Ahead of PGCIL’s FPO opening on 3
rd Dec, the price band for the issue has
been fixed at Rs85-90 a share, as per company's filing on BSE. The 13% fresh
issue by PGCIL implies an equity infusion in the range of Rs51bn-54bn, and
estimated net-D/E will range between 2.35x-2.40x by FY16E, slightly ahead
of normative 70:30 levels prescribed by CERC. Our Sep-14 DCF based PT of
Rs110, implies 22%-29% upside potential over the issue price band. Maintain
OW. A multistage DCF valuation methodology incorporates a fair number of
assumptions and bias. In this report we test alternate valuation
methodologies in the context of PGCIL: (1) Dividend discount model, (2)
Book Value approach, and (3) a derived EV/EBIT approach.
Outlining the 3 valuation methodologies. (1) Dividend yield in next fiscal
= (CoE – g); (2) P/B = (RoE - g)/ (CoE - g); (3) We revisit basic textbook
equations to derive EV/EBIT: (a) Gordon Growth formula: EV =
FCF/(WACC - g); (b) Definition of FCF = EBIT*(1-tax rate) +
Depreciation - Capex – ΔNWC; (c) another definition of FCF = EBIT* (1-
reinvestment rate)* (1-tax rate). For the mathematically inclined EV/EBIT
equates to [(1-tax rate)*{1- (ρ/EBIT*(1-tax rate))}]/(WACC - g), where ρ =
(Capex + ΔNWC – Depreciation). The definitions of variables, assumptions
and derivations have been provided inside the report.
Conclusions. Back testing dividend discount model and book value
approach to derive stable state growth/terminal growth (or g) around CMP
yields values in excess of 6%─ too high, in our view. This merely
establishes that it’s still too early to be looking at PGCIL as a utility in
stable state- – we estimate 52% diluted EPS growth over FY13-17. In the
EV/EBIT approach, to minimize bias we value only the stable cash flow
from commissioned and regulated return projects as of FY14, in other
words we keep g=0. Assuming base RoE permitted by the regulator remains
stable at 15.5%, we conclude that operational projects of PGCIL alone are
worth Rs92/share (at 14% RoE worth Rs85/share) excluding visible growth
over 12th Plan period (+Rs10/share) and beyond (+Rs8/share).
��
rd Dec, the price band for the issue has
been fixed at Rs85-90 a share, as per company's filing on BSE. The 13% fresh
issue by PGCIL implies an equity infusion in the range of Rs51bn-54bn, and
estimated net-D/E will range between 2.35x-2.40x by FY16E, slightly ahead
of normative 70:30 levels prescribed by CERC. Our Sep-14 DCF based PT of
Rs110, implies 22%-29% upside potential over the issue price band. Maintain
OW. A multistage DCF valuation methodology incorporates a fair number of
assumptions and bias. In this report we test alternate valuation
methodologies in the context of PGCIL: (1) Dividend discount model, (2)
Book Value approach, and (3) a derived EV/EBIT approach.
Outlining the 3 valuation methodologies. (1) Dividend yield in next fiscal
= (CoE – g); (2) P/B = (RoE - g)/ (CoE - g); (3) We revisit basic textbook
equations to derive EV/EBIT: (a) Gordon Growth formula: EV =
FCF/(WACC - g); (b) Definition of FCF = EBIT*(1-tax rate) +
Depreciation - Capex – ΔNWC; (c) another definition of FCF = EBIT* (1-
reinvestment rate)* (1-tax rate). For the mathematically inclined EV/EBIT
equates to [(1-tax rate)*{1- (ρ/EBIT*(1-tax rate))}]/(WACC - g), where ρ =
(Capex + ΔNWC – Depreciation). The definitions of variables, assumptions
and derivations have been provided inside the report.
Conclusions. Back testing dividend discount model and book value
approach to derive stable state growth/terminal growth (or g) around CMP
yields values in excess of 6%─ too high, in our view. This merely
establishes that it’s still too early to be looking at PGCIL as a utility in
stable state- – we estimate 52% diluted EPS growth over FY13-17. In the
EV/EBIT approach, to minimize bias we value only the stable cash flow
from commissioned and regulated return projects as of FY14, in other
words we keep g=0. Assuming base RoE permitted by the regulator remains
stable at 15.5%, we conclude that operational projects of PGCIL alone are
worth Rs92/share (at 14% RoE worth Rs85/share) excluding visible growth
over 12th Plan period (+Rs10/share) and beyond (+Rs8/share).
Investment Thesis, Valuation and Risks
Power Grid Corporation of India (Overweight; Price Target:
Rs110.00)
Investment Thesis
Being the monopoly transmission utility in long distance high voltage power
transmission, with a regulated return model, PGCIL offers a relatively safe and stable
growth haven as compared to IPPs which face significantly higher uncertainty
around land, fuel, environmental clearances and merchant prices. In the near term, an
FPO overhang remains, we maintain OW based on PGCIL's strong fundamentals.
Valuation
We maintain our Sep-14 DCF based PT of Rs110 implying 16% upside potential
from CMP. Our DCF valuation factors in WACC of 9.3%. Terminal growth rate of
2.5% beyond FY30 remains unchanged. Our PT includes a 13% dilution at
Rs90/share. Our PT implies 1.5x FY15E P/B and 10.8x P/E.
Risks to Rating and Price Target
(1) A slowdown in capitalization and equity dilution.
(2) The possibility of reversion to 14% RoE vs. 15.5% applicable currently for
transmission is a remote risk, in our view.
(3) PGCIL has won three competitively bid central sector transmission projects,
arguably the bid annuity to project cost ratio appears aggressive. However,
aggregate project cost of these three is just Rs48bn, not even 0.5% of funds
already deployed in regulated return projects. It is still too early to judge;
risk to profitability, in our assessment.
(4) SEB health is a structural sector risk, but relatively much lower for PGCIL.
Its near monopoly status in long distance high voltage power transmission
and the service forming low percentage of overall cost of electricity
supports greater discipline in payments to PGCIL by SEBs.
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