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Utilities: low confidence in electricity producers

Several power producers are ensnared in un-remunerative power purchase agreements, tariff disputes and excessive leverage

Power sector stocks continue to trail the broader markets. The S&P BSE Power index has gained just 3% in the last two fiscal years, while the S&P BSE Sensex during the period is up 13%. The under-performance reflects low investor confidence in electricity producers even as sector valuations are undemanding at less than 10 times one-year forward earnings estimates.

True, a drop in coal prices and higher production in India improved fuel availability. But demand remains the bugbear. As a result, the sector is operating at sub-optimal levels—thermal plant utilisation levels stood at 62% last fiscal.

Electricity generation picked up from January this year. Production is up 9% in the first three months and most of April also saw good growth. The improvement, however, is driven by drought conditions and rise in temperatures. Demand from industrial and commercial entities, which consume 38% of electricity, remains muted.

Also, due to their weak financial condition, state-controlled electricity distribution companies, the biggest procurers of electricity in India, are not forthcoming about purchases.

The central government is prodding states to clean up distribution companies. However, action on this front is slow. According to ICRA Ltd, state utilities are not in favour of filing tariff petitions for 2016-17, which would help reduce financial stress.

Apart from this, several power producers are ensnared in un-remunerative power purchase agreements, tariff disputes and excessive leverage. The tariff orders, if not favourable, can have adverse financial implications for Tata Power Co. Ltd and Adani Power Ltd. There is no clarity when the companies will overcome these headwinds. Hence, the cautious view on the sector.

If one leaves the demand problems aside, then analysts are seeing value in state-owned companies such as NTPC Ltd and Power Grid Corp. of India Ltd.

NTPC is liked for its low valuations—the stock is trading at 10 times the 2017-18 earnings estimate. Its facilities have production tie-ups and generate fixed return on equity. Like the rest of the electricity producers, NTPC also faces demand risks. But the problem is not as acute, and NTPC’s utilisation levels are far better.

Also, strong balance sheet and improving fuel availability means it is better placed to capture benefits of demand recovery, when it happens.

Power Grid, which constructs and maintains transmission lines, is preferred for its strong project pipeline. Power Grid’s regulated asset base is growing at a strong pace.

With the company estimated to capitalise new projects worth around 24,000 crore in the current and next fiscal years, analysts expect the earnings to see strong growth.

Also, unlike electricity producers, Power Grid faces lower risks in terms of asset utilisation levels. The stock is trading at around 1.4 times the 2017-18 price-to-book value estimate. “Power Grid has strong visibility of earnings growth and is the best among regulated businesses. While NTPC and NHPC have to maintain both PLF (plant load factor) and PAF (plant availability factor), Power Grid has to maintain only PAF. It is, thus, less dependent on external factors," Motilal Oswal Securities Ltd said in a note.

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