What to bet on in power sector?

While a lot has happened in the power sector in the last two years, stock price movements seem to suggest a different story.

After riding the Modi wave that began in late 2013, most power stocks lost momentum in 2015. Today, most stocks have ended much lower than where they were when the rally began. What explains this? One, many stocks have been bogged down by company specific issues such as low tariffs and high debt levels. Two, while the reform process has been initiated, it is still too soon for the impact to be felt in a big way. Many initiatives such as UDAY, improving the power transmission infrastructure and ensuring better coal utilisation will take time to make a visible difference.

As that happens, the benefit should percolate down to the companies too. Here’s taking a look at the some of the better placed players in the sector.

Assured returns Power Grid Corporation of India (Power Grid), which has near-monopoly over the country’s inter-state and inter-regional power transmission network, is one such company. It should benefit from the government’s focus on bolstering the country’s transmission infrastructure. While the transmission segment was opened to the private sector in 2011, many large transmission projects, due to reasons of complexity and/or the need for speedy completion, continue to be assigned to Power Grid outside the bidding mechanism. That transmission charges set by the Central Electricity Regulatory Commission (CERC) enable Power Grid to fully recover costs and earn 15.5 per cent return on equity (ROE) on its commissioned projects, provides revenue certainty. For the year ended March 2016, Power Grid reported 21 per cent and 19 per cent growth in revenue and profit respectively.  At ₹150, the stock trades at 1.8 times its 2015-16 book value, lower than its five-year average historical valuation of 2.2 times.

 NTPC too earns assured returns on its power sales. While a change in regulations, last year - grossing up the ROE based on the actual tax rate (and not the higher corporate tax rate) and generation-linked incentives - has impacted earnings, NTPC still enjoys tariffs that provide it a complete pass-through of costs plus an assured pre-tax ROE of 15.5 per cent. An assured fuel supply and a healthy balance sheet (debt-to-equity ratio of 1.2 times as of March 2016) are the other positives. Weak power demand from the discoms has however impacted the company. This is reflected in the poor growth in power generation and the falling plant load factor in recent years. A strong growth in power demand should benefit the company. At ₹148, the stock trades at 12 times its consolidated 2015-16 earnings, the same as its five year average historical valuation.

For Tata Power, the recent favourable tariff order by APTEL asking CERC to decide on the compensatory tariff for the company’s Mundra plant, is the single biggest positive. This will help stem the company’s fuel under-recovery (both past and ongoing) at the plant and boost earnings.

In 2015-16, helped by higher sales by its subsidiaries and lower coal costs, the company posted revenue and profit growth of 6 per cent and 43 per cent respectively. At ₹74, the stock trades at 1.4 times its 2015-16 book value, lower than its five-year average historical valuation of 1.7 times.

Fuel boost Torrent Power, a power generation, transmission and distribution company, operates over 80 per cent of its capacity on gas.

With the fall in domestic gas production, the company’s plants were starved of fuel. In 2015-16, the allocation of subsidised auctioned gas came to the company’s rescue. With the steep fall in international gas prices, Torrent Power plans to import LNG to run its plants. At ₹178, the stock trades at 1.1 times its 2015-16 book value, lower than its five-year average historical valuation of 1.3 times.

COMMENT NOW