near future. On the
merchant power front, the company will sell ~730MW from Kondapalli II & III and ~420MW
from Amarkantak I & II and Anpara C, in the short-term regional power market. As the states of
Tamil Nadu, Kerala and Uttar Pradesh are having elections in the 2011-12, we see power
healthy demand for short-term power in the respective regions during the period.
Therefore, we do not see the SEB financial health impacting LITL and maintain our estimates
for LITL.
Valuations
At the CMP of Rs39/share LITL is trading below the fair value of its power business alone, which in
our SOTP valuation stands at Rs47/share. The value of power business is very sensitive to
merchant power realizations, which we have assumed at Rs3.5/unit for FY12E and Rs3.3/unit
FY13E onwards and a PLF of 70% for merchant capacity. However, if we assume merchant
realisation at Rs3/unit and Rs4/unit, the value of power vertical will be Rs37/share and Rs68/share
respectively.
The EPC segment, that has an order book of Rs275bn, is valued at 8xFY13E (20% discount to its
peers) EPS at Rs22/share. We arrive at a FY12E SOTP value of Rs73/share. Currently the stock is
trading at a FY12E P/E of 5.9x and P/B of 2.4x.
PTC India Ltd
PTC’s business model exposes it to the risk of both lower power demand from SEBs, as 63% of its
current volumes are short-term in nature, and default or delayed payments by SEBs. However, as
we have highlighted earlier in the report we do not see the SEBs defaulting on payments, the risk
of lower short-term volumes is mitigated by increasing share of long-term power. Over FY12E &
FY13E, ~8.5GW PPA tied-up generation capacity will get commissioned. Beyond this, the company
has PPA for ~6GW that will get commissioned through FY16E. We expect the share of long-term
power traded in total volumes to increase to 85% by FY16E.
Valuations
PTC is currently trading at FY12E P/E of 15.3x, which we believe is a significant discount to its fair
value, considering that the company has strategic investments valued at Rs70/share and the value
of PFS comes at Rs25/share. We have valued PTC’s core power trading business at 9xFY13E P/E
and arrive at a fair value of 65/share. Our FY12E SOTP value for the company stands at
Rs160/share.
PTC India SOTP valuation
Rs/Share
Power trading business - P/E of 9x FY13 EPS of Rs7.3 65
Cash & Equivalent 40
PTC FS - 1.5x P/B 25
PTC Tolling valued at 7xFY13E P/E 30
Total 160
Source: Centrum Research Estimates
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Power Sector- Concerns over SEBs’ Financial Health
Overdone
We believe implementation of distribution reforms in the
power sector has been slow and if ignored could impact
companies that operate in generation and transmission
verticals. However, state electricity board (SEB)-wise
analysis reveals that barring Haryana, Madhya Pradesh,
Rajasthan and Uttar Pradesh, the 12 highest power
consuming states are carrying out meaningful distribution
reforms. Overall, as India’s power deficit is set to continue
and tripartite agreements remain valid till FY15E,
generation utilities would not face the risk of SEBs
defaulting or asking gencos to back down, and therefore,
NTPC, CESC and Tata Power will not be affected. Merchant
players could feel the heat of lower demand and realizations
depending on the state/region they are operating in and the
political activity there.
Tepid distribution reforms haunt power sector: Halfhearted
implementation of distribution sector reforms has
resulted in power sector stocks losing significant value
(many have declined 40% from their November 2010
levels). The concerns emanate from the fact that the SEB
level losses have registered 57% CAGR to Rs343bn over
FY07-09, which is due to a) AT&C losses at national level
remain high at 28.4% in FY09 (declined only 2.18PP
between FY07 and FY09), b) un-recovered subsidy bill has
increased from Rs7.5bn in FY07 to Rs113bn in FY09 and c)
ineffective state regulators.
