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Top pick post the power conference; NHPC; Valuations comfort plus regulatory triggers and commissioning pick up
One of the most important highlight of our power conference was that CERC is in the midst of working out few regulatory changes which should incentivise hydro power. As per CERC, hydro entails highest risk (longer gestation period and hydrology risk) compared to thermal generation or transmission. But the ROEs are lower. Therefore CERC is thinking about bringing a mid-term amendment in regulations which should incentivise hydro proportionate to risks. However, it did not give any concrete measures. As per our calculations, core ROEs possible with maximum efficiencies are Hydro - 20-23%, Transmission - 20% and thermal 22-25%.
Also, NHPC in its recent analyst meet, guided for full tax grossing up in FY12E (they have done it for FY11 and FY10). Since in FY12E, higher capacity (1000MW) is expected to be commissioned, the grossing up at full rate is a positive surprise and would lead to 23% core ROE in FY12E. As per mgmt, in FY11, NHPC has earned a core ROE of 23%. Apart from normal regulated ROE (15.5%), It earned 1.5% from incentives, 1.3% from Secondary energy, 1.5% from UI and about 3% from grossing up at full rate. The water charge levy (Rs1.4bn for Nov-Mar11) by J&K state government will not have any impact on NHPC because mgmt said it would be a pass through and CERC has already admitted the petition (so no negative surprises from here).
NHPC commissioned 120MW (total capacity 5295MW at the end of FY11) in FY11 and have guided for 1050MW in FY12E (capitalization of Rs60bn). Current regulated equity is about Rs80bn (our estimate).
Valuations comfort with 25% upside plus regulatory triggers coupled with better commissioning ahead; Top pick post power conference
In our view, though hydro projects are longer gestation projects and requires huge money to be locked up as CWIP, grossing up ROE at full rate makes a huge difference. We say value CWIP only at 1x Book. However, the regulated equity of Rs100bn (taking capitalization at Rs60bn in next two years vs mgmt guidance of Rs60bn in FY12E) at the end of FY13E, has to be valued at minimum 2x (considering COE of 11.5%). This fair value of core book comes to Rs200bn and value of balance net worth is Rs190bn (1x) – total fair value of Rs390bn. Current mkt cap is Rs310bn, indicating an upside of 27% (dividend yield of ~2.5% in FY12E). Calculating fair value for other regulated utilities (power grid, NTPC) this way gives a value which is almost equal to market cap, therefore NHPC has margin of safety. Plus any regulatory upside remains added kicker.
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