Capacity addition concerns recede but
operational parameter concerns increase
Margins and earnings stress to persist
during FY13, bounce back only in FY14
Power Grid with high capacity and lower
operational risk remains our top pick;
we also like NHPC, JPVL, CESC, PTC
��
Capacity addition concerns recede but lowest ever PLF and
PAF increase investor concerns about margins. Private
sector-led record capacity addition of 33GW in FY11-12 has
considerably reduced investor concerns about capacity.
However a sharply reduced PLF and PAF (plant load and
availability factor) for both public and private generators
(lowest since FY07) is a matter of concern and we believe has
greatly eroded margins and profitability. The operational
weakness was most acute for the newest projects, while a drop
in operating levels was sharper for private companies with less
visibility on coal supply.
We expect the top line as well as margins to remain under
pressure during FY13 due to operational stress. Two major
utilities (NTPC and Adani Power) reported a lower than
expected top line and much lower margins due to operational
stress. We expect the same story to be repeated for most of the
utilities, except Power Grid, NHPC and JPVL. We believe
operational performance will remain stressed for most of FY13
as demand and supply side pressure is likely to persist; we
expect a bounce-back only in FY14 (see page 7).
Prefer companies with growth and lower operational risk.
In the current scenario we prefer companies that will show
strong top line growth in FY13-14 but are not impacted by fuel
supply constraints; these are Power Grid, NHPC and JPVL. We
also like companies that show a significant improvement in
other parameters; we like PTC which is likely to see recovery of
its receivables and CESC which is likely to see a big reduction
in losses from its retail business. We lower our net profit
estimates and target price for Adani, PTC and CESC, while
increasing for Power Grid and Lanco. Our net profit
estimates for the sector are 1-3% lower versus consensus for
FY13-14 while 4-5% ahead for Power Grid.
large,
underperformed during the past year (an
exception being Power Grid). We believe the
main reason for the underperformance has been
concerns about the poor financial health of the
state distribution companies, as well as the
pressure on fuel supply. While initially there was
scepticism about the capacity additions, this
gradually reduced as we saw unprecedented
capacity added over the last two years, both in the
generation and transmission segments.
We expect investors to continue to focus on
operational parameters as they have performed
poorly in the current year. While we expect the
demand side issues (e.g. state financial health) to
improve, fuel supply-related operational pressure
should continue during FY13 despite intervention
by the Prime Minister’s office on the issue (refer
to Indian power and coal – New supply deal won’t
hurt Coal India, dated 3 May 2012).
Our top pick is Power Grid, with least operational
risk (no fuel risk), 44% capacity addition during
FY11-12, and capacity estimated to grow at a 23%
CAGR over FY13-14 resulting in EPS growing at a
16% CAGR over the same period. We also like
NHPC and JPVL, which have hydro projects
without any fuel risks, plus expected good capacity
addition in FY13-14. We believe mid-caps like
CESC and PTC that saw price corrections over the
past year (mainly due to other business concerns)
are trading at attractive valuations and could
provide a good potential return.
Initial concerns on capacity addition
to reduce significantly after record
capacity addition in FY12
We expect that a record 22% increase in
generation capacity during FY11-12 to reduce
initial concerns about capacity addition. 20GW of
capacity was added during FY12 (18.5GW of this
capacity was thermal) and 11.3GW was added in
FY11. Power Grid added 44% capacity in the two
years ended FY12. The bulk of the capacity
Shifting investor focus
Investors to focus more on operational parameters as capacity
addition fears reduce after high capacity addition in FY11-12
Coal supply constraint led to an unexpected drop in PLF (plant
load factor) and PAF (plant availability factor) in FY12; we expect
fuel pressure to reduce only in FY14
Companies with growth and least operational risks are our
preferred picks (Power Grid, NHPC and JPVL); mid-caps like PTC
and CESC are other value stocks
Investors likely to focus more
on operational parameters
Utility sector companies have, by and large,
underperformed during the past year (an
exception being Power Grid). We believe the
main reason for the underperformance has been
concerns about the poor financial health of the
state distribution companies, as well as the
pressure on fuel supply. While initially there was
scepticism about the capacity additions, this
gradually reduced as we saw unprecedented
capacity added over the last two years, both in the
generation and transmission segments.
We expect investors to continue to focus on
operational parameters as they have performed
poorly in the current year. While we expect the
demand side issues (e.g. state financial health) to
improve, fuel supply-related operational pressure
should continue during FY13 despite intervention
by the Prime Minister’s office on the issue (refer
to Indian power and coal – New supply deal won’t
hurt Coal India, dated 3 May 2012).
Our top pick is Power Grid, with least operational
risk (no fuel risk), 44% capacity addition during
FY11-12, and capacity estimated to grow at a 23%
CAGR over FY13-14 resulting in EPS growing at a
16% CAGR over the same period. We also like
NHPC and JPVL, which have hydro projects
without any fuel risks, plus expected good capacity
addition in FY13-14. We believe mid-caps like
CESC and PTC that saw price corrections over the
past year (mainly due to other business concerns)
are trading at attractive valuations and could
provide a good potential return.