Top power consuming states show improvement: We
concede that the pace of distribution reforms has been slow
and calls for immediate attention. However generalisation
would be incorrect as in pockets of the country distribution
reforms have taken off very well, Delhi and West Bengal
exemplify the same. Of the 12 major power-consuming
states in India, barring the Haryana and Madhya Pradesh
SEBs, all other SEBs have improved operationally and are
taking measures towards curtailing losses. While the
Rajasthan SEB, is improving operationally, it is suffering on
account of non fulfillment of subsidy obligations by the
state government and is thus facing systemic issues.
Merchant players may get affected, but selectively: As
we expect power deficit to prevail in India and the tripartite
agreements are valid till FY15E, utilities will not face any
backing down or default risks. However, merchant power
players could get impacted depending on the financial
condition and political activity in beneficiary state/region.
Impact on LITL and PTC: LITL will have 1,200MW of
merchant capacity by FY12E. Our realisation assumptions of
Rs3.5/unit and Rs3.3/unit for FY12E and FY13E, respectively,
are reasonable, as few states in the relevant regions have
assembly elections in FY12/13E. PTC too will not be affected
as the volume mix changes from current 38% to 85% in
FY15E in favour of long-term power.
Distribution reforms haunt power sector
As delicensing in 1991 failed to bring in private sector investments in power sector, the Electricity
Act 2003 was put in place. The Act guided for a slew of measures to revive the sector and make it
commercially viable. It aimed at making the sector more competitive and also included the setting
up of an autonomous regulator to free it from political hegemony. However, taking stock of the
progress made in the past few years, it is clear that implementation has not been uniform across
the states of India and is broadly in areas that are non-political in nature. In other words, while due
to unbundling of SEBs and arrangements like tripartite agreements generation and transmission
sector reforms have been carried out, implementation of distribution reforms, that desired more
political will and maturity at the state-level has been rather half-hearted.
What’s irking the market?
The recent practice of lower purchases by the SEBs and the slow implementation of distribution
reforms have suddenly attracted the attention of stakeholders in the sector. As a result, the power
sector stocks have taken a beating (down by ~40% from their Nov 2010 levels vs broad indices
which fell ~13% during the same period).
SEBs’ losses in FY09 are reported at Rs343bn. This was a similar situation in 2004, when the SEBs
losses stood at~Rs300bn and bonds were issued under OTSS (One Time Settlement Scheme) for
~Rs200bn to settle SEB dues. Considering the rise in cost of power, and assuming no major reform
taking shape in the distribution sector, SEB losses are expected to rise to Rs450bn in FY10 and
Rs680bn in FY11, translating into 45% CAGR. Further, in the absence of any significant reforms
being undertaken and due to increasing cost of power, losses are expected to breach the
Rs1,400bn mark by FY15E.
The primary reasons for distribution companies’ (DISCOM) poor financial health is (1) high AT&C
losses; (2) cross-subsidy and declining subsidy realizations; and (3) inability of state regulators to
undertake distribution reforms like issuing distribution tariffs, reduction in cross subsidies etc.
T&D losses
T&D losses in India are higher than most of the under-developed / developing countries. The
improvement over last few years too has been insignificant. The AT&C losses still remain high at
28.4% in FY09 vs the GoI’s target of reducing the AT&C losses to 15%. This is despite launching
APDRP, a program dedicated to reduction of AT&C losses.
So are we in a soup? Not really, SEB-wise analysis says so
We concede the pace of power distribution reforms has been slow and calls for immediate
attention. However, generalisation would be incorrect. While in some states, effective
reforms have been undertaken, in others reforms are in various stages of implementation.
Out of the 12 major power-consuming states in India, barring the Haryana and Madhya
Pradesh SEBs, all other SEBs have improved operationally and are taking measures towards
curtailing losses. The Uttar Pradesh SEB though has shown operational improvements, is
still suffering from enormous AT&C losses (40.3% in FY09) and has not been filing for
distribution tariff orders with the regulator. Similarly, the Rajasthan SEB, while
operationally improving, is suffering on account of non fulfillment of subsidy obligations by
the state government and is thus facing systemic issues. If reforms, both political and
distribution, are delayed further the condition of these four SEBs (Haryana, Madhya
Pradesh, Rajasthan and Uttar Pradesh) would deteriorate further and would impact the
players operating in other verticals (generation and transmission) of the sector.
