Torrent Power: Large operational gains ahead

While the GERC order allowing for underrecoveries will boost profits; when gas availability improves, it will lead to higher returns

Recovery of dues (relating to tariff differential) and hopes of higher gas availability have led to renewed interest of investors in Torrent Power as the market believes that these developments will have positive impact on the company's earnings. Also, lower valuations make the risk-reward equation favourable. At the current market price of Rs 122, the stock is trading at 6.4 times its estimated FY15 earnings.

The book value of Torrent’s existing projects alone is about Rs 80 a share. Considering the regulated business with 18 per cent core return on equity (RoE), even if a 1.2-1.5 times price to book value is assigned, the value of these assets works out to around Rs 96-120 a share; the upper band is equal to the current market price.

“In this entire valuations game, the moving part is gas-based plants. Its two gas-based plants of about 1,600 Mw where the company has invested about Rs 2,400-2,500 crore alone on a conservative basis have a book value of Rs 50 a share. Individuals might be completely writing off that, but those who are willing to take a view on gas availability (increasing) there is a fair chance of valuation re-rating,” said Devam Modi, who is tracking the company at Equirus Capital.

The biggest support has come from the recent order of the Gujarat Electricity Regulatory Commission (GERC). The order has allowed the company to implement tariff increase, which means there would not be any underrecoveries in the coming months. This will provide a big boost to Torrent’s financials, because in FY13, the company booked underrecoveries of about Rs 680 crore. This is almost equal to current years’ expected net profit of the company, thus a reason for the market to expect a surge in earnings in the coming quarters. In the first half also, the company has booked underrecoveries of about Rs 375 crore. With this development, in second half the underrecoveries will be less and in FY15 almost zero.

That apart, the market is also building in hopes that gas availability will increase as they believe that output at Reliance Industries’ KG basin would rise from 2014 onwards after gas price hikes and further investments into the block. Besides, the hike in gas price for the producers will only encourage higher production in the long run.

Torrent Power has total operational power generation capacity of 1,698 Mw, out of which about 1,250 Mw is fuelled by gas and 400 Mw by coal. Currently, its 1,148 Mw gas-based power plant, Sugen, is operating at just about 25 per cent plant load factor (PLF) as against the coal-based power plants which are operating at around 75 per cent PLF. Lack of domestic gas availability has hit its existing plants as well as raised questions over its upcoming gas based plants to the tune of 1,570 Mw.

Torrent is also present in the power distribution and transmission business segment, making it an integrated player. The distribution business sources power from the generation business for sale in cities like Ahmedabad, Gandhinagar and Surat besides Bhiwandi in Maharashtra and Agra in Uttar Pradesh. High efficiencies and very low T&D losses have helped the company.

However, lack of gas has seen the company source power from the market, leading to higher costs in the recent quarters. Together with under recoveries, it has impacted the company’s performance. It reported net loss of about Rs 37 crore in the first half of FY14. However, after the new GERC order, analysts are expecting the company to return to profits from third quarter onwards.

Further gains will come when gas availability improves. Should things pan out along expectations, the power sector which is second on the priority sector list after fertiliser, will see priority allocation to gas-based power generation assets that operate on regulated returns, believe analysts. And thus, the company, which has portfolio of regulated power assets, should stand to gain in the form of higher output and profits as well as better visibility for its upcoming projects. However, the market is still reading these developments carefully considering that if the environment does not improve as expected, these capacities will weigh on the company’s performance.