| NTPC (NTPC IN) CERC's answers to objections against new tariff regulations mar hopes of partial rollback | Overweight Price: Rs115.75 07 May 2014 Price Target: Rs138.00 PT End Date: 31 Mar 2015 | |
CERC recently issued an exhaustive ‘Statement of Objects and Reasons (SOR)’ with the intent of explaining the rationale and objectives behind FY15-19 tariff regulations. The document summarizes comments and objections expressed by stakeholders and CERC’s views to clarify their reasoning in the matter. Our impression after studying CERC’s answers to material objections by NTPC and state generation utilities is that the possibility of partial rollback on adverse changes in tariff regulations is low. The Delhi High Court had asked CERC to decide on the NTPC representation against the tariff regulations and the matter is fixed for further hearing on 19th May.
· On the issue of calorific value of coal to be considered for determining the energy charges. Generation utilities have objected to shift in the pass through payment mechanism for coal in new regulations using Gross Calorific Value (GCV) “as received” vs. GCV “as fired” earlier. The utilities argue that there is deterioration in calorific value of up to 150kcal/kg during storage before firing in boiler (~4% if “as received GCV is 3500kcal/kg). In reply, CERC cites international studies which imply that average loss in heat value over 10 days of storage in stock yard at plant would be very marginal (3kcal/kg). CERC’s contention is that the generating stations have so far provided the GCV details on “as fired” basis only and the GCV details on “as received” basis have not been provided despite clear directions in this regard. CERC states that any arbitrary practice of using GCV “as fired” for Station Heat Rate (SHR) computations without proper guidelines for determining the same would only lead to inflated claims on coal consumption. The extent of benefit NTPC has enjoyed in fuel cost recovery on this count in the past is a grey area given inadequate data, in our view. As per CERC, the slippage in “as received” GCV at plant vs. “dispatch” GCV by CIL should be sorted as per provisions in FSA and the consumers of electricity should not be burdened for this deterioration of fuel quality during transportation.
· Shift to PLF vs. PAF for incentive calculation. The new regulations specified that incentive to a generating station will be payable at Rs0.50/kWh above 85% PLF. CERC turned down the request of generation utilities to provide incentives linked to plant availability for the following reasons - (a)generating stations which have slipped in the merit order would continue to be incentivized if PAF is used. Even if the generating station is not scheduled to provide electricity, the beneficiaries would be bound to make payment of incentives in addition to payment of entire fixed cost without receiving any power; (b) it will not incentivize the generator to optimize the procurement of fuel from alternate source. CERC endorses the view that incentives should be ‘earned’ and not ‘granted’.
· Tightening of O&M fee. NTPC submitted to CERC that - (a) performance related pay (PRP) to employees should be considered while fixing the O&M norms, (b) the escalation rate to be used for escalating the O&M expenses should be based on actual WPI/CPI of last 5 years, which would yield escalation rate of 8.62% vs. 6.35% allowed, (c) O&M norms of select plants (old, gas based) should be relaxed. In response CERC observed that - (a)PRP is linked to efficient operation and high performance level of generating station and are payable only in case the plant overachieves vs. normative operational levels, and not the other way round; (b) The average increase in actual O&M expenses which are controllable was found to be ~6%; so keeping in mind the interest of the consumers, the escalation rate was kept at a discount to actual WPI/CPI over last 5 years, (c) quite a few of NTPC’s plants need manpower rationalization; these plants are running at inefficient man/MW ratios, leading to abnormal O&M cost. The commission is of the view that no relaxed norms should be allowed as ample time has been provided to these generating stations for manpower rationalization and the consumer cannot be burdened for failure on part of the generator in this regard.
· On sharing of 40% of financial gains related to controllable parameters (SHR, AUX) with Discoms. The commission is of the view that the sharing ratio needs to be specified considering the fact that operational norms have been specified in the regulations based on actual performance with some margin. In this respect, CERC has clearly shown a preference to demands of the Discoms in a bid to make the cost of electricity cheaper to the end consumer.
Investment Thesis
NTPC is India's largest power producer with an operating capacity of 42GW (incl 5.4GW owned by JV's) with an established execution track record. At current growth aspirations and after factoring in the new normal on profitability we estimate that NTPC's cash balance of USD2.8bn will keep growing beyond FY15, thus meeting its equity requirement from internal accruals. In our assessment, NTPC would still be able to manage a core RoE (on regulated project equity) of 18% on its portfolio in the new tariff regime. This combined with an EPS CAGR of ~8% post FY15 in the medium term. All this is currently available at 1.0x FY15 P/B. We maintain OW.
Valuation
We have a Mar-15 PT of Rs138, implying 1.2x FY15 P/B. Our PT includes 90% value for standalone business and remaining for JVs (Rs7/share, at 1.2x P/B for NTPC’s share and Rs49B of OTSS bonds (Rs6/share). For Rs125/share value for the standalone business we use a perpetual growth rate of 4%. PT implies ~20% upside potential.
Risks to Rating and Price Target
Key risks to our OW rating and price target include:
1. Weak ramp up of domestic coal supply by CIL and from captive coal blocks
2. Aggressive bidding for UMPPs
3. Weak execution translating into delays in capacity addition
4. Further regulatory changes by CERC that could cap incentives
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