AT&C losses
Reduction of AT&C losses is crucial to long-term financial viability of SEBs. Therefore, the GoI
launched the APDRP and R-APDRP with an objective of bringing down the AT&C losses to 15%.
The progress on this front has been rather disappointing. All-India AT&C losses have declined by
just 2.18 percentage points (PP) to 28.4% in FY09 from FY07. However, the reduction in AT&C
losses has not been uniform through out the country.
Amongst the 12 highest power consuming states in the country, that consume 85% of total
power, 8 have registered consistent and significant decline in AT&C losses. West Bengal, Delhi,
Punjab, Gujarat, Andhra Pradesh and Karnataka have registered AT&C loss reduction of 7.93 PP,
16.35PP, 3.58PP, 1.55PP, 4.89PP and 7.08PP, respectively to bring the AT&C losses below the
national average of 28.4%, while AT&C losses of Rajasthan and Uttar Pradesh though remain
above the national average have registered significant reduction of 6.22PP and 3.93PP between
FY07 and FY09. It is on account of high and in some cases increasing AT&C losses in states like
Madhya Pradesh (61.1% AT&C loss and consumes 4.2% of total power), Maharashtra (31.2% AT&C
loss and consumes 12% of total power) and Haryana (33.3% AT&C losses and consumes 4.1% of
total power) that the national average remains high at 28.4%. Excluding these three states, the
FY09 AT&C losses for the country stand at ~20%. Thus, while there are more efforts required on
this front, situation is improving in most of the cases.
Cross-subsidy
Power is a highly politicized commodity in India, and is often used by political parties/ state
governments while doling out populist policies. Thus, to completely corporatise SEBs, the
Electricity Act 2003, guided that the state governments should provide for the subsidies they
announce, and subsidies for no segment should be more than 50% of the cost of supply. Looking
at the political environment prevailing in the country, we do not see the agriculture/BPL subsidies
getting rolled back or agricultural power metering being pursued aggressively in the near future.
Thus, we do not expect cross-subsidies to reduce. However, if the subsidy is offset by the industrial
revenues or is paid in full by the respective state governments, cross-subsidy is not a problem for
SEBs in the near-term. We have observed that with the increase in cost of power in general and
SEBs buying more power from the short-term market, the subsidy booked by SEBs has increased
at a 2 year CAGR of 47% to Rs297bn in FY09, which, owing to further increase in fuel cost and
higher short-term power purchases, is expected to be even higher in FY10 and FY11E. However,
what is more worrying is that the gap between subsidy booked and subsidy received has widened
from Rs7.5bn in FY07 to Rs112.8bn in FY09, implying that the state governments are not
honouring their power-subsidy obligations. But again, 67% of this gap due to the Jharkhand,
Rajasthan and governments, that have been under-paying subsidies for past three years.
Effectiveness of state regulators
We believe under-performance of regulators is the biggest concern of the three parameters
highlighted in this report, which leads to static revenues against rising costs. As per PFC’s report
on SEBs’ Financial Health, though 23 of total 30 SEBs have state regulators operational, only 9
have issued distribution tariff orders till April 2010. As per the same report out of the top 12 power
consuming states in India, 7 have been issuing MYTs. However, burdened by increasing cost of
power supply and stagnant revenues, recently Tamil Nadu SEB has filed for distribution tariff
increase to the regulator after a gap of seven years. Punjab SEB too is now in the process of issuing
MYT distribution tariff. Though these SEBs have been issuing MYTs, the accumulated losses of
previous years continue to remain in the balance sheets of SEBs, which will be realized or written
off over a period of time. That leaves behind the states of Uttar Pradesh and Haryana, amongst the
top 12 power consuming states of India, wherein the regulators are though operational but have
not issued MYTs/Distribution Tariff Orders.
Key Observations on top 12 power consuming states in India
We have observed that the West Bengal, New Delhi and Gujarat SEBs have made progress by
reducing AT&C losses significantly and turning profitable (post subsidy). In a recent
development, the Delhi Electricity Regulatory Commission had taken stance against the state
government and implemented reforms.
