NTPC: Valuations cheap but return on equity at risk...

...despite the fuel supply pacts signed with Coal India

Shares of NTPC have fallen four per cent over the past fortnight, but it isn't a conviction 'buy'. Even though the stock trades at 1.2 times its FY15 book value, which is considered to be attractive, analysts believe the company's return on equity continues to face a downside risk. In the June quarter, the company has reported a return on equity (RoE) of 5.5 per cent. The poor availability of coal has cast a shadow on NTPC's performance, despite the fuel supply agreements it has signed recently.

During the first quarter of FY14, the firm's power generation declined 3.2 per cent, year-on-year (y-o-y) , to 57,007 GW on lower capacity available on tight coal supplies from Coal India. Although NTPC has not conveyed why its generation revenues fell three per cent, analysts believe it's largely due to low power offtake and lower plant availability at 84 per cent during the quarter due to coal shortage. NTPC's profitability is driven by how much of its capacity is available for generation. During the first quarter, its plant capacity was below 85 per cent on fuel supply issues, which has impacted generation revenues. According to Angel Broking, new capacity adds and clarity on coal supply would be key triggers for the stock.

Due to lower capacity utilisation during the quarter, the regulated power producer did not need to use imported coal at all. This is apparent from the fall in the fuel cost during the quarter. Fuel cost as a percentage of sales fell 11 per cent annually and 9.3 per cent sequentially. Lower fuel cost and revenues indicate that no imported coal was used, which helped shore up operating margins by 475 basis points, y-o-y, 27.3 per cent in the June quarter.

Undoubtedly, the 16 fuel supply agreements that (FSAs) NTPC signed with Coal India over the last few weeks indicate that coal supply could improve, but other risks to the company's RoE also exist. Given that another 11 FSAs are signed with Coal India, the risk of coal supply may abate somewhat. However, some other regulatory gaps may be plugged, which would impact NTPC's RoE. For one, the company can no longer sell surplus power under the unscheduled interchange segment. Prior to last year's grid collapse, NTPC could sell surplus power at higher rates, but now regulations mandate producers to sell only through the power exchanges to prevent grid congestion. Emkay Global believes that while the downside to the stock from the current price levels looks limited, it sees no major upside either.