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UBS Investment Research
India Power Utilities
SEB losses: situation is grim but subsidies
a nd tariff hikes help
Event: the data on financials of SEBs is now available up to FY10
In a recent report on “Performance of State Power Utilities” by Power Finance
Corporation, the actual numbers on financial status of State Electricity Boards
(SEBs) have been reported up to FY10. The data shows, a) in FY10, the situation
has not become significantly worse vs. FY09, b) huge variations among states and
situation is alarming in only ~20% cases, c) supply for agriculture remains the key
problem area for SEBs.
Impact: Tariff hikes and more subsidies from states to SEBs would help
As state governments are unlikely to receive help from the central government,
they have started to make progress in lowering SEB losses; more than 70% of the
SEBs had either no or manageable losses in FY10. The states have also: 1) released
more subsidies to their respective SEBs; and 2) have also raised tariffs.
Action: Sector underperformance provides buying opportunity
We prefer companies with low risk (Power Grid and NTPC) or those with
compelling valuations (Lanco and Reliance Infra). Investors who are bearish on
SEB losses may prefer Power Grid, NTPC and Reliance Infra.
Our top pick: Power Grid and Lanco
We prefer Power Grid and Lanco. We also have Buy ratings on NTPC, Tata
Power, Reliance Power and Reliance Infra. We have recently initiated coverage on
Jindal Steel and Power with a Sell. Please refer to our initiation report ‘Risks
outweigh strong fundamentals’ dated 7 October 2011.
SEB losses: challenge remains
The issue of SEB losses is the most critical challenge for the Indian Power
sector today. In a recent report on “Performance of State Power Utilities for the
years 2007-08 to 2009-10” by Power Finance Corporation (PFC), the actual
numbers for SEBs financial health have been published for FY10. We believe
that though the situation has not improved, the satisfaction is that the
deterioration has slowed down. This is in-line with our estimates and the
view we have.
In FY09, the cost recovery from income (81.5% in FY08 to 76.8% in FY09) had
deteriorated significantly due to factors such as power purchase at very high
rates by distribution companies. In FY10, the situation did not improve much
but has not further deteriorated significantly.
The other key points in the report are as follows;
The gap on subsidy received basis increased from Rs0.28/kwh in the year
2007-08 to Rs0.55/kwh in 2008-09 and to Rs0.59/kwh in the year 2009-10.
The receivables for sale of power for utilities selling directly to consumers
increased in terms of revenue from Rs555bn (109 days sales) as on 31 March
2009 to Rs649bn (109 days sales) as on 31 March 2010.
The average AT&C losses (%) for utilities selling directly to consumers
reduced from 27.74% in the year 2008-09 to 27.15% in 2009-10.
The aggregate energy sold (Mkwh) to all consumer categories registered an
increase of 8.82 % in 2009-10 as compared to the year 2008-09. The energy
sold to agricultural consumers remained at 23% during this period. The share
of revenue from Agricultural Consumers remained at approximately 6%.
The share of energy sold to industrial consumers in total energy sold was
approximately 34% in the year 2009-10. The share of revenue from
industrial consumers in total revenue during the year 2009-10 was
approximately 46%.
The borrowings from FIs, Banks and market continue to be the major source
of capital employed in the sector. The share of these borrowings in the total
capital employed increased from 60% as at the end of FY 2008 to 65% as at
end of FY 2009 and to 72% at the end of FY 2010. State Government Loans,
which constitute the second-largest component in the capital employed, has
shown a steady reduction from 16% as at the end the FY 2008 to 14% as at
the end of FY 2009 and further to 12% as at the end of FY 2010.
The outstanding State Gov’t. loans have increased from Rs419bn as on
31 March 2008 to Rs439bn as on 31 March 2009 and further to Rs444bn as
on 31 March 2010. The outstanding loan from Banks/FIs, bonds &
debentures and other loans constituted about 86% of the total borrowings of
the utilities during 2009-10. These loans increased from Rs1,580bn as on
31 March 2008 to Rs2,011bn as on 31 March 2009 and to Rs2,665bn as on
31 March 2010.
The power purchased by utilities selling directly to consumers increased
from 581,406 Mkwh in 2008-09 to 648,650 Mkwh in the year 2009-10,
reflecting an increase of 11.56%. The sale of power (Mkwh) for utilities
selling directly to consumers increased from 486,316 Mkwh in the year
2008-09 to 529,225 Mkwh in the year 2009-10.
