Power Sector: Light at the end of the tunnel

Returns ratios of JSW Energy and NTPC to improve in FY16, as power demand picks up

The Street is gradually turning positive on the power sector. Several factors have come together to make the environment conducive for power companies. Lower coal prices, revival in power demand, easing transmission hurdles and possible improvement in the financials of distribution companies would give a fillip to power generators. Power stocks have been battered over the past three years, though the Sensex has been steadily rising. Now, there are murmurings the sector could come out of the woods, as some of the issues are getting resolved.

Coal shortage has been the sector’s bane for several years, as Coal India could not produce enough to feed  power plants. Imported coal wreaked havoc with the financials of generators. The share of imported coal in the fuel basket rose from three per cent in FY08 to 10 per cent in FY13 and on a higher base. Coal prices also shot through the roof in this period. Coal imports rose from Rs 3,200 crore in FY08 to Rs 17,200 crore in FY13, say analysts. However, with the government committing to producing one billion tonnes of coal by FY20 and global coal prices falling 25 per cent, the input cost of most producers will come down. Falling coal prices will even make those power plants viable, which are fired by imports, as lower coal costs would lead to savings of 50 paise per unit of power. According to Motilal Oswal, total savings on units generated (on project with pass-through benefit) due to imported coal could be Rs 7,900 crore or 16 per cent of FY13 cash losses.

Though the market does not expect Coal India to achieve the target of one billion tonne production, even if it produces higher than current levels, generators such as NTPC would benefit, as the plant load factor of its units would improve. UBS prefers utilities with high return on equity (profile) and growth visibility but without the need to change regulations. Tata Power’s compensatory rate rise and changes in NTPC’s regulated returns are overhangs in such a case. However, Religare Institutional Equities believes bonus debentures and a few proposed acquisitions would help shore NTPC’s return ratios.

Analysts are also bullish on JSW Energy, as it is the least levered utility and its 3.14 gigawatt thermal power portfolio is generating power. UBS expects it to generate free cash flow of Rs 2,300 crore in FY16. Also, the acquisition of JP Power Venture’s assets will be earnings-accretive from next year. JSW Energy has risen 119 per cent over the past year.