NTPC, Power Grid: Kotak cautions against overvaluation, sees them neither value, not growth

Shares of state-run blue-chip companies including NPTC Ltd and Power Grid Corporation of India Ltd (Power Grid) have remained on the radar of investors as both the counters have delivered multibagger returns of the investors. However, the domestic brokerage firm Kotak Institutional Equities see neither of them as growth or value stocks.
 

"We see NTPC and Power Grid as two great examples of the narrative nature of the Indian market and use of wrong valuation methodologies to justify narratives," said Kotak. "The market is super bullish on the electricity sector narrative, but overlooking that these companies’ earnings are linked to stock of assets, which will grow slowly and valuations are super expensive."
 

The domestic brokerage does not agree with the way investors are valuing NTPC and Power Grid stocks, even as it agrees with the view of new capacity creation in the power sector. Their earnings growth depends on the growth in the stock of assets, unlike ‘flow’ stocks, where earnings growth depends on growth in revenues and profitability, it said.
 

"We are keeping aside other relevant issues of questionable terminal value of NTPC’s thermal assets and gradual shift in their business models to competitive low-RoE versus the current assured high-RoE businesses," Kotak added. "We expect fairly muted earnings growth of NTPC and Power Grid."
 

Shares of NTPC were trading on a muted note at Rs 376 on Thursday, commanding a total market capitalization of close to Rs 3.65 lakh crore for the day. The stock has gained about 105 per cent from its 52-week lows at Rs 183.50. The stock has turned its value nearly five times from its Covid-19 lows.
 

Similarly, Power Grid shares inched up slightly at Rs 328.15 during the session, with its market capitalization hitting Rs 3.05 lakh crore mark. The stock has zoomed about 85 per cent from its 52-week lows at Rs 177.60. The stock has quadrupled its value from its covid-19 lows so far.
 

Their earnings growth is linked to the growth in their regulated equity base, which will depend on the addition of new assets and their asset base will grow slowly over the next few years; for gross block, new assets capitalization and regulated equity base for the past few years and FY2024-26E, Kotak said. "It is obvious that capitalization of new assets cannot be very high relative to the total stock of assets."
 

Kotak has pegged the fair values of NTPC and Power Grid are a lot lower than their current market prices. Currently, NTPC is valued at 16 times and Power Grid at 18 times at their FY25E EPS, which may look optically cheap relative to the market or other capital goods stocks and electricity plays.
 

The brokerage argues that the multiples are not low in the context of low growth in earnings, as discussed above and limited terminal value in the case of NTPC for most of its current asset base. In fact, valuations are quite stiff in the context of price-to-book value P/B as NTPC trades at 2 times FY25E BV and Power Grid at 3.2 times FY5E BV, said Kotak.
 

"Adjusted P/B, removing cash and investments from market cap and using regulated equity instead of reported equity, is the most appropriate valuation methodology," it said. "We note that end-FY24 regulated equity of NTPC and Power Grid stood at Rs 89 per share and Rs 83 per share, respectively."
 

Our reverse valuation exercises show that NPTC’s stock price is discounting about 50-70 GW of new thermal capacity versus its end-FY2024 thermal capacity of 59 GW and Power Grid's stock price is discounting Rs 2.6 trillion of the additional asset base versus its end FY24. The implied assumptions are quite unrealistic, Kotak adds.