If we look across states, there are significant regional variations e.g. three
states contribute ~50% of losses and seven states ~80%.
UBS view
We think the SEBs have been trying to lower their losses by raising tariffs and
controlling their purchases. We also believe that tariffs can be adequately raised
to cover costs and lower losses as this is more a question of political will from
the state governments. During the tariff hikes over the past six to 12 months,
resistance from the opposition political parties has been manageable for the local
governments. Another key factor supporting tariff hikes is that among the state
governments, there was hope that the central government would help the SEBs
if things do not improve. The Power Ministry and Planning Commission has
informed the states in clear terms that this is now highly unlikely.
The SEBs’ poor financial health and losses are significant concerns as progress
on distribution reform remains slow. However, no state government can afford
to go without power. We believe the importance of electricity as a political issue
and a key input of India’s GDP growth has also been overlooked by investors.
India’s GDP cannot grow at a 7-8% annual rate without electricity. The
Planning Commission and CEA estimate there has been an impact of 100-150bp
on India’s GDP growth due to the lack of sufficient and good quality power
(consistent and uninterrupted). While the SEBs’ losses are a concern, we believe
there have been positive developments as well. In our view, the situation is
manageable and improving.
SEBs have made progress in cutting losses
We think some states have made reasonable progress in cutting their SEB losses.
In FY10, many large states did not post losses. In some other states, the losses
were not at alarming levels and the situation was much better and more
manageable, in our view.
However, we think the progress has been uneven. For example, seven states were
contributing more than 80% of the total SEB losses reported across the country
(three states were contributing ~50% of the total losses).
Nevertheless, it would not be wise to paint all the SEBs with the same brush as
some have successfully contained their losses. As the central government is
unlikely to help the SEBs, the states would have to resort to tariff hikes (we
think this is inevitable in states where tariffs have not been raised for a long
time). There is a strong possibility that even Tamil Nadu’s SEB will raise its
tariffs in the next month.
As highlighted in India Power Utilities: Not all doom and gloom published on
25 August 2011, we continue to believe that the SEBs are unlikely to default in
the next two to three years.
States are raising tariffs and releasing subsidies
According to news reports and our analysis of newsflow, many state
governments have moved forward on power tariff hikes. Of the 28 states in India,
at least 16 states (more than 80% of total consumption) have either enacted or
proposed power tariff hikes over the past nine months. The key states where
tariffs have been revised or will be revised are: Karnataka (22%), Delhi (20%),
Rajasthan (20%), Orissa (20%), Bihar (19%), Jharkhand (16%), Assam (14%),
and Chhattisgarh (14%).
Tariff hikes across states
State Tariff hike
Karnataka 22%
Rajasthan 20%
Orissa 20%
Delhi 20%
Bihar 19%
Jharkhand 16%
Assam 14%
Chhattisgarh 14%
Andhra Pradesh 12%
Punjab 9%
West Bengal 9%
Gujarat 8%
Madhya Pradesh 6%
Uttarakhand 5%
Maharashtra 5%
Haryana 3%
Source: UBS estimates
We believe reasonable and regular tariff hikes by the distribution companies is
key in keeping the SEBs’ losses manageable. Hence, the tariff hikes are a
positive development, in our view.
In states where the SEBs are in urgent need of financial support, the state
governments have started to release subsidies for the SEBs from the state
budgets.
Stock implications
We believe there are two categories of stocks depending on investor preferences.
The first is for companies with relatively low risk. In this category, we prefer
Power Grid (Buy, Rs135.00 price target) and NTPC (Buy, Rs215.00 price
target). We believe they have low risk as their business models are based on
regulated returns on investments (a good option for risk-averse investors). The
second category is for stocks that have significantly corrected and are trading at
compelling valuations. While these companies may be perceived as having high
risk—such as Lanco (Buy, Rs30.00 price target) and Reliance Infrastructure
(Buy, Rs700.00 price target)—they could offer strong upside if investor
sentiment turns positive.
