Power: Muted profitability

Trend of strong revenue growth and low profitability witnessed in the September 2010 quarter will continue.

The Indian power sector is expected to witness yet another disappointing quarter. Analysts expect operating profits of the nine power producing companies to decline marginally by around 1.5 per cent year-on-year to Rs 6,086 crore, as higher fuel costs (up about 35 per cent) and weak merchant rates (down by 35 per cent) are likely to be compensated by high volumes and capacity additions. But, net profit is expected to drop around 19.5 per cent to Rs 2,938 crore, courtesy higher interest and depreciation expenses.

However, revenue growth will continue to remain strong on capacity addition and high demand due to a pick-up in overall economic activity after the monsoon. Aggregate sales of companies are expected to jump 18.3 per cent to Rs 22,370 crore.

India’s largest power producer, National Thermal Power Corporation, is expected to drive the overall performance of the sector, with a sales growth of 21 per cent at Rs 13,540 crore, a marginal fall in operating profit (to Rs 3,340.5 crore) and a decline of 13 per cent in net profit (to Rs 2,055 crore). CESC is likely to post the best overall performance, while diversified players like GMR, GVK and Lanco are expected to report mixed numbers.

The outlook for the sector continues to be cautious, despite an accelerated pace of capacity addition expected in the final year of the Eleventh Plan (2011-12), as execution challenges plague the industry’s growth prospects. Apart from the already softening merchant rates, an uptrend in coal prices and high dependence on imported coal will affect profitability. Aggressive coal mine acquisitions at expensive valuations may also hit companies’ balance sheets.

Stocks have corrected substantially to discount the above concerns and look reasonable at an average valuation of 16 times the 2011-12 estimated earnings. But, analysts prefer to be stock-specific. They like NTPC, CESC and Tata Power, as they operate predominantly under a regulated regime and provide relatively better fuel security.