Earnings downgrades of power utilities likely

Earnings downgrades of power utilities likely

Private sector power utilities may report improved sequential performance in revenue and profit for the March quarter. Though, several factors warrant an earnings downgrade for the sector in the next 12 months.

The deplorable health of state electricity boards (SEBs) is a key trigger for downgrades, along with higher fuel (coal) prices and linkages, and lower merchant tariffs.

Shares of private utilities such as Lanco Infratech Ltd, Tata Power Co. Ltd, Reliance Power Ltd, Adani Enterprises Ltd and GVK Power and Infrastructure Ltd have gained on the Street over the last three months. Higher peak-hour deficit and power demand during the March quarter, after a fall in hydro- and wind-power generation, translated into better tariffs of about 4.60/kWh (kilowatt hour) since February; they were nearly a rupee lower in the previous quarter. So, the March quarter may register higher average realization and revenue than the preceding quarter; though, they may be lower than the year-ago period.

Yet, consensus estimates spell earnings downgrades over the next 12 months. The Shunglu committee estimated SEB losses to double to 68,000 crore in fiscal 2011 (FY11). The reasons are well-known—low tariffs due to political compulsions, high distribution loss and delayed payment of subsidies by governments—all have led to a sharp deterioration in the health of SEBs. A report by Emkay Global Financial Services Ltd says “unsustainable SEB losses to trigger panic situation starting FY12E and they would resort to price caps, power cuts/demand management, payment delays, etc.". Another report by India Infoline Ltd adds, “Blended tariffs would have to increase by around 25% if SEBs have to break even." From 2007-09, tariffs rose about 6.5%, while the cost of supply rose by three times that amount.

Meanwhile, the recent March quarter saw higher plant load factor (PLF), which will translate into higher operating profit compared with the preceding quarter. But, given their poor finances, SEBs may resort to load shedding instead of buying more power, resulting in lower generation.

The relatively high power tariffs may, therefore, be sustained only until the first quarter of FY12 during peak demand. Thereafter, the onset of the monsoon and the supply of hydropower will cool tariffs. This is evident from the forward price curves. Data from power exchanges suggest that the forward rates for March-May delivery are higher than the preceding three months, but lower from June onwards.

Besides, rising coal prices and the paucity of committed gas linkages will impact PLF and generation. For example, for the December quarter, GMR Infrastructure Ltd reported flat revenue in the energy sector due to fuel shortage.

Analyst estimates for the March quarter for firms that are pure power plays, such as Lanco and Tata Power, indicate a year-on-year drop in operating profit margin by 400-500 basis points. Net profit margin, too, will be lower, as most firms have added capacity, leading to higher interest and depreciation. One basis point is one-hundredth of a percentage point.

The challenges ahead could lead to earnings downgrades at least over a 12-month horizon. In the long term, higher capacity and increased power availability are expected to bring uniformity in power tariffs at a lower level (about 4/kWh during FY12), when compared with the seasonality displayed by the sector recently. An Edelweiss Securities Ltd report also expects the volatile merchant tariffs to finally converge with stable, but lower power purchase agreement rates. Until clarity emerges, regulated power plays such as NTPC Ltd and Power Grid Corp. of India Ltd may score over private firms, which have to grapple with these uncertainties in the near term.

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