We upgraded our rating on Reliance Power (Rs105.00 price target) from Sell to
Buy in August 2011. We think captive coal—where it has a strong advantage
in—will be a key success factor for the power generation companies. Tata
Power (Buy, Rs1,350 price target) has corrected significantly. We maintain our
Buy rating on the stock but we think the overhang from Mundra will remain a
resistance. We maintain our Sell rating on Adani Power (Rs80.00 price target).
Overall, we prefer Power Grid, Lanco, NTPC, Reliance Infrastructure, Tata
Power and Reliance Power in that order. Please refer to India Power Utilities:
Not all doom and gloom published on 25 August 2011.
We have recently initiated coverage on Jindal Steel and Power with a Sell.
Jindal Steel and Power (JSPL) is one of the largest steel and power companies in
India. Its key businesses are: steel, iron ore and coal mining, power generation,
hot briquetted iron and pellet plant. Its 96.43%-owned subsidiary, power
generation utility Jindal Power, has coal-based operational plant of 1,000MW
and 11,140MW under implementation (thermal 5,040MW, hydro 6,100MW).
We are negative on the stock as we think Jindal Power faces substantial
execution risk. It has encountered significant delays in its expansion projects: 1)
Tamnar II (2,400MW) was initially held up for almost 12 months due to delays
in receiving environmental clearance from the Ministry of Environment and
Forests and is still awaiting Consent to Establish (CTE) from the state
government; 2) both Dumka and Godda (1,320MW each) have yet to receive
state government clearances to start construction; and 3) hydro projects are
back-ended and are not due to become operational until at least 2018. After the
recent earthquake in Sikkim, most of the hydro projects in the north-east could
face delays in commissioning.
We derive our price target of Rs470 from a SOPT methodology. For power
business (Rs285/share), we use plant-by-plant DCF for thermal capacities of
6,040MW, we value hydro projects at 1x equity invested and non-captive power
business in the standalone at 1.0x P/BV. We are not conservative in our
execution estimates or operational parameters for the power business. We have
initiated coverage of JSPL with an anti-consensus Sell rating. We believe the
continuous decline in ROCE (from 41% in FY10 to 21% in FY14E) and ROE
(from 45% in FY10 to 24% in FY14E) means a premium valuation is
unwarranted. Please refer to our initiation report ‘Risks outweigh strong
fundamentals’ dated 7 October 2011.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Power Utilities
SEB losses: situation is grim but subsidies
a nd tariff hikes help
Event: the data on financials of SEBs is now available up to FY10
In a recent report on “Performance of State Power Utilities” by Power Finance
Corporation, the actual numbers on financial status of State Electricity Boards
(SEBs) have been reported up to FY10. The data shows, a) in FY10, the situation
has not become significantly worse vs. FY09, b) huge variations among states and
situation is alarming in only ~20% cases, c) supply for agriculture remains the key
problem area for SEBs.
Impact: Tariff hikes and more subsidies from states to SEBs would help
As state governments are unlikely to receive help from the central government,
they have started to make progress in lowering SEB losses; more than 70% of the
SEBs had either no or manageable losses in FY10. The states have also: 1) released
more subsidies to their respective SEBs; and 2) have also raised tariffs.
Action: Sector underperformance provides buying opportunity
We prefer companies with low risk (Power Grid and NTPC) or those with
compelling valuations (Lanco and Reliance Infra). Investors who are bearish on
SEB losses may prefer Power Grid, NTPC and Reliance Infra.
Our top pick: Power Grid and Lanco
We prefer Power Grid and Lanco. We also have Buy ratings on NTPC, Tata
Power, Reliance Power and Reliance Infra. We have recently initiated coverage on
Jindal Steel and Power with a Sell. Please refer to our initiation report ‘Risks
outweigh strong fundamentals’ dated 7 October 2011.
SEB losses: challenge remains
The issue of SEB losses is the most critical challenge for the Indian Power
sector today. In a recent report on “Performance of State Power Utilities for the
years 2007-08 to 2009-10” by Power Finance Corporation (PFC), the actual
numbers for SEBs financial health have been published for FY10. We believe
that though the situation has not improved, the satisfaction is that the
deterioration has slowed down. This is in-line with our estimates and the
view we have.
In FY09, the cost recovery from income (81.5% in FY08 to 76.8% in FY09) had
deteriorated significantly due to factors such as power purchase at very high
rates by distribution companies. In FY10, the situation did not improve much
but has not further deteriorated significantly.
