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NBFCs/Utilities
India
Actions will speak louder than words; statement of intent is encouraging
though. The state power ministers’ conference on reforms to bring down losses in the
distribution segment has resolved to take a series of steps to bring down commercial
losses. We are encouraged by the sense of urgency shown in the statement of intent,
though we would like to see implementation, as lack of political will has so far stymied
improvement in the financial health of distribution utilities despite the existence of a
strong policy framework. Given the backdrop of recent tariff hikes, likely forward policy
on power reforms and attractive valuations, we have a positive view on REC and PFC.
We have an ADD rating for both.
Statement of intent encouraging, shows a sense of urgency across state utilities
We are encouraged by the resolve of the various state power ministers to (1) ensure automatic
pass through in tariff for any increase in fuel cost, (2) ensure payment of all outstanding dues from
various departments of state government and institutions, (3) take effective steps to reduce AT&C
losses to less than 15%, and (4) immediately initiate steps to appoint distribution franchises in
urban areas through competitive bidding, among other measures. We note that the extant policy
framework already allows for some of these measures, though lack of political will has so far
limited the benefits of a strong policy framework.
Recent spate of tariff revisions reflects a firm resolve to address financial woes
The recent spate of tariff hikes across key states such as Rajasthan, Orissa, Chhattisgarh and Bihar
are reflective of the sense of urgency on the part of the distribution utilities to address the current
state of affairs. Notably, some of these states have not had a tariff revision in the past several years.
Tamil Nadu and Rajasthan (among the largest contributors to aggregate losses) had not revised
their tariffs since FY2004 and FY2005, respectively. While in the case of Uttar Pradesh (the thirdlargest
loss-making state), the state distribution company has not filed its ‘Annual Revenue
Requirement’ for the past few years. We note that Rajasthan, Tamil Nadu and Uttar Pradesh
together contributed to ~49% of total SEB losses of Rs526 bn in FY2009.
PFC/REC/PSU Banking stocks to be beneficiaries of perceived lower risk in the sector
The statement of intent does offer a lot of comfort for power financiers, as there seems to be
some urgency to reform the power distribution segment. Further, the recent tariff hikes, which we
believe will be undertaken by almost all state utilities, should also bode well for financials. We also
read the statement of intent as a clear sign by the centre that there may be no bailout/additional
finance available from the centre unless a reform process is initiated.
In this light and given the backdrop of heightened concerns on the sector and attractive
valuations, we are positive on REC/PFC and other public banks, which had also corrected sharply
owing to their high exposure to the power sector.
Exhibit 1: Statement of intent encouraging, shows a sense of urgency across state utilities
Summary of set of measures to bring down the distribution losses
[A] Regular tariff revision keeping in view the profitability
Ensure that the accounts of the utilities are audited upto the year 2009-10 and also ensure that the accounts of a
financial year are audited by September of the next financial year, henceforth
Ensure that the distribution utilities file their Annual Tariff Revision Petition every year, by December – January of the
preceding financial year to the State Regulators as stipulated by the National Tariff policy
Tariff petition to be file keeping in view the increase of the Power purchase cost (which accounts for nearly 70-80%
of the Cost of supply) and states will ensure that the difference between ARR and ACS is not only bridged but is
positive to generate internal surpluses
Ensure automatic pass through in tariff for any increase in fuel cost by incorporating the same in the regulations
[B] Distribution franchise and self sufficiency in generation
Immediately initiate steps to appoint distribution franchises in urban areas through competitive bidding
Immediately invite bids for meeting the uncovered generation capacity gap viz- a -viz the requirement in their States
by the end of 12th Plan. The process to be completed by March, 2012
[C] Others
Eligibility criteria for inclusion of towns under R-APDRP assistance with population of 30000 (10000 for special
category states) should be reduced to 15000 (5000 for special category states).
Ensure payment of all outstanding dues from various departments of state government and institutions to the
distribution utilities or release payments from the State budget directly.
Consider converting loans due from the state governments to the distribution utilities as state government equity to
ensure capital infusion and improvement in net worth of utility
Take effective steps to reduce AT&C losses to less than 15% by administrative measures, curbing pilferage of
electricity and by setting up special police stations and special courts to deal exclusively with power theft related
cases
Create a unit in their states for integrated planning of generation, transmission and distribution to meet the future
requirement of their states
Source: Press Information Bureau, Kotak Institutional Equities
Exhibit 3: Prime reason has been the lack of willingness from Discoms to file for tariff revisions or truing up
Factors for financial losses of key states
State Reason for losses
Lack of true-up mechanism for various cost parameters of the ARR (except for power purchase cost which is passed through by way of
Fuel Surcharge Adjustment)
Disallowance of interest cost on short-term borrowings for meeting the revenue deficit of previous year and carrying cost for time lag
involved in recovery of FSA.
Disallowance of Return on Equity, as the capital employed by Discoms is estimated to be negative
Madhya Pradesh
SERC disallowed power purchase quantum of Discoms on account of high T&D loss or lower sales to unmetered agriculture category. A
part of the disallowed power purchase cost can be considered as unreasonable on the grounds that the SERC has only considered costlier
power for disapproval
There is absence of true-up mechanism in the State and the Discoms themselves have not claimed / requested for any true-up for the past
years
SERC approved measures like State Government’s support in the form of short-term loans, efficiency improvements, savings in power
purchase, which never materialized
Punjab
SERC has capped the employee cost taking into account such cost, as incurred by the utility in FY2006; and has allowed only inflationary
increases on the same
Orissa
The actual loss levels of the Discoms are higher than the approved loss levels. SERC has followed the distribution loss trajectory estimated
during the privatization process. However, this trajectory lacked proper baseline data for loss estimation.
Tariff has not been revised since FY2005 leading to widening of gap between average realization per unit and average cost per unit.
Increase in short term loans, as gap between approved and actual power purchase cost is increasing due to delay in True Up orders.
Karnataka Shortfall and delay in subsidy disbursements by the State Government is leading to financial losses of the DISCOMs.
Tariff has not been revised for the past seven years. The accumulated revenue deficit up to FY2009 was Rs167.7 bn (as per unaudited
accounts).
Free electricity for agriculture consumers. The subsidy required to support agricultural consumption was Rs58.3 bn in FY2010 against
which only Rs2.7 bn has been released by the State Government.
Haryana
Uttar Pradesh
Rajasthan
Tamil Nadu
Source: Forum of Regulators, Kotak Institutional Equities
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