Energetic Stocks

Rahul Oberoi/Money Today        Print Edition: December 2011

Power was one sector where you thought you could not go wrong. After all, demand was assured in a country that is desperately short of power. Or so you thought.

Things have not turned out that way. Shares of power generation companies, power equipment makers and power distribution companies have been on a free fall since the start of 2011.

During the first 10 months of the calendar year 2011 till October 31, 2011, NTPC, Bharat Heavy Electricals Ltd (BHEL) and Tata Power have fallen 11 per cent to Rs 179, 32 per cent to Rs 317 and 27 per cent to Rs 100, respectively.

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The Bombay Stock Exchange (BSE) power index has fallen 26 per cent, or 783 points, to 2,205 during the period. Power equipment makers such as BHEL, ABB, Crompton Greaves, Siemens and Thermax have close to 30 per cent weight in the BSE Power index.

SLOWDOWN BLUES

There are many reasons for the slump. Market experts point out rising losses and debt of power distribution companies and shortage of fuel. Another reason is stringent pricing rules which make it difficult for power generators to pass on costs to consumers.

Power firms face investment deficit

"Engineering companies have been hit by a fall in orders, high interest costs and competition from Chinese companies. Power producers have been affected by outstanding dues from state electricity boards, high interest rates, coal shortage and a fall in merchant power tariff," says Rikesh Parikh, vice president, markets strategy and product development, equities, Motilal Oswal Securities. Merchant power plants compete for tariffs and absorb the full market risk.


Rs 3 lakh crore was the cumulative debt of state power utilities, including distribution entities, at the end of March 2011.


"A confluence of factors has had a negative impact on the sector. Power generation companies have been hit by fuel supply constraints, high fuel prices and delays in commissioning of projects. The medium-to long-term prospects of reliable coal supply are under doubt. The power equipment manufacturing space is facing a slowdown in capacity addition, competition from local and international players and a rise in commodity prices," says Ashutosh Bishnoi, acting chief executive officer, L&T Mutual Fund.

MAJOR ISSUES

Shortage of coal is one of the biggest concerns as 66 per cent power in India is produced from the fuel. During the first half of financial year 2011-12, production at Coal India, the world's largest coal producer, fell 3.3 per cent year-on-year.

The company aims to dispatch 454 million tonnes coal in 2011-12. According to CLSA, it needs to dispatch another 254 million tonnes, 13 per cent more than in the same period last year, in the second half of the financial year, which looks difficult. With another 14,000 MW capacity based on domestic coal expected to be commissioned over the next 12 months, the problem of coal shortage is likely to aggravate.

How the power companies fare


According to a research report by CRISIL, losses in the distribution segment doubled to Rs 35,000-40,000 crore between 2008-09 and 2010-11. Due to funding of losses from debt, the cumulative debt of state power utilities, including distribution entities, was Rs 3 lakh crore at the end of March 2011.

Fuel unavailability and pricing can hit almost one-third of the 56,000 MW thermal power capacity that is being built.

However, Arvind Prasad, managing director, Ushdev Power Holdings, a producer of renewable energy, is hopeful. "Issues such as uncertainty over coal and gas availability for power plants are short-term pressures. The way the industry is progressing, they should get resolved shortly," he says.

DEBT TROUBLE

The government has formed a committee under former comptroller and auditor general VK Shunglu to suggest power distribution reforms. The committee's draft report has pegged the losses of distribution utilities at Rs 1 lakh crore.

To protect power finance companies, lenders have started restricting loans to fund state utilities' losses. The health of lenders to the power sector is under scrutiny. The lenders - including banks, Power Finance Corporation and Rural Electrification Corporation - have so far shown resilience but urgently need strong policy action to maintain health.

"Around Rs 56,000 crore of these lenders' exposure, comprising 12 per cent of their power sector advances of Rs 4.8 lakh crore on March 2011, is potentially at risk if there are no meaningful reforms in the next 18 months," says the CRISIL report.

ATTRACTIVE VALUATION

After falling 30 per cent between October 2010 and October 2011, the valuation of the BSE power index looks reasonable. On October 31, 2011, the price-to-earning (P/E) ratio of the index was 16.79. It was 28 on October 29, 2010.