The other key points in the report are as follows;
The gap on subsidy received basis increased from Rs0.28/kwh in the year
2007-08 to Rs0.55/kwh in 2008-09 and to Rs0.59/kwh in the year 2009-10.
The receivables for sale of power for utilities selling directly to consumers
increased in terms of revenue from Rs555bn (109 days sales) as on 31 March
2009 to Rs649bn (109 days sales) as on 31 March 2010.
The average AT&C losses (%) for utilities selling directly to consumers
reduced from 27.74% in the year 2008-09 to 27.15% in 2009-10.
The aggregate energy sold (Mkwh) to all consumer categories registered an
increase of 8.82 % in 2009-10 as compared to the year 2008-09. The energy
sold to agricultural consumers remained at 23% during this period. The share
of revenue from Agricultural Consumers remained at approximately 6%.
The share of energy sold to industrial consumers in total energy sold was
approximately 34% in the year 2009-10. The share of revenue from
industrial consumers in total revenue during the year 2009-10 was
approximately 46%.
The borrowings from FIs, Banks and market continue to be the major source
of capital employed in the sector. The share of these borrowings in the total
capital employed increased from 60% as at the end of FY 2008 to 65% as at
end of FY 2009 and to 72% at the end of FY 2010. State Government Loans,
which constitute the second-largest component in the capital employed, has
shown a steady reduction from 16% as at the end the FY 2008 to 14% as at
the end of FY 2009 and further to 12% as at the end of FY 2010.
The outstanding State Gov’t. loans have increased from Rs419bn as on
31 March 2008 to Rs439bn as on 31 March 2009 and further to Rs444bn as
on 31 March 2010. The outstanding loan from Banks/FIs, bonds &
debentures and other loans constituted about 86% of the total borrowings of
the utilities during 2009-10. These loans increased from Rs1,580bn as on
31 March 2008 to Rs2,011bn as on 31 March 2009 and to Rs2,665bn as on
31 March 2010.
The power purchased by utilities selling directly to consumers increased
from 581,406 Mkwh in 2008-09 to 648,650 Mkwh in the year 2009-10,
reflecting an increase of 11.56%. The sale of power (Mkwh) for utilities
selling directly to consumers increased from 486,316 Mkwh in the year
2008-09 to 529,225 Mkwh in the year 2009-10.
If we look across states, there are significant regional variations e.g. three
states contribute ~50% of losses and seven states ~80%.
UBS view
We think the SEBs have been trying to lower their losses by raising tariffs and
controlling their purchases. We also believe that tariffs can be adequately raised
to cover costs and lower losses as this is more a question of political will from
the state governments. During the tariff hikes over the past six to 12 months,
resistance from the opposition political parties has been manageable for the local
governments. Another key factor supporting tariff hikes is that among the state
governments, there was hope that the central government would help the SEBs
if things do not improve. The Power Ministry and Planning Commission has
informed the states in clear terms that this is now highly unlikely.
The SEBs’ poor financial health and losses are significant concerns as progress
on distribution reform remains slow. However, no state government can afford
to go without power. We believe the importance of electricity as a political issue
and a key input of India’s GDP growth has also been overlooked by investors.
India’s GDP cannot grow at a 7-8% annual rate without electricity. The
Planning Commission and CEA estimate there has been an impact of 100-150bp
on India’s GDP growth due to the lack of sufficient and good quality power
(consistent and uninterrupted). While the SEBs’ losses are a concern, we believe
there have been positive developments as well. In our view, the situation is
manageable and improving.
SEBs have made progress in cutting losses
We think some states have made reasonable progress in cutting their SEB losses.
In FY10, many large states did not post losses. In some other states, the losses
were not at alarming levels and the situation was much better and more
manageable, in our view.
However, we think the progress has been uneven. For example, seven states were
contributing more than 80% of the total SEB losses reported across the country
(three states were contributing ~50% of the total losses).
Nevertheless, it would not be wise to paint all the SEBs with the same brush as
some have successfully contained their losses. As the central government is
unlikely to help the SEBs, the states would have to resort to tariff hikes (we
think this is inevitable in states where tariffs have not been raised for a long
time). There is a strong possibility that even Tamil Nadu’s SEB will raise its
tariffs in the next month.
As highlighted in India Power Utilities: Not all doom and gloom published on
25 August 2011, we continue to believe that the SEBs are unlikely to default in
the next two to three years.
