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On average, for every rupee of shareholder funds invested in the business, Power Grid generates 35-40 paisa in operating cash flow on a standalone basis. And, since returns are largely regulated, the return on net worth, both standalone and consolidated, have hovered around 14 per cent, providing downside support.
But, given the asset-heavy business model, it is also necessary to continuously invest in the business to sustain growth. In recent years, the capital expenditure (capex) needs though have grown at a fast pace to cater to the needs of the power generation industry, and much ahead of the retained profits (after dividends to shareholders) that get added to shareholder funds.
As a result, it becomes necessary to raise fresh equity to bridge the gap.
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Including its initial public offering (IPO) in 2007, the company has raised funds through fresh equity twice. Not surprisingly, it is again (for the third time) planning to raise equity funds through a follow-on offer (FPO) expected later this month.
It is this equity dilution, and despite the fact that net profit is expected to grow at a compounded annual rate (CAGR) of 17 per cent during FY13 and FY15, the earnings per share (EPS) will grow nine per cent CAGR.
One argument is the company could cut dividends in lieu of the frequent dilution. But that option seems less acceptable, given the government’s dividend pay-out policy for public sector undertakings. An official recently told Business Standard that being a public sector unit, the company needed to provide adequate dividends. The company has maintained a pay-out (dividend as a percentage of net profit) ratio of 31-34 per cent in the last five years. Over FY13-15, it is expected to pay dividends worth Rs 4,500 crore (assuming this ratio is maintained), which is close to the planned FPO amount of Rs 5,200-Rs 5,400 crore, based on a marginal discount to current price.
On the other hand, assuming if the profits are invested, or at least a significant part of it, in capex instead of paying dividends, shareholders would potentially lose dividend income of Rs 9 a share over three years. However, EPS would stand increased to Rs 11 in FY15 against Rs 9.8 estimated currently post-expected FPO (13 per cent equity dilution). Due to the fear of equity dilutions, analysts say the market is giving the stock a PE (price to earnings) multiple of 10 times, which otherwise would have been 12 times. As a result, the stock could have been valued at Rs 132 as against Rs 96 currently, more than offsetting the loss due to dividends.
The stock’s performance in the last four years provides some proof. Despite profits more than doubling, Power Grid’s share price has been in the Rs 85-120 band. Frequent equity fund raising not only restricts earnings growth (versus profits) but also increases supply of paper in the counter.
“In the FPO, Power Grid is issuing 13 per cent fresh equity and divesting four per cent of existing shares. We are building in 13 per cent dilution in our numbers. The government is keen to push the disinvestment program and Power Grid seems an easy target,” said Inderjeetsingh Bhatia who tracks the company at Macquarie Capital Securities in a note.
And it doesn’t end here.
“We believe PGCIL may need to raise additional equity over next three years, which will be a long-term overhang on the stock,” says Bhavin Vithlani who tracks the company at Axis Capital.
“Our calculations suggest that even after the current FPO, there would be a funding gap of Rs 3,200 crore in FY16. Hence, Power Grid would have to again raise equity in FY17, unless it decides to constrain its capex. This overhang could limit the stock upside,” says Vithlani.
