NHPC divestment: An uphill task

Project delays, cost overrun and absence of new capacity addition are key concerns in the near term

NHPC's divestment might not be easy, considering the size of the stake sale, the market's appetite for hydro-power projects and the company's poor track record, which shows it has under-delivered both on operating performance and return fronts.

The government plans to divest 11 per cent stake, which would fetch Rs 2,900 crore at current price levels. NHPC has been a victim of the systemic problems of the power sector, particularly those related to environment clearances. Many of its projects faced significant delays and cost overrun, eroding returns. In fact, It has been seeking permissions from ministries to capitalise such huge cost overrun, which, if accepted, will be positive. Because of these issues, a large amount of money is stuck in projects that are under development. In FY14, NHPC reported capital work-in-progress of Rs 16,097 crore, which was 26 per cent of its gross assets. NHPC's current operational power generation capacity is 4,987 Mw.

The total regulated equity (which is entitled to regulated return or return on equity - RoE) of these projects is estimated at Rs 9,800 crore or 31 per cent of NHPC's total equity (net worth) of Rs 31,700 crore. As a result, the company is earning a blended RoE of only 7.8 per cent, which is expected to continue for some more years. "NHPC has not started construction of any new project in the past five years. After commissioning of 130 Mw in FY15, the management expects next capacity addition only in FY17/18 when Kishanganga (330 Mw) and Parbati-II (800 Mw) will be commissioned," said Bhavin Vithlani of Axis Capital.

These concerns will have a bearing on valuations and demand for its shares at higher prices. At the current price of Rs 25.75, the stock is trading at one time its estimated FY15 book value, which is still expensive considering the expected RoE and earnings growth of eight-nine per cent and five per cent, respectively, over the next two years.

"We maintain our underperform rating as 47 per cent of fixed assets remain stuck in work-in-progress due to delays in 2,800 Mw projects, which caps RoE at eight-nine per cent until FY18E", said Jonas Bhutta, who tracks the company at Bank of America- Merrill Lynch, in a note. Second, there is a risk of further charges in the fourth quarter of FY15 if construction does not resume in lower the Subansiri project and the stock is a potential value trap at 0.9 times FY15 estimated price to book value for a company with poor execution track record, adds Bhutta.

In the fourth quarter of FY14, NHPC reported for the first time losses of Rs 707.4 crore, largely on account of Rs 1,270 of non-recurring expenses due to delay in construction at some of its projects. If NHPC is not allowed to capitalise the expenses, it will erode earnings from existing projects. In this light, although the divestment will not impact earnings, it could put the stock under pressure.