States are raising tariffs and releasing subsidies
According to news reports and our analysis of newsflow, many state
governments have moved forward on power tariff hikes. Of the 28 states in India,
at least 16 states (more than 80% of total consumption) have either enacted or
proposed power tariff hikes over the past nine months. The key states where
tariffs have been revised or will be revised are: Karnataka (22%), Delhi (20%),
Rajasthan (20%), Orissa (20%), Bihar (19%), Jharkhand (16%), Assam (14%),
and Chhattisgarh (14%).
Tariff hikes across states
State Tariff hike
Karnataka 22%
Rajasthan 20%
Orissa 20%
Delhi 20%
Bihar 19%
Jharkhand 16%
Assam 14%
Chhattisgarh 14%
Andhra Pradesh 12%
Punjab 9%
West Bengal 9%
Gujarat 8%
Madhya Pradesh 6%
Uttarakhand 5%
Maharashtra 5%
Haryana 3%
Source: UBS estimates
We believe reasonable and regular tariff hikes by the distribution companies is
key in keeping the SEBs’ losses manageable. Hence, the tariff hikes are a
positive development, in our view.
In states where the SEBs are in urgent need of financial support, the state
governments have started to release subsidies for the SEBs from the state
budgets.
Stock implications
We believe there are two categories of stocks depending on investor preferences.
The first is for companies with relatively low risk. In this category, we prefer
Power Grid (Buy, Rs135.00 price target) and NTPC (Buy, Rs215.00 price
target). We believe they have low risk as their business models are based on
regulated returns on investments (a good option for risk-averse investors). The
second category is for stocks that have significantly corrected and are trading at
compelling valuations. While these companies may be perceived as having high
risk—such as Lanco (Buy, Rs30.00 price target) and Reliance Infrastructure
(Buy, Rs700.00 price target)—they could offer strong upside if investor
sentiment turns positive.
We upgraded our rating on Reliance Power (Rs105.00 price target) from Sell to
Buy in August 2011. We think captive coal—where it has a strong advantage
in—will be a key success factor for the power generation companies. Tata
Power (Buy, Rs1,350 price target) has corrected significantly. We maintain our
Buy rating on the stock but we think the overhang from Mundra will remain a
resistance. We maintain our Sell rating on Adani Power (Rs80.00 price target).
Overall, we prefer Power Grid, Lanco, NTPC, Reliance Infrastructure, Tata
Power and Reliance Power in that order. Please refer to India Power Utilities:
Not all doom and gloom published on 25 August 2011.
We have recently initiated coverage on Jindal Steel and Power with a Sell.
Jindal Steel and Power (JSPL) is one of the largest steel and power companies in
India. Its key businesses are: steel, iron ore and coal mining, power generation,
hot briquetted iron and pellet plant. Its 96.43%-owned subsidiary, power
generation utility Jindal Power, has coal-based operational plant of 1,000MW
and 11,140MW under implementation (thermal 5,040MW, hydro 6,100MW).
We are negative on the stock as we think Jindal Power faces substantial
execution risk. It has encountered significant delays in its expansion projects: 1)
Tamnar II (2,400MW) was initially held up for almost 12 months due to delays
in receiving environmental clearance from the Ministry of Environment and
Forests and is still awaiting Consent to Establish (CTE) from the state
government; 2) both Dumka and Godda (1,320MW each) have yet to receive
state government clearances to start construction; and 3) hydro projects are
back-ended and are not due to become operational until at least 2018. After the
recent earthquake in Sikkim, most of the hydro projects in the north-east could
face delays in commissioning.
We derive our price target of Rs470 from a SOPT methodology. For power
business (Rs285/share), we use plant-by-plant DCF for thermal capacities of
6,040MW, we value hydro projects at 1x equity invested and non-captive power
business in the standalone at 1.0x P/BV. We are not conservative in our
execution estimates or operational parameters for the power business. We have
initiated coverage of JSPL with an anti-consensus Sell rating. We believe the
continuous decline in ROCE (from 41% in FY10 to 21% in FY14E) and ROE
(from 45% in FY10 to 24% in FY14E) means a premium valuation is
unwarranted. Please refer to our initiation report ‘Risks outweigh strong
fundamentals’ dated 7 October 2011.
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