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Utilities
India
Power headwinds—policy makers perspective. Capital Ideas, our investor forum in
Delhi on April 4, 2011, hosted meetings with policy makers—regulators and officials—-
associated with the power sector. The focus of discussion was (1) the financial health of
state distribution companies and (2) the lack of incremental coal supplies to fuel the
aggressive coal-based capacity additions in the generation space. Policy-makers believed
that the former, although worrisome, will not lead payment defaults; they however
viewed the lack of coal supplies as a more potent risk.
State Electricity Board losses—dealing with the ‘politics of electricity’
Our interactions with CERC and Ministry of Power suggest that absence of tariff revisions is
amongst the key reasons for the deteriorating financial health of state distribution companies.
Tamil Nadu and Rajasthan (amongst the largest contributors to aggregate losses) have not revised
their tariffs since FY2004 and FY2005, respectively. In the case of Uttar Pradesh (the third-largest
loss making state), the state distribution company has not filed its ‘Annual Revenue Requirement’
for the past few years. We highlight that these three states contributed to ~49% of total SEB
losses of Rs526 bn in FY2009.
The policy-makers however remained optimistic on schemes such as APDRP and a National
Electricity Fund, which offer grants/subsidies for improving the viability of the distribution segment
only against proven reduction in losses. The policy makers were also optimistic that the current
situation will improve (Rajasthan has recently effected a tariff increase of ~30%) and not
culminate into payment defaults by SEBs (either to financers or generating companies) that had
previously resulted in a ‘One time settlement scheme’ through the issue of bonds.
Availability of coal—dependence on imports to increase
The policy makers admitted that lack of availability of coal remains a larger issue for the sector due
to Coal India’s inability to match the improved execution rate by the power sector. The problem is
compounded by a lack of logistics infrastructure—both railways and ports that limit the transport
of imported as well as domestically produced coal. We estimate the total coal deficit in the country
to go up to ~150 mn tons by FY2012E from 68 mn tons in FY2010 taking cognizance of capacity
addition plans for XIIth plan period and inadequate ramp up of domestic production (CIL and
captive mining). Exhibit 3 below highlights the demand and supply of coal in India till FY2015E.
Align with integrated utilities or resource owners, avoid financers of state utilities
In a scenario of deteriorating demand-supply imbalance of coal and a likely worsening financial
situation of state electricity boards, we recommend aligning with utilities which are integrated
with end-distribution business (Tata Power, CESC), or are not dependent on coal from Coal India
(NHPC), thereby minimizing exposure to state-owned distribution companies and/or linkage coal
from Coal India.
We agree that a default on loans to PFC and REC may be a low probability event due to their
nodal agency role, payment security mechanisms (discussed later) and RAPDRP. However, we see
risks to the potential loan growth for financers of state electricity boards in case of a severe
deterioration in the financials of state distribution companies. The overhang of large exposures to
state utilities will remain an overhang for stock price of PFC and REC. Valuations have moderated
over the past 3-4 months, relatively, but we still find better potential in public banks, which are
available at lower valuations and offer a better risk return profile.
We retain our REDUCE rating on both REC and PFC. Our rating is also influenced by the
current high interest rate environment, which do not bode well for non-banks. This, coupled
with ever increasing competition from banks, will result in higher margin pressure over next
couple of years at least.
Mechanisms to safeguard collection efficiency for generators – so far, so good
The provisions of the Electricity Act have ensured that generating companies have realized
100% dues post the last one-time settlement scheme. The stringent conditionalities to
ensure timely payments include (1) maintaining irrevocable Letter of Credits, (2) progressive
reduction in supply of power if payment not received within 60 days from date of billing,
and (3) claims over Central government dues payable to the states if payment not received
within ninety days.
Payment security mechanisms for financers—trudging along, despite the odds
In most cases, PFC and REC’s loans are secured and have a priority claim over the surplus
revenue from the utilities over any loan granted by the State government, whereas almost
20% of their loans are guaranteed by State Governments. Additionally, the escrow
mechanism (85% of loans) ensures discipline in servicing loans but may not work in case of
severe deficits.
