2018 marked the turnaround of the thermal power sector. A steady rise in demand began pushing up utilization levels, and as fuel supplies lagged demand, prices in the spot electricity market shot up. But insufficient coal and high maintenance shutdowns weighed on earnings, leading to subdued performance of shares of power companies.
Even so, an earnings rebound is now increasingly looking likely. First, demand has continued to perk-up. Thermal power generation between April and November is up 5%, slightly higher than the growth in the year ago period. Fuel supplies are improving, even though only incrementally.
Importantly, draft regulations for the next regulated period—FY20-FY24—adopted an accommodative stance, brightening the outlook for regulated utilities. It proposes that regulated utilities can continue derive a 15.5% return on equity, despite a general easing of finance costs (from 2014). “It (draft) encourages investment versus the myopic view India does not need to order any thermal plants till FY27. This may be due to a recent collapse in new capacity additions and a 30% rise in merchant prices (spot tariffs). The regulation improves long-term visibility till FY24," broking firm CLSA said in a note. Companies such as NTPC Ltd and Power Grid Corp. of India Ltd function on the regulated business model.
There is also reprieve in the offing for private sector firms Tata Power Co. Ltd and Adani Power Ltd. The Supreme Court directed the electricity sector regulator to revise tariffs for the companies’ troubled power plants in Gujarat, after the state filed a conciliatory petition. While final tariffs are yet to be agreed upon, considering that the troubled plants are losing money, even a no-gain, no-loss agreement will be a positive outcome. These developments should remove a key overhang and aid the stocks which are trading at undemanding valuations. According to Motilal Oswal Securities Ltd, the sector is trading at close to its lowest trailing price to book value of around one time compared to the peak of 2.5 times in FY10.
If India’s macroeconomic conditions remain stable, then the market can see convergence of valuations benefiting inexpensive value stocks, say analysts at Kotak Institutional Equities. “Recent positive policy (indirectly) and regulatory developments for certain value sectors may result in some re-rating of the stocks from current low levels," adds Kotak Institutional Equities.