BHEL, NTPC shares: Kotak says stock market’s excitement puzzling, sees up to 72% downside

Kotak Institutional Equities in its latest note on electricity sector said the market seems more interested in short-term supply-demand imbalance and related demand for thermal electricity and is ignoring the growing existential threat to businesses. The domestic brokerage said global glut in solar modules and collapse in solar module prices may result in ultra-cheap solar electricity for an extended period of time. But stock investors are unfazed.

BHEL shares are up 234 per cent in the past one year while those of NTPC have climbed 108 per cent during the same period. "We are puzzled by the market’s (1) excitement about short-term developments and events (new thermal capacity creation etc.), which will not add any meaningful value to companies in the electricity chain and (2) complete lack of concern about developments that threaten the business models and raise serious concerns about the terminal value of the companies," it said.

The brokerage gave an example of prevailing market capitalisations of BHEL Ltd and NTPC Ltd, which imply large terminal value, which Kotak says is quite questionable.

Kotak said thermal electricity tariffs have been significantly above solar power tariffs in recent years and in fact, solar tariffs are similar to NTPC’s fuel costs. It expects thermal electricity tariffs to increase further as coal costs will likely increase further without any intervention from the government.

Kotak said coal prices have seen steady increases to absorb rising cost of production, which has resulted in continued high profitability and returns for Coal India. NTPC’s new thermal electricity generation capacity will have higher tariffs given the guaranteed 15.5 per cent return (plus incentives) on higher capex/unit, it said.

The brokerage has a ‘Sell’ rating on PSU BHEL with a fair value target of Rs 70, which suggests a 72 per cent potential downside over the prevailing BHEL stock price of Rs 252.40. It also has a 'Sell' rating on NTPC with a fair value target of Rs 270, which suggests 22 per cent downside over the prevailing stock price of Rs 347.65.