NTPC, Power Grid charged up with demand picking up, decent valuations

Rebound in power demand, reducing concerns over receivables, and decent valuations among multiple headwinds

Shares of power utilities, such as Power Grid and NTPC, have rebounded 18-28 per cent from their March lows. The improving power sector scenario suggests there is more steam left in these stocks.

While the easing of the nationwide lockdown bodes well for power demand, the government's stimulus package and the proposed power reforms augur well for recovery of bills due from electricity distribution companies (discoms). The two companies have significant exposure to regulated businesses (over 90 per cent of revenue). NTPC and Power Grid, both earn a fixed return (15.5 per cent) on the capital (equity) employed in these businesses, irrespective of demand and flow of power.

The returns are determined by the central electricity regulator; the portion of funds that earns this fixed return is called regulated equity.
 

Some operational parameters, too, influence their earnings. Against this backdrop and excluding some temporary collection issues, analysts at HSBC see little risk to their earnings. Other analysts say these to firms' earnings are relatively insulated compared to private power sector peers. After dipping during the lockdown period, power demand is now rebounding well. Analysts' channel checks show a recovery in industrial demand, led by Uttar Pradesh, Rajasthan, and Tamil Nadu. Industrial customers from the cement, metals, and some other sectors are getting back to business and have reached about 67 per cent of the pre-Covid-19 volumes, estimate analysts.

 

All this bodes well for the health of discoms and, in turn, reduces concerns on fixed-cost recovery of the two state-owned companies. It also improves the growth prospects with respect to regulated equity. Typically, when demand is impacted, clients (discoms) start requesting to delay project commercialisation. So, the demand concern getting addressed is positive for earnings growth and return ratios.
 

Analysts at CLSA expect a 237 basis point rise in NTPC's return-on-equity during FY20-23, led by regulated equity growth of 43 per cent as the country's largest power generator commercialises 11.3 Gw of capacity over the three-year period. Further, a rebound in peak demand to the pre-Covid-19 level of 164 Gw should help thermal power absorption and raise plant load factors (PLF), say analysts. Transmission of power, too, will return to normal levels, improving capacity utilisation of Power Grid.
 

With improved coal availability in the country, the plant availability factor (PAF) at NTPC’s critical plants (such as Sipat, Korba and Talcher, which were affected by the coal supply disruption in the previous year) has recovered, say analysts at Motilal Oswal Financial Services. The analysts say that the PAF at these critical plants stands at more than 90 per cent for June, and well above the 85 per cent levels seen in the past. This should bode well for NTPC, which has been facing concerns over the PAF and under-recoveries for its plants. The government’s stimulus by way of loans to state discoms means that dues receivable by the power utilities should reduce, easing pressure on their working capital. Concerns over under-recovery of fixed cost, too, have eased with the improving demand, points out Rupesh Sankhe at Elara Capital, who sees improved liquidity, cheap valuations, and good dividend yield as other factors that can drive upside in the stocks.
 

Analysts also see a limited impact of the power ministry’s directive indicating that NTPC will give 20-25 per cent rebate on fixed charges to customers, for the nationwide lockdown period. Analysts at Jefferies have reduced their FY20-21 EPS by 2-9 per cent to reflect the 25 per cent rebate and adjusted the dividend. They, however, believe valuations will not de-rate as the ministry has harped on this being one-time in nature. Further, the regulated equity has remained untouched and this is an important signal.
 

Anuj Upadhyay at Emkay Research shares a similar view and says he continues to prefer regulated-return earning entities like NTPC and Power Grid because of their attractive valuations.
 

Experts say the business model of these entities remains intact as the government has maintained the tariff structures and return-on-equity will continue to be determined on a capacity availability basis. So, the impact of the lockdown will be limited.

For Power Grid, analysts say the current project execution gives enough visibility for Rs 12,000-15,000 crore annual capitalisation for the next two-three years.
 

Moreover, both Power Grid and NTPC stocks provide a high 6-7 per cent dividend yield, a tad over 10-year government bonds, which is another positive. All this, in a falling interest rate scenario, makes these companies a good investment bet.