Gap estimate of “problem” SEBs Closer look at SEB finances – Would this restructuring be a game changer:: Nomura Research

Expect operating breakeven for most “problem” SEBs post FRP
Following the recently announced financial restructuring plan (FRP) for
SEB-Discoms (state electricity board distribution companies), our analysis
(based on the recently published FY11 financial statements and the FY13
tariff orders of SEBs), indicates that the operating gap for a majority of the
“problem” Discoms (Tamil Nadu (TN), Madhya Pradesh (MP), Andhra
Pradesh (AP), Punjab and Haryana), is likely to turn positive due to a
combination of lower interest expense derived from the FRP, tariff hikes
and fixed cost rationalization. The UP regulator is expected to announce a
tariff hike on the back of a 30% increase sought by the Discom; in our
view, Rajasthan may need a 15-20% hike over the next three years to
erase its operating losses. We expect PFC and REC to be major
beneficiaries of these developments

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The FRP links central government incentives to a trajectory of 25% gap
reduction every year, with FY11 as the benchmark year and FY13-15 as
the eligible years. Using FY11 data and applying the FRP’s 25% gap
reduction assumption, we infer operating losses for these seven Discoms
over this period, assuming adherence to this trajectory (Fig. 3) with a
sensitivity analysis of operating losses to consumption growth and gap
reduction (Exhibit 4). PFC and REC have committed to extend 170bn each
of transition loans to tide over losses in the interim.
Implementation key to the potency of FRP — catalysts and caveats
As per recent discussion with lenders such as PFC, we believe the next
steps for implementation of FRP include: 1) setting up a nodal bank for each
Discom; 2) the filing of an application by each Discom with the Department
of Financial Services; and 3) getting approval from the Ministry of Power.
Based on our discussions, we think the window for FRP is likely to be
extended beyond Dec 12. Regarding implementation, we see:
 Near-term catalysts: 1) Signing of FRPs by stressed Discoms by December
2012; 2) notification of new tariff orders by 30 April; 3) UP tariff hike.
 Key caveats: 1) near-term elections in states such as Rajasthan and MP
could impact the ability to make commensurate tariff hikes; 2) a few
states such as Punjab would need serious fiscal consolidation to fit FRP
within FRBM mandates (Fig. 7, 8).
PFC and REC potential beneficiaries of FRP; reiterate Buy ratings
We are increasing our earnings estimates for PFC and REC by 16% and
17% respectively for FY13F. At our target prices, PFC and REC would
trade at 1.4x and 1.5x average FY13F-14F P/ABV, respectively. We
reiterate our Buy rating on both the names.