Fuel Security is the Theme – Karvy Top Picks are: “CESC, NTPC & Tata Power”

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Fuel Security is the Theme
– Key Differentiator & Determinant of Profitability –
Our Top Picks are: “CESC, NTPC & Tata Power”
Why do we like the power sector?
The BSE Power Index has underperformed by 23.3% to Sensex over past
12 months due to near-term concerns i.e. unavailability of coal, lower
merchant rates and deteriorating financial condition of State Electricity
Boards (SEBs). This underperformance offers an opportunity amid
historically low valuation, assured returns in regulated business model,
likely tariff hike by the distribution companies (DISCOMs), coal asset
acquisitions, and allocation of coal blocks, which we believe would
improve the sector al outlook and the performance of the stocks. Again, the
Power Index is trading at 2.07x at 33% discount to its last three years
average mean of 3.1x, which provides the margin of safety. We also see a
strong demand with restricted supply (demand-supply gap to remain till
FY15E), commissioning of 1.1 lakh MW capacity (up 60%) over FY10-15E.
Power Deficit to Persist till FY15E despite Rise in Supply
With ~110,000MW of generation capacity estimated to be added over
FY10-15E, the power deficit would reduce from 10.1% in FY10 to 3.3% in
FY15E. While, the power supply is likely to rise at a CAGR of 10.2%, the
demand is expected to rise at 8% CAGR.
“Fuel Security” is the Theme: Coal Deficit to Continue
Over FY10-15E, while the coal demand is likely to rise at CAGR of 10.2%,
the output is set to rise at CAGR of 7.2%. Thus the deficit is likely to result
in rise in India's coal imports from 35 mn metric tonne (MMT) in FY10 to
134 MMT in FY15E.
Merchant Rates at Rs. 3.5/unit levels to yield ~22% RoEs in FY13E
The merchant power rates in India have gone up from Rs. 3 per unit in
FY06 to Rs. 6 in FY10 due to increased power deficit. However, with new
capacities coming up, the merchant rates settling at levels of Rs. 3.5 per
unit in FY13E – marking a decline of 40% over FY10-13E – would yield
RoEs of ~22%.
Differentiating Parameters over the Near -term
In our view the best players have huge capacity addition in the near-term
providing revenue visibility, execution capability and fuel security. With
rising coal deficit, we expect RoE of merchant-based capacities to level
down to sustainable levels of 22% from 35-40% current level.
We prefer utilities with I. Assured RoEs of regulated business model vs.
merchant business model (due to high coal price and lower merchant
realization), II. Fuel Linkages, III. Strong Balance Sheet & Execution Track
Record, and IV. Low Valuation & Low-risk business models.
We initiate coverage with “BUY” recommendation on CESC (Fuel
Security, Attractive Valuation), NTPC (Fuel Security, Assured RoE) &
Tata Power (Fuel Security, Strong Portfolio). We initiate coverage on
Adani Power (Fundamentally Priced-in) & JSW Energy (High
Dependence on Imported Coal, Exposure to Merchant Biz) with “HOLD”
recommendation.