The Escrow Agreement is typically a tripartite agreement entered by the bank/NBFC, the
borrower and the bank designated as escrow agent. Under the terms of the agreement, the
borrower is required to deposit all of its receivables (from certain centers) into the
designated escrow account and is prohibited from opening any other account for the
purpose of collection of revenues. In the event of a loan default, the escrow agent is
authorized to pay the amount owed to the bank/NBFC from the funds in the escrow.
We believe that the escrow mechanism ensures that the receipts of the state utility are
channelized in the right manner thereby reducing leakages in the system. However,
structurally the waterfall will always favour suppliers (generation company or fuel supplier),
operating overheads (like employee expenses) over finance charges. Thus, in case of severe
deficit of collections, the finance company may have to share the collections with these
parities despite a superior charge.
R-APDRP—establishing baseline data for monitoring AT&C losses to begin
We expect restructured Accelerated Power Development and Reforms Program (RAPDRP) to
addresses the key issue of unviable AT&C losses. The Cabinet Committee on Economic
Affairs (CCEA) had approved a budget outlay of Rs515 bn towards R-APDRP for the XIth
Plan as compared to an outlay of Rs400 bn and actual spend of Rs89 bn for the Xth plan.
R-APDRP places increased emphasis on establishment of baseline data that would enable
energy audits and monitor AT&C losses. R-APDRP has also formulated incentives for the staff
of SEBs to progressively reduce AT&C losses below 15% in the ensuing five years. Projects
under the scheme are to be taken up in two parts – Part A will include the projects for
establishment of baseline data and IT application for energy accounting and audits while
Part B regular distribution strengthening projects. The steering committee for
implementation and monitoring of APDRP had approved 1,344 projects totaling to Rs49 bn
under Part A as of December 2009. There is also a third part which is an enabling
component for RAPDRP and has to be implemented by MoP and PFC (nodal agency).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Utilities
India
Power headwinds—policy makers perspective. Capital Ideas, our investor forum in
Delhi on April 4, 2011, hosted meetings with policy makers—regulators and officials—-
associated with the power sector. The focus of discussion was (1) the financial health of
state distribution companies and (2) the lack of incremental coal supplies to fuel the
aggressive coal-based capacity additions in the generation space. Policy-makers believed
that the former, although worrisome, will not lead payment defaults; they however
viewed the lack of coal supplies as a more potent risk.
State Electricity Board losses—dealing with the ‘politics of electricity’
Our interactions with CERC and Ministry of Power suggest that absence of tariff revisions is
amongst the key reasons for the deteriorating financial health of state distribution companies.
Tamil Nadu and Rajasthan (amongst the largest contributors to aggregate losses) have not revised
their tariffs since FY2004 and FY2005, respectively. In the case of Uttar Pradesh (the third-largest
loss making state), the state distribution company has not filed its ‘Annual Revenue Requirement’
for the past few years. We highlight that these three states contributed to ~49% of total SEB
losses of Rs526 bn in FY2009.
The policy-makers however remained optimistic on schemes such as APDRP and a National
Electricity Fund, which offer grants/subsidies for improving the viability of the distribution segment
only against proven reduction in losses. The policy makers were also optimistic that the current
situation will improve (Rajasthan has recently effected a tariff increase of ~30%) and not
culminate into payment defaults by SEBs (either to financers or generating companies) that had
previously resulted in a ‘One time settlement scheme’ through the issue of bonds.
Availability of coal—dependence on imports to increase
The policy makers admitted that lack of availability of coal remains a larger issue for the sector due
to Coal India’s inability to match the improved execution rate by the power sector. The problem is
compounded by a lack of logistics infrastructure—both railways and ports that limit the transport
of imported as well as domestically produced coal. We estimate the total coal deficit in the country
to go up to ~150 mn tons by FY2012E from 68 mn tons in FY2010 taking cognizance of capacity
addition plans for XIIth plan period and inadequate ramp up of domestic production (CIL and
captive mining). Exhibit 3 below highlights the demand and supply of coal in India till FY2015E.