"The sector is attractively valued for a reasonable return in the next 12-18 months. The government's policy initiatives are likely to make it more attractive," says Rakesh Goel, senior vice president, Bonanza Portfolio.


19 is the number of companies in the BSE power index. It includes power distribution, generation & equipment makers.


Market experts are optimistic for the next one year. "The BSE power index found support in the beginning of October and there could be recovery of at least 15-20 per cent in the next one year," says Goel.

Bishnoi of L&T Mutual Fund says, "The fundamentals of the sector have undergone a lot of changes in the last one year. Some of them are structural and will take time to be resolved, which will determine the functioning of companies in this sector. However, given the huge unmet demand for power in India, the longer term outlook for the sector is bright."

REPORT CARD

As on October 31, 2011, out of 19 companies in the BSE power index, only seven had filed their September quarter results. For the quarter ended September 30, 2011, NHPC, NTPC and Torrent Power reported net profit of Rs 966 crore (up 40 per cent), Rs 2,424 crore (up 15 per cent) and Rs 292 crore (up 31 per cent), respectively, compared Rs 690 crore, 2,107 crore and 223 crore, respectively, in the corresponding quarter last year. Suzlon Energy registered a lower net loss of Rs 19 crore compared to Rs 89 crore in the corresponding quarter a year ago.

During the quarter ended September 31, 2011, Suzlon Energy reported net sales of Rs 1,939 crore, up 82 per cent, as against Rs 1,067.95 crore in the corresponding quarter ended September 2010.

INVESTMENT OPTIONS

Market experts are positive on stocks such as CESC, NTPC and Power Grid Corporation. We discuss these in detail.

CESC: The company supplies power to Kolkata. According to a PINC Research report, CESC aims to nearly double its capacity to 2,400 MW by 2014-15 by adding a 600 MW unit each at Chandrapur and Haldia.

Performance and Valuation: Since the beginning of 2011, the stock has fallen 25 per cent. It was at Rs 275 on October 31, 2011. The stock is trading at 0.6 times estimated 2012-13 book value based on standalone financials. CESC's loss-making retail venture, Spencer's, in which it has a 94 per cent stake, has been a drag on the stock.

Powerful bets: Best companies of the lot


V Srinivasan, research analyst, Angel Broking, says, "The retail business has shown signs of revival and has turned EBITDA (operating profit) positive at the store level. The company plans to focus on high-margin segments in the retail business and is expected to break-even by 2013-14. We recommend a buy on the stock."

NTPC: The company is primarily into power generation. It has a generating capacity of 34,854 MW. According to the company website, it plans to become a 75,000 MW company by 2017.

Performance and Valuation: This year till October 31, 2011, the stock has fallen over 10 per cent to Rs 179. However, market experts are positive on the stock.

Rupesh Sankhe, power analyst, Karvy Stock Broking, says, "The company has a capacity of 34,850 MW and is working on another 16,500 MW. NTPC has signed power purchase agreements for a cumulative capacity of 1 lakh MW. At a PE multiple of 12.3 times 2012-13 forward earnings and a price-to-book value of 1.7 times 2012-13 earnings, NTPC trades at a 25-30 per cent discount to the average multiple of domestic peers. Fuel security and a strong balance sheet make it better placed relative to peers."

Power Grid Corporation: The company was incorporated in 1989 for transmission of electricity across the country. For financial year 2011-12, it plans a capital expenditure of Rs 17,600 crore. However, during April-October 2011, it spent only Rs 4,900 crore. The company plans to invest Rs 1 lakh crore in the 12th Five-Year Plan (2012-17).

Performance and Valuations: During the first ten months of calendar year 2011, the stock rose 6.6 per cent. It was at Rs 104 on October 31, 2011. However, market experts are upbeat.

Nomura Financial Advisory and Securities says prospects for five-year (2010-11 to 2016-17) earning per share are bright and one-year forward multiple is 20-25 per cent below the long-term average. The stock has the potential to move upward from the present levels.

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