In the Southern Region, AT&C losses have come down by 3.78pp to 17.4% in FY09. However,
Tamil Nadu which already had low AT&C losses, at 18.5%, hasn’t registered an improvement
in AT&C loss, but has started taking measures by filing for tariff order with the SERC after 7
years. Similarly, the Karnataka SEB has brought down its AT&C losses by 7PP and at the same
has been filing for distribution tariffs on a regular basis. Andhra Pradesh SEB too has seen
significant improvement in AT&C Losses, which have come down from 17.9% in FY07 to 13%
in FY09. While operationally the SEB is improving, the concern here is on the state
government not honouring their subsidy bills. As per AP Electricity Regulatory Commission,
the DISCOMs are now allowed to raise loans against the dues and carrying cost is also payable
by the government. However, we see this practice of raising loans to fulfill subsidy obligation
as a systemic issue and needs a sustainable solution.
Amongst the states in the Northern Region, the condition of Rajasthan and Uttar Pradesh
SEBs is a cause for concern. In the case of Rajasthan, though the AT&C losses have dropped
by 6.2PP since FY07 to 29.5%, the issue here is the non-payment of the high subsidy bill by
the state government. The state government has been under-paying the subsidy bill, and unrecovered
subsidy at the SEB end reached 86.3% in FY09 from 34% in FY07. The Uttar
Pradesh SEB is plagued by whopping AT&C losses of 40%. Though the losses are on a
declining trend, but in comparison to the magnitude of loss, the reduction of 3.9PP in two
years is on the lower side. Considering this and the fact that state regulator has been
ineffective, we do not see the SEB achieving fiscal discipline in the near future.
We believe that the condition of Madhya Pradesh SEBs is critical primarily on account of
exceptionally high AT&C loss of 61%, despite the state regulator issuing ARR for distribution
companies.
We concede that the distribution reforms in India seriously lag behind the expectations and
benchmarks set and in absence of political will to implement reforms in distribution sector, other
verticals of the sector would get impacted in future. However, we also realise that of the 12 major
power-consuming states in India, barring Haryana, Madhya Pradesh, Rajasthan and Uttar Pradesh
SEB, the condition of all other SEBs has improved.
Utilities are safe, merchant players can get affected
While we maintain our view on the demand-supply scenario in the country that we
highlighted in our report dated 23 Dec 2010, an SEB-wise study reveals that the Haryana,
Madhya Pradesh, Rajasthan and Uttar Pradesh SEBs are more troubled. As the power deficit
will prevail in India and tripartite agreements are valid till FY15E, utilities do not be face any
backing down risk or default risk. However, merchant power player might potentially get
affected depending on the financial health of beneficiary state and the political activity
therein.
Maintain our view on Power Scenario in India:
Power Sector Update, Dated 23 Dec 2010 - “A detailed analysis of the demand-supply situation
indicates that the power deficit in India would decline from 10% to ~4.5% in FY13E, as strong
capacity addition (13% CAGR over FY11-13E) would outstrip the growth in demand (assumed at
6.5% annually). However, as state electricity boards (SEBs) are facing severe financial burden, they
are tempted to buy less power, thus resulting in a superficial reduction in demand growth (3.6%
reported by CEA for the current year till October vs GDP growth of ~9%). Going forward, such
practices along with events like elections or any other populist policies/measures would impact
reported demand number, and also momentarily swing merchant rates either ways. Excluding
such scenarios, a declining deficit scenario would cause merchant power rates to fall from their
high of Rs6/unit in FY10 to Rs3.3/unit in FY13E, at par with long-term PPA rates. “
Impact of SEB financial health on players in other verticals:
Deteriorating financial health of SEBs/DISCOMs affects the players operating in other verticals of
power value chain in two ways: a) Default risk b) Suppressed demand representation by SEBs.
