NHPC: Bunching of capacity to drive core earnings growth :Motilal Oswal

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Bunching of capacity to drive core earnings growth, RoE
Growth visibility poor; risks include higher cost, delays and generation linked recovery
NHPC is facing delays in project execution and related cost escalation, which impacted
earnings growth/RoE improvement. The CEA's latest review of hydro power projects
indicates NHPC's 4.2GW capacity, which is under construction, will be commissioned by
FY15, doubling capacity to 9.5GW from 5.3GW in March 2011. Earnings growth is thus
expected to be robust at 14.7% over FY11-13. However, RoE improvement will be limited
to ~7.5% by FY13 vs 6.3% in FY11, as cash/CWIP comprise 42% of capital employed in FY11
and FY13. NHPC is executing only one project of 330MW due to be commissioned beyond
FY15, which provides poor growth visibility. The key risk to the business includes lower
than normal monsoons leading to delay in recovery of RoE, non-approval/delays in project
costs and delays in capacity addition. We initiate coverage with a Neutral rating.
We expect bunching over FY12-14 due to execution delays
Hurdles such as geological surprises, local unrest and environmental issues have led
to delays in NHPC's project commissioning by six months to three years for its
4.5GW of projects under construction. This is despite NHPC having spent 40-80% of
its cost on the projects as at March 2010. According to CEA's latest review and in our
view, the projects will bunch up for commissioning over FY12-14. We expect NHPC to
commission 515MW in FY12, 1.1GW in FY13,1.8GW in FY14 and 750MW in FY15.
Cost overruns, lower generation could impact RoEs
Cost overruns are inevitable in hydro power projects due to complexities and delays.
For projects under construction, NHPC has witnessed a 30-80% increase in its cost
and thus, cost approvals by state regulators/discoms pose a risk to earnings. NHPC
had faced issues of cost overruns not being allowed initially for its Dulhasti, Chamera
and Teesta V projects. Besides, as per new tariff norms NHPC's recovery of RoE is
partly linked to generation and thus, hydrology risk is passed on to it. Although this is
allowed to be recovered over the years, the shortfall in generation may delay recovery
of RoE and impact NHPC's reported earnings/RoE. NHPC's reported RoE moved up
from 5% in FY06 to 7% in FY10 as it received tariff arrears on projects for which its
higher costs were approved.
Earnings CAGR of 15% over FY11-13, RoE expansion limited
We expect NHPC to report earnings CAGR of 14.7% over FY11-13, driven by
commissioning of 1.6GW of projects, and its RAB to grow from Rs70b in FY11 to
Rs94b in FY13. Our estimates assume latest cost estimates and delays in approval/
disapproval could impact earnings. We expect NHPC's reported RoE to be subdued
over FY11-13, as CWIP remains high and cash on books yields lower returns (together
accounting for 42% of capital employed in FY11, expected to fall to 35% by FY14).
Reported RoE is thus expected to grow from 7% in FY10 to 9% in FY14.
Valuations fair, growth option limited
The stock offers very limited growth opportunity, with a PER of 12.9x FY13E (in line
with 12.6x for NTPC, with a better growth profile) and 1x P/BV (a large part of net
worth deployed in cash/CWIP) and are reasonable in our view. We initiate coverage
with a Neutral rating and a target price of Rs27.