NTPC-Upgrade to ADD on reasonable valuations: Kotak Sec

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NTPC (NATP)
Utilities
Upgrade to ADD on reasonable valuations. We upgrade NTPC to ADD based on
(1) recent underperformance providing 11% upside to our target price of Rs195/share,
and (2) reasonable valuations as NTPC trades at 1.9X P/B and 15X on FY2012E
earnings. Our revised earnings and target price factor in delayed capacity addition and
we now factor incremental capacity addition of 6.4 GW by FY2012E. Delay in
commissioning of capacities remains the key risk to our estimates.




Valuations at lower end of historical band, upgrade to ADD
We upgrade NTPC to ADD as we believe that recent price correction offers an attractive entry
point into the stock. NTPC is currently trading at 1.9X FY2012E book value and 15X FY2012E
earnings which is at the lower end of the historical band for NTPC (see Exhibits 1 and 2). Although,
NTPC’s valuations are at a premium to the regional utilities (1.4X book value and 12.5X earnings),
we highlight that NTPC has traditionally commanded a premium compared to regional peers due
to (1) superior return profile compared to regional peers, and (2) premium for growth as NTPC
envisages ~38 GW (40 GW previously) of capacity by FY2012E. Our revised target price of
Rs195/share offers an upside of 11% from current levels.

Earnings growth to be strong though execution will be the key
NTPC’s revenues and PAT will grow at a CAGR of 13.5% and 9.4%, respectively, on the back of
incremental capacity addition of 12 GW in the next three years. Exhibit 3 highlights the year wise
capacity addition target of NTPC. Although we see some slippages in execution which could likely
delay the capacity addition target of 12 GW by FY2013E, we highlight that the entire portfolio of
NTPC is already under construction and significant capex has already been incurred for most of
these projects.

Fuel security—relatively better placed than peers
We believe that NTPC is relatively better placed than most of its Indian peers in terms of fuel
security. As both coal and gas continue to become dearer on account of robust demand and
constrained domestic supply, fuel security, both in terms of pricing and availability will likely
become the focal point for generation companies in near future. The sale of power on a cost-plus
basis mitigates the pricing risk, however, the presence of captive coal blocks with geological
reserves of 5.7 bn tons mitigates to an extent fuel availability risk. We note that NTPC has entered
into formal coal supply agreement with an annual quantity of 98.7 mtpa (as opposed to linkages)
for all of its extant capacities, barring Kahalgaon and Farakka.


Key changes in earnings model
We revise our EPS estimates to Rs10.4 (Rs12.5 previously) in FY2011E and Rs12 (Rs14.7
previously) in FY2012E to factor (1) delay in commissioning of capacities, (2) grossing up of
post-tax RoE at MAT rate, and (3) higher cost of fuel as reflected in the interim results
reported.

􀁠 Impact of MAT-based reimbursement. Our revised earnings estimates now factor
grossing-up of RoEs on MAT rate versus marginal tax rate previously, as large-scale
commissioning of capacities.

􀁠 Delay in commissioning of capacities. We now factor commissioning of 2.6 GW (4.3
GW previously) of capacities in FY2011 and 3.8 GW (4.4 GW previously) capacity in
FY2012 versus management guidance of 4.1 GW in FY2011E.


Investments in coal assets – enhancing fuel security
NTPC has a portfolio of eight coal mining blocks with geological reserves of 5.7 bn tons, of
which two coal blocks with reserves of 2 bn tons are being developed under a joint venture
with Coal India Ltd (CIL). NTPC has entered into coal mining to ensure better control, greater
reliability and lower cost of its coal supply. We highlight the broad status of development of
these mines:
􀁠 For Pakri Barwadih, Kerandari and Chatti Bariatu, NTPC is in advance stages of land
acquisition. Environmental clearances have been received for these mines and production
is expected to commence by FY2012
􀁠 Management has guided for production of 15 mtpa by FY2012 from Pakri Barwadih
􀁠 NTPC plans to attain a peak production of 47 mtpa by FY2017E from all these mines
Our earnings estimates and valuation do not include any value for the coal mines, most of
which are currently in the development stage. Exhibit 4 highlights the details of coal mining
blocks allocated to NTPC and status of their development.

Secure business model, now at reasonable valuations
NTPC sells its entire capacity under the regulated regime which assures a post-tax ROE of
15.5% on the invested equity. Along with the assured ROE component, NTPC, being a coalbased
generator, is able to accrue an additional 4-5% return on invested equity from costsavings
on fuel cost. However, we note that the ongoing expansion phase of NTPC masks
the true return profile of the company with a large amount of investment in non-return
yielding CWIP and the burden of low-income yielding tax-free bonds.
We highlight that as projects come on stream there will be a shift of funds from capital work
in progress and investments into productive earnings yielding operational equity which
would drive the balance sheet ROE from current levels of 14% (FY2010) to 18% in FY2015E.