Power Grid Corporation of India (PGRD.BO) Top Pick With a Target Price of Rs121  Citi Research

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Power Grid Corporation of India (PGRD.BO)
Top Pick With a Target Price of Rs121
 Top India electric utility pick — We expect PGCIL to deliver 15% EPS growth in
FY11-14E with an average RoE of 14%. The company remains, in our view, the safest
play in the Indian electric utilities sector, which has been riddled with coal shortages,
falling merchant prices and deteriorating SEB finances. The above risks could impede
PGCIL’s growth due to delayed capacity additions. However, we adequately factor in
the risk (XIth Plan capex of Rs504bn v/s target of Rs550bn and XIIth Plan capex of
Rs700bn v/s tentative target of Rs1000bn).
 Target price increased to Rs121 from Rs118 — We revise EPS by 0-2% for FY12E-
15E and roll forward our target P/BV of 2.2x to Mar13E (from Dec12E).
 Solid 2Q FY12 PAT growth — PGCIL’s 2Q FY12 recurring PAT was Rs7.1bn, +18%
yoy (CIRA: Rs7.1bn), driven by sales of Rs22.6bn (+10% yoy) and an EBITDA margin
of 83.8%. Adjusted for forex, PAT growth is higher at 32% yoy. PGCIL delivered PAT of
Rs14.1bn in 1H FY12, +18%, and is on track to meet our target of Rs29.2bn.
 Improvement in receivable days — PGCIL’s 1H FY12 receivable days came off to
105 from 133 days a year back, a significant improvement. Management expects
debtor days to decline to 1 month by Mar 12.
 Capitalization update — Capitalized Rs40.6bn in 1HFY12 and Rs51bn till Oct11 and
on track to meet CIRA FY12E of Rs90bn (below management estimate of Rs110bn).
 XIIth Plan capex — The capex plan for XIIth Plan (Rs750bn on 11 high capacity power
transmission corridors)of Rs1,000bn. According to management, coal shortages will not
affect future capex because even if a plant operates at low PLFs, it would need a
transmission line. Much of the XIIth Plan capex is for transmission corridors, which
have multiple beneficiaries. Even if 1 or 2 beneficiaries do not complete projects, it
would not matter because other beneficiaries would need the transmission line.
Maintain Buy – Target price increased to Rs121
 We expect PGCIL to deliver 15% EPS growth over FY11-14E with an average
RoE of 14%. The company remains, in our view, the safest play in the Indian
Electric Utilities universe, which has been riddled with coal shortages, falling
merchant prices and deteriorating SEB finances.
 The above factors could impede PGCIL’s growth capex due to delayed capacity
additions. However, we believe we have factored in the above risks adequately in
our estimates as we assume XIth Plan capex of Rs504bn (vs. target of Rs550bn)
and XIIth Plan capex of Rs700bn (vs. tentative target of Rs1,000bn).
 We increase our target price to Rs120 (from Rs118) to factor in our EPS
revisions and rolled forward of target P/BV of 2.2x for Mar13E (Dec12E earlier)


Power Grid Corporation of India
Company description
PGCIL (61.42%% owned by the Government of India) is India's Central
Transmission Utility (CTU) mandated to establish and operate regional and national
grids to facilitate transfer of power within and across regions. It commenced
operations in April 1992 and carries about 45% of India's generated electricity. As on
31 March 2008, it had a transmission network of about 66,807 circuit kms with 111
substations, and system availability of above 99.65%. PGCIL also plays an active
role in distribution sector reforms initiated by government. Recently, PGCIL
diversified to provide broadband telecom services and consultancy for T&D projects
in India and abroad.
Investment strategy
We rate PGCIL a Buy to factor in (1) its scarcity value, as it is the only listed play on
the regulated transmission business in India vis-a-vis plenty of generation
companies to chose from and (2) EPS CAGR of 15% over FY11-14E with average
RoE of 14%. PGCIL plans Rs550bn of capex during the XIth Five Year Plan (FY08-
12). Management suggested that capex during the next plan could be as high as
Rs1000bn. Under the regulatory regime, PGCIL's sales and earnings growth is
largely driven by capex and capex that it capitalizes and brings into its gross block.
The capex is incrementally funded through a 70:30 debt: equity mix. Capitalization
again depends on commissioning transmission lines.
Valuation
DCF is normally preferred when valuing an electric utility company that has
regulated earnings and cash flow streams. However, for a company like PGCIL,
which we estimate will be FCF negative until at least FY12E and might continue to
be FCF negative beyond FY12E depending on the scale of the capex it undertakes
in the XIIth Plan (FY13E -FY17E), the DCF approach could either overestimate or
underestimate the value of the company based on the terminal year cash-flow
assumptions.
The entire value would be dependent on the steady state case assumed when
growth capex stops and the company does only maintenance capex and generates
substantial amounts of cash. The DCF value would also be extremely sensitive to
the maintenance capex assumption in the terminal year. We therefore believe P/BV
valuation methodology is more appropriate.
Our target price of Rs121 is set at 2.2x P/BV for Mar13E, a ~12% discount to the
historical average P/BV of 2.5x since listing given the sector's generic risks of coal
shortage, falling merchant prices and deteriorating SEB finances.
Risks
Key downside risks to our target price include: 1) Creditworthiness of the State
Power Utilities; 2) Changes in the regulatory environment; 3) Increased competition;
and 4) Project-related risks. Key upside risks are: 1) Faster-than-expected project
execution leading to earlier capitalization of capex; 2) Higher-than-expected shortterm
open access revenues due to a spurt in power trading, and 3) Higher-thanexpected
revenues and profitability in consulting and telecoms businesses.