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UBS Investment Research
India Banking & Finance Sector
P roposed SEB reforms +ve for power fincos
Event: Meeting of state power ministers to discuss rising distribution losses
In a meeting yesterday power ministers of various state governments adopted
measures to lower losses of distribution utilities and ensure financial sustainability
of DISCOMs. Key measures include: conversion of state loans to equity; annual
tariff revision in lieu of costs; clearing of outstanding subsidies; bidding out
distribution franchises (to help improve efficiency); and financial auditing. Rising
state electricity board (SEB) losses (Rs780bn, 1% of GDP as per media reports)
have been an oft cited concern regarding the financial viability of state utilities.
Impact: Improving financial health is a positive for REC and PFC
State utilities account for 83% of REC’s and 65% of PFC’s loan books. Valuations
for PFC/REC have de-rated on concerns of a default by SEBs, especially after the
State of Tamil Nadu (TN) approached the centre for a bailout (please refer to our
note of 20 June, TN SEB US$9bn bailout package). Recent measures, while
advisory in nature according to UBS Utilities analyst Pankaj Sharma, underline the
systemic importance of SEBs and the low likelihood of a default by a state utility.
Action: Buy REC, PFC; valuations remain attractive
PFC/REC’s share prices reacted strongly today to the news. We believe valuations
are not factoring in possible high medium-term growth of 20%+ and ROE of 18-
20%. Our price targets imply 29% potential upside for PFC and 25% potential
upside for REC from current levels. A risk is a lack of implementation of the
reforms by various states.
Reiterate our view that default is unlikely but
restructuring could be a worst case eventuality
We reiterate our view that listed central government entities will bear the cost of
state utility inefficiencies. REC/PFC exposure is covered by an escrow
mechanism and backed by explicit government guarantees in a few cases.
A default by a state government entity could have severe implications for the
financial system as a whole, as it would imply a state government default. Tamil
Nadu (TN) exposure is partially backed by explicit state government guarantees
and default on a single exposure would be construed as a default by the TN
government. A cut in interest rates is a possibility, but the chance of this
happening is low in our view, as unlike in the mid-2001 restructuring interest
rates were reduced due to a significant gap between market rates and REC/PFC
lending rates. Recently, lending to state electricity boards (SEBs) has been
competitive with PSU banks especially active, which ensured best rates to the
SEBs.
Our price targets are derived from a residual income model.
Below is the press release from the Ministry of Power
The State Power Ministers’ Conference on “Distribution Sector Reforms”
organized in New Delhi today has underlined the need for urgent steps to arrest
and reverse the growing losses in power distribution. The Conference chaired
by Union Minister of Power Shri Sushilkumar Shinde was attended by Power
Ministers of the States from across the country. Highlighting that power is a
concurrent subject, Mr. Shinde said that while the Centre is always ready to
help the States, it is their responsibility to ensure implementation of the reforms.
He said that the target of bringing down the distribution losses to 15% is
achievable if the States devise utility-wise turn-around plan and closely monitor
it at the highest level.
In their presentations, the states highlighted the administrative and financial
measures taken by them to address the issue of electricity pilferage and power
thefts. They assured of early completion of auditing of accounts of the utilities,
clear all the outstanding subsidies to them and ensure advance payment of
subsidy as per the Electricity Act.
In a unanimously adopted resolution, the Conference agreed upon a set of
measures to bring down the distribution losses. These are as follows:
The state governments would ensure that the accounts of the utilities are
audited up to the year 2009-10 and also ensure that the accounts of a
financial year are audited by September of the next financial year,
henceforth. Computerization of accounts would be undertaken on priority, if
not done already.
The states would ensure that the distribution utilities file their Annual Tariff
Revision Petition every year, by December – January of the preceding
financial year to the State Regulators as stipulated by the National Tariff
policy.
The Annual Tariff Revision Petition would be filed before the SERC, keeping
in view the increase of the Power purchase cost (which accounts for nearly
70-80% of the Cost of supply) and states will ensure that the difference
between ARR and ACS is not only bridged but is positive to generate internal
surpluses which can be used for network expansion and maintenance.
The state governments would ensure automatic pass through in tariff for any
increase in fuel cost by incorporating the same in the regulations, as
provided in Section 62(4) of Electricity Act, 2003. (State Governments can
issue directions to SERCs under Section 108 of the Electricity Act, 2003).
The state governments would not only clear all the outstanding subsidies to
the utilities, but ensure advance payment of subsidy as per the Section 65 of
the Electricity Act, 2003 in future.
The eligibility criteria for inclusion of towns under R-APDRP assistance
with population of 30000 (10000 for special category states) should be
reduced to 15000 (5000 for special category states). All district headquarter
towns in special category states should also be covered under R-APDRP,
irrespective of their population.
The state governments would ensure payment of all outstanding dues from
various departments of state government and institutions to the distribution
utilities or release payments from the State budget directly.
The state governments would consider converting loans due from the state
governments to the distribution utilities as state government equity to ensure
capital infusion and improvement in net worth of utility.
The state governments would take effective steps to reduce AT&C losses to
less than 15% by administrative measures, curbing pilferage of electricity
and by setting up special police stations and special courts to deal
exclusively with power theft related cases, if not done already.
States would immediately initiate steps to appoint distribution franchises in
urban areas through competitive bidding.
States would immediately invite bids for meeting the uncovered generation
capacity gap viz- a -viz the requirement in their States by the end of 12th
Plan. The process will be completed by March, 2012.
States would create a unit in their states for integrated planning of
generation, transmission and distribution to meet the future requirement of
their states.
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