While the escrow mechanism ensures that the SEBs/DISCOMs do not default, in the last two
quarters we have seen the SEBs demanding less power. This was reflected in the lower merchant
power realizations and lower PLF of utilities (as they too were asked to back-down). While the
financial constraints of SEBs lead to lower merchant power demand and hence the rates went
down, a good monsoon which resulted in lower power-demand from irrigation sector and higher
than average hydel generation prompted SEB to ask even the utilities too to back down. However
unless in case of similar eventuality, utilities like NTPC, CESC and Tata Power, will remain largely
unaffected by the risk of lower demand by the SEBs. Concerns are more tangible for players
operating in short-term power markets and players dealing with the troubled SEBs. Prima facie, of
the companied under our coverage, Lanco Infratech and PTC India potentially may get impacted
due to the SEB financial health.
Lanco Infratech Ltd
Lanco Infratech Ltd (LITL) is perceived to get affected due to its exposure to structurally weak SEBs
and high merchant power capacity.
Impact due to higher merchant capacity: By FY16E LITL will have ~30% of its generation
exposed to short-term power market. This capacity will cater to northern and southern
regions, that are major power consuming regions and have huge deficits. In the immediate
future, LITL will bring ~1200MW of merchant power capacity on board. In view of the fact that
few states in the respective regions are having state assembly elections, we find our
assumption of Rs3.5/unit for FY12E and Rs3.3/unit for FY13E realisations reasonable.
Impact due to exposure to vulnerable beneficiary states: LITL has tied up ~ 5.8GW of
generation capacity under long-term PPA. The major beneficiary states are Andhra Pradesh,
Tamil Nadu, Karnataka, Uttar Pradesh and Maharashtra. As mentioned earlier in the report, we
do not see any default or lower off-take risk for the tied-up capacity in the near future. On the
merchant power front, the company will sell ~730MW from Kondapalli II & III and ~420MW
from Amarkantak I & II and Anpara C, in the short-term regional power market. As the states of
Tamil Nadu, Kerala and Uttar Pradesh are having elections in the 2011-12, we see power
healthy demand for short-term power in the respective regions during the period.
Therefore, we do not see the SEB financial health impacting LITL and maintain our estimates
for LITL.
Valuations
At the CMP of Rs39/share LITL is trading below the fair value of its power business alone, which in
our SOTP valuation stands at Rs47/share. The value of power business is very sensitive to
merchant power realizations, which we have assumed at Rs3.5/unit for FY12E and Rs3.3/unit
FY13E onwards and a PLF of 70% for merchant capacity. However, if we assume merchant
realisation at Rs3/unit and Rs4/unit, the value of power vertical will be Rs37/share and Rs68/share
respectively.
The EPC segment, that has an order book of Rs275bn, is valued at 8xFY13E (20% discount to its
peers) EPS at Rs22/share. We arrive at a FY12E SOTP value of Rs73/share. Currently the stock is
trading at a FY12E P/E of 5.9x and P/B of 2.4x.
PTC India Ltd
PTC’s business model exposes it to the risk of both lower power demand from SEBs, as 63% of its
current volumes are short-term in nature, and default or delayed payments by SEBs. However, as
we have highlighted earlier in the report we do not see the SEBs defaulting on payments, the risk
of lower short-term volumes is mitigated by increasing share of long-term power. Over FY12E &
FY13E, ~8.5GW PPA tied-up generation capacity will get commissioned. Beyond this, the company
has PPA for ~6GW that will get commissioned through FY16E. We expect the share of long-term
power traded in total volumes to increase to 85% by FY16E.
Valuations
PTC is currently trading at FY12E P/E of 15.3x, which we believe is a significant discount to its fair
value, considering that the company has strategic investments valued at Rs70/share and the value
of PFS comes at Rs25/share. We have valued PTC’s core power trading business at 9xFY13E P/E
and arrive at a fair value of 65/share. Our FY12E SOTP value for the company stands at
Rs160/share.
PTC India SOTP valuation
Rs/Share
Power trading business - P/E of 9x FY13 EPS of Rs7.3 65
Cash & Equivalent 40
PTC FS - 1.5x P/B 25
PTC Tolling valued at 7xFY13E P/E 30
Total 160
Source: Centrum Research Estimates
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