A power surge in energy stocks has led to valuations that appear difficult to justify using traditional benchmarks.
But some analysts are defending valuations of India’s listed power generation firms by pointing to the high demand expected for the Reliance Power Ltd’s initial public offering (IPO) that will open for subscription on 15 January. Others are justifying the valuations, saying they are a benchmark for Reliance Power’s own valuation.
A similar trend was seen at the time of DLF Ltd’s listing for real estate stocks and the recent issue by Edelweiss Securities Ltd for brokerages.
Indian power generation companies have operated in a tightly regulated environment, where the government caps the return on capital on most projects. Raamdeo Agrawal, joint managing director of Motilal Oswal Securities Ltd, a Mumbai-based brokerage, says, “When returns are capped between 13% and 16%, the price-to-book valuation shouldn’t be more than 1.5-2 times even in the most optimistic scenario.”
But NTPC Ltd, most of whose projects have a cap on return on equity, now trades at a price-to-book valuation of 4.07 times fiscal 2008 estimates published by Bloomberg News. In the beginning of the fiscal, the company had a valuation of 2.25 times book value.
The price-to-book value is a ratio that compares a stock’s market value to its book value. It is calculated by dividing the latest price of the stock by the book value per share.
NTPC’s competitors in the private sector, Tata Power Ltd and Reliance Energy Ltd, enjoy a FY08 price-book valuation multiple of 4.84 times and 5.98 times, respectively. These stocks have risen by 202%and 417%, respectively, since April.
Reliance Energy, of course, will hold 45% in Reliance Power once it lists and most of its value comes from this holding. The value of its holding, calculated at the higher end of the price band, is Rs45,765 crore, at least 78% of its current market capitalization of Rs58,255 crore.
Not all of the projects run by private companies are regulated in terms of returns but, in its IPO grading note on Reliance Power, rating agency Crisil Ltd noted that returns on projects won through a competitive bidding process may not be substantially higher due to competition.
In any case, a price-book of five to six times assumes high return on capital, high growth and high reinvestment of annual profit. “Investors have assumed all of these and ignored the risk of timely execution and spiralling costs,” points out a fund manager of a domestic mutual fund who did not want to be quoted.
Agrawal of Motilal Oswal Securities Ltd adds that the economics are actually worsening with the cost of coal rising substantially and with no indication that the price of power would rise commensurately.