Align with integrated utilities or resource owners, avoid financers of state utilities
In a scenario of deteriorating demand-supply imbalance of coal and a likely worsening financial
situation of state electricity boards, we recommend aligning with utilities which are integrated
with end-distribution business (Tata Power, CESC), or are not dependent on coal from Coal India
(NHPC), thereby minimizing exposure to state-owned distribution companies and/or linkage coal
from Coal India.
We agree that a default on loans to PFC and REC may be a low probability event due to their
nodal agency role, payment security mechanisms (discussed later) and RAPDRP. However, we see
risks to the potential loan growth for financers of state electricity boards in case of a severe
deterioration in the financials of state distribution companies. The overhang of large exposures to
state utilities will remain an overhang for stock price of PFC and REC. Valuations have moderated
over the past 3-4 months, relatively, but we still find better potential in public banks, which are
available at lower valuations and offer a better risk return profile.
We retain our REDUCE rating on both REC and PFC. Our rating is also influenced by the
current high interest rate environment, which do not bode well for non-banks. This, coupled
with ever increasing competition from banks, will result in higher margin pressure over next
couple of years at least.
Mechanisms to safeguard collection efficiency for generators – so far, so good
The provisions of the Electricity Act have ensured that generating companies have realized
100% dues post the last one-time settlement scheme. The stringent conditionalities to
ensure timely payments include (1) maintaining irrevocable Letter of Credits, (2) progressive
reduction in supply of power if payment not received within 60 days from date of billing,
and (3) claims over Central government dues payable to the states if payment not received
within ninety days.
Payment security mechanisms for financers—trudging along, despite the odds
In most cases, PFC and REC’s loans are secured and have a priority claim over the surplus
revenue from the utilities over any loan granted by the State government, whereas almost
20% of their loans are guaranteed by State Governments. Additionally, the escrow
mechanism (85% of loans) ensures discipline in servicing loans but may not work in case of
severe deficits.
The Escrow Agreement is typically a tripartite agreement entered by the bank/NBFC, the
borrower and the bank designated as escrow agent. Under the terms of the agreement, the
borrower is required to deposit all of its receivables (from certain centers) into the
designated escrow account and is prohibited from opening any other account for the
purpose of collection of revenues. In the event of a loan default, the escrow agent is
authorized to pay the amount owed to the bank/NBFC from the funds in the escrow.
We believe that the escrow mechanism ensures that the receipts of the state utility are
channelized in the right manner thereby reducing leakages in the system. However,
structurally the waterfall will always favour suppliers (generation company or fuel supplier),
operating overheads (like employee expenses) over finance charges. Thus, in case of severe
deficit of collections, the finance company may have to share the collections with these
parities despite a superior charge.
R-APDRP—establishing baseline data for monitoring AT&C losses to begin
We expect restructured Accelerated Power Development and Reforms Program (RAPDRP) to
addresses the key issue of unviable AT&C losses. The Cabinet Committee on Economic
Affairs (CCEA) had approved a budget outlay of Rs515 bn towards R-APDRP for the XIth
Plan as compared to an outlay of Rs400 bn and actual spend of Rs89 bn for the Xth plan.
R-APDRP places increased emphasis on establishment of baseline data that would enable
energy audits and monitor AT&C losses. R-APDRP has also formulated incentives for the staff
of SEBs to progressively reduce AT&C losses below 15% in the ensuing five years. Projects
under the scheme are to be taken up in two parts – Part A will include the projects for
establishment of baseline data and IT application for energy accounting and audits while
Part B regular distribution strengthening projects. The steering committee for
implementation and monitoring of APDRP had approved 1,344 projects totaling to Rs49 bn
under Part A as of December 2009. There is also a third part which is an enabling
component for RAPDRP and has to be implemented by MoP and PFC (nodal agency).
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