Initial concerns on capacity addition
to reduce significantly after record
capacity addition in FY12
We expect that a record 22% increase in
generation capacity during FY11-12 to reduce
initial concerns about capacity addition. 20GW of
capacity was added during FY12 (18.5GW of this
capacity was thermal) and 11.3GW was added in
FY11. Power Grid added 44% capacity in the two
years ended FY12. The bulk of the capacity
addition has come from private power companies
(refer Table 3).
3: India coal capacity installed over 11th Five-year Plan
Installed
capacity (MW)
FY08 FY09 FY10 FY11 FY12 YoY %
Central 26,525 27,275 29,015 32,505 36,825 13.3%
State 39,912 40,672 43,177 44,987 47,987 6.7%
Private 4,350 4,850 7,395 11,955 22,789 90.6%
Total coal 70,787 72,797 79,587 89,447 107,601 20.3%
y/y 2.8% 9.3% 12.4% 20.3%
Source: CEA
Closely monitor operating parameters
post poor performance in FY12
We believe investors will start to monitor
operating parameters more closely as these could
suppress margins and hence impact earnings
(refer Exhibits 4-5).
PLF and PAF dropped sharply in last two
years. Demand as well as supply side pressure
caused a sharp drop in the operating performance
of new power plants, which also saw a marginal
drop in the operational performance of existing
power plants.
The result was a sharp 2ppt drop in the PLF of
power plants at an all-India level and an average
16ppt drop in the PLF for private sector plants.
While NTPC reported a 3.4ppt decline in PAF, we
estimate the PAF drop for the private power
plants will be even sharper. PAF drop is mainly
attributable to two factors: lack of fuel supply or
non-readiness of evacuation lines for new power
projects. We expect this to result in lower than
expected revenue growth and margin compression
for utilities.
While we expect a q-o-q improvement in 4Q
performance for most companies, performance is
poor across the board on a y-o-y basis.
We expect improvement from FY14
as fuel and demand pressure ease
We expect a significant improvement from FY14 for
several reasons, such as consumer tariff revisions by
the states and increasing pressure on Coal India to
supply coal to projects with approved linkage.
However, the Central Electricity Authority (CEA)
forecasts only 5% growth yoy in generation for
FY13 after a 13% increase in capacity addition in
FY12 and 10% expected in FY13. Hence despite the
new fuel supply agreement (FSA) being signed by
Coal India for projects coming up in FY10-15e, we
do not expect coal supply or demand pressure to ease
significantly during FY13. Improvements are likely
to be gradual; we expect them to become apparent in
FY14 as capacity added in FY10-13 becomes
operational and shows a better performance after
easing of supply and demand constraints.
Top pick is Power Grid
Power Grid has added 44% capacity during FY11-
12 and is on track for large capex during FY13-
14. We expect the stock to continue to outperform
the Sensex; key points of our investment case are
listed below:
1 Limited competition and least operational risk
in the power space with no fuel risk
2 Accelerated capacity addition to drive the
regulated equity growth at a 23% CAGR over
FY13-14, underpinning a strong 16% CAGR
in EPS over FY13-14e. The growth is
expected to sustain until FY17 with the equity
base increasing 2.5x, supporting 14%+ EPS
growth over FY15-17. Our net profit
estimates for FY13-14 are ahead of consensus
by 4-5%.
3 PGCIL is trading at the lower end of its PB
(1.8x vs range of 1.6-3.3x) and PE (13.0x vs
range of 12-26x), 20-25% below its historical
average, offering value despite
outperformance in the last year.
4 Our DCF-based target price implies FY14 PE
of 15.3x and PB of 2.1x, which is at the mid
range of its historical trading range.
Mid-cap companies provide higher
return albeit with higher risk
Some of mid-cap names like PTC, CESC and JPVL
are trading at great discounts to their large-cap peers
and do have significant growth potential. We believe
these stocks will be the first to bounce bank once the
power issues start getting resolved.
However concerns about these stocks have mostly
focussed on their non-core businesses. For PTC,
non-payment of dues from SEBs (which make up
c70% of its market cap) has been an issue, but we
expect it to get the bulk of these dues next quarter.
For CSEC, concerns have centred around ongoing
losses in its retail business and delayed start-up of its
new projects. Concerns on JPVL have been its high
leverage and captive coal block approval. While we
expect these issues to be resolved, the risk of nonresolution
is an overhang for these stocks.
Hydro companies set to outperform
as next two quarters are seasonally
best
We believe hydro companies will do well over the
next two years. We have seen the worst hydro
project additions over the last five years,
especially in government sector companies like
NHPC which added only 120MW (since its IPO
four years ago). However in the next two years we
expect NHPC to add 1,372MW and hence see
upside from current levels. JPVL is the largest
private sector hydro player with 1,700MW
operational projects, and is another company we
expect to do well, although all of its new projects
will be thermal which have much better visibility
on fuel supply. In addition, from a short-term
perspective, while 4Q is typically the worst
quarter for the hydro sector we expect the next
two quarters to be much stronger.
Estimate, rating and target price
changes
We lower our net profit estimates and target price
for Adani, PTC and CESC while increasing for
Power Grid and Lanco. Our ratings are unchanged
(but we add the volatility flag to Adani and PTC;
see Tables 10-10A).
Our net profit estimates for the sector are 1-3%
lower than consensus for FY13-14 while ahead
for Power Grid by 4-5%
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