How Power Grid eroding its investors' wealth

With frequent dilutions and dividends to govt, investors on loosing end

On an average for every rupee invested in the business, Power Grid makes around 54 paisa in operating cash flow. Considering its asset heavy business model the company have to keep on investing in the business for higher growth.

Importantly when the internal rate of cash generation does not meet the required capex in the business the company have to raise equity to bridge the gap. No wonder including its IPO in 2007, the company again for the third time planning to raise equity funds through its follow on offer (FPO) expected in this month.

This is also a reason that because of fear of equity dilution for quite some time, despite the fact that net profit is expected to move up at about 17% annually during 2013 and 2015, but earnings per share will grow merely by 9% annually after taking the effect of fresh issue of shares planned in its upcoming FPO.

One logical argument against the frequent dilution could be to cut the dividends, however that option too seems to be less acceptable given the government holdings in the company. Over the year 2013-15, the company is expected to pay dividends of worth Rs 7,325 crore, which is more than its planned FPO of Rs 5400-6000 crore in this month.

Assuming if the company uses dividend money, investors would lose possible total dividend of Rs 10.3, but earnings per share would be Rs 11 per share in FY15. Today because of the fear of dilution the market is giving it a 10 time price to earnings multiple, if there is no fear of dilution, even at 12 times its shares will be valued at Rs 132 as against the current ruling price of Rs 95.5 per share. Investors in this case could have made far better returns than by way of dividends.

No wonder in last four years despite profits have more than doubled share price have been flat and hovering around Rs 100 a share. One drawback of frequent equity fund raising has been a pressure on share prices because of the fear of both dilution and lower prices.

"We believe PGCIL may need to raise additional equity over next 3 years, which will be a long term overhang on the stock" Bhavin Vithlani who tracks the company at Axis Capital

The planned FPO would be no different at current market price the company will have to dilute about 13% of its earnings, which already had its impact on share prices. Earlier the company was expected to report earnings per share of Rs 11 per share in FY15, now after taking into account the increase in number of shares the company is expected to see a cut in earning per share to Rs 9.6 per share.

"In the FPO, Power Grid is issuing 13% fresh equity and divesting 4% of existing shares. We are building in 13% dilution in our numbers. The government stake currently stands at 69.4% and will be diluted to 57.9%. Government is keen to push the disinvestment program and Power Grid seems to be an easy target," said Inderjeetsingh Bhatia who tracks the company at Macquarie Capital Securities in a note. Importantly the Street also fears that there could be more dilution in the coming years.

"Our calculations suggest that the even after current FPO, there would be funding gap of Rs 3,200 crore in FY16. Hence, Power Grid would have to again raise equity in FY17, unless it decides to constrain its capex. This overhang could limit the stock upside" says Bhavin Vithlani.