There’s a noticeable dichotomy within power sector companies. While there is surplus capacity and low utilization of existing capacity among power generation firms, the stage is all set for revenue and order book growth for power transmission and distribution (T&D) firms.
This is not without reason. Analysts from the sector are hopeful that the draft National Electricity Plan (December 2016), which signals a sizeable Rs2.6 trillion investment into building T&D networks between 2017 and 2022, should open avenues for firms in this business.
In any case, after some sluggishness until fiscal year 2015, domestic T&D orders started to pick up. Firms like KEC International Ltd, Kalpataru Power Transmission Ltd, Techno Electric and Engineering Co. Ltd, and ABB India Ltd have shown robust order inflows in the last three-four quarters. The road ahead is clear too. An Emkay Global Financial Services Ltd report says, “The addressable opportunity for larger engineering, procurement and construction (EPC) players in transmission lines would be around Rs900 billion (Rs90,000 crore) and in the substation segment around Rs750 billion, over the next five years.”
It was after the FY08-09 downturn that some of these firms battled losses and were also caught in a debt trap. However, stringent cost management has now brought large-sized companies back on to the profit track. Those that could not cope are not in the race to bid for new orders. Further, the government is also clear that firms that are yet to complete orders will not be given fresh contracts. Hence, there is lower competition for large-sized companies that have weathered the tough times.
Meanwhile, some firms have struck a meaningful geographic balance to diversify risks. For example, two-thirds of Kalpataru Power’s current order book accrues from the Middle-East, Africa and South-East Asia. KEC and Thermax Ltd have successfully diversified in terms of geographic regions and business verticals. Else, the T&D orders, which are mainly government tenders, run the risk of delays in awards and cost overruns.
Some others are restructuring businesses to improve profitability. Techno Electric, for instance, has taken the decision to exit the wind power generation business and plough back the funds raised towards more viable substation projects, besides repaying debt.
Such efforts have powered up the operating margins by 100-150 basis points in the last few quarters and they are poised to grow further as order inflows bring in benefits of operating leverage too. A basis point is one-hundredth of a percentage point.
No doubt, T&D stocks in the entire power sector are to investors what roads are in the infrastructure universe. In a year, shares of KEC and Kalpataru Power have returned twice that of the BSE Capital Goods index. Although the price-to-earnings multiple did expand, the expected order inflows and revenue momentum should expand earnings to support valuations.