News of reform in the power sector has led to some recovery in share prices of companies undertaking transmission and distribution (T&D) projects. Companies such as KEC International, Kalpataru Power and Jyoti Structures depend on state electricity boards (SEBs), as well as central undertakings such as Power Grid, for a large part of their orders. Hence, any improvement in the financial health of SEBs should lead to better management of receivables and increased business for these companies.
Due to concerns surrounding the sector, most of these stocks had fallen to 52-week lows. Though they have risen of late, valuations of five to eight times one-year forward earnings multiple are still reasonable. While the planned reforms in the sector will have a positive impact only in the long run, analysts suggest the markets are still ignoring the changing environment.
“Amid all the bad news surrounding the sector, including the recent captive coal block allocation mess up, markets are completely ignoring the meaningful steps on ground reforms such as 20-40 per cent (rate) hikes by most SEBs, Coal India asked to sign FSAs (revised fuel supply agreements) and proposals of (price) pooling of imported coal and the Attorney General’s ruling in favour of reviewing of fixed-price PPAs (power purchase agreements),” says Bhavin Vithlani, who tracks the sector at ENAM Securities, in a recent report. Analysts say once the perception of the risk about the sector changes, it could lead to more upside for these stocks.
| IMPROVING OUTLOOK | |||
| FY12 | FY13E | FY14E | |
| RoE (%) | |||
| KEC International | 15.1 | 18.3 | 19.8 |
| Kalpataru Power | 9.9 | 9.5 | 9.8 |
| Jyoti Structures | 13.5 | 13.1 | 13.4 |
| Order book (Rs cr) | |||
| KEC International | 8590 | 10150 | 11530 |
| Kalpataru Power | 6100 | 6680 | 7370 |
| Jyoti Structures | 4320 | 4390 | 4430 |
| Sales growth (%) | |||
| KEC International | 30.0 | 13.7 | 16.8 |
| Kalpataru Power | 5.5 | 14.6 | 12.6 |
| Jyoti Structures | 8.9 | 11.1 | 10.8 |
| Profit growth (%) | |||
| KEC International | -24.4 | 40.8 | 28.1 |
| Kalpataru Power | -13.5 | 4.6 | 12.3 |
| Jyoti Structures | -22.9 | 7.8 | 16.0 |
| RoE is return on equity Source: Edelweiss Securities | |||
Revival hopes
The recent SEB debt restructuring is seen in a positive light, as the benefits provided are linked with improvement in operating performance such as reduction in transmission and distribution (T&D) losses. The measures also ensure a gradual rise in power rates along with the increase in the cost of power purchased. These will provide liquidity support to loss-making SEBs and create a path for enhancing viability. And, revive the market for power generation, triggering capex in downstream segments like T&D.
“In India, the under-investment in T&D as compared to generation is well known. The recent restructuring exercise undertaken by the central government is only for improving servicing of bank debts and simultaneously improving the financial health of discoms (distribution companies),” says Rabindra Nath Nayak, research analyst, SBICAP Securities. “These measures would reduce annual losses by 10-12 per cent and address the liquidity mismatch issues of SEBs,” says Harshvardhan Dole, who tracks the sector at IIFL Institutional Equity Research, in a recent report. Analysts also believe this will provide incentives to initiate the capital expenditure needed in the sector and revive stalled projects.
For instance, in the 11th five-year Plan, the power T&D sector attracted investment of about Rs 140,000 crore, including about Rs 55,000 crore by Power Grid. With the power generation target set higher by 30 per cent over the next five years, this should reflect on investments in T&D as well. Power Grid alone is aiming for Rs 100,000 crore of investment in this area. This is positive for T&D equipment and EPC companies like KEC, Jyoti and Kalpataru.
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KEC, a diversified player in terms of geography and services, also has the capability to undertake large T&D projects. While a little over half its order book is from international clients, this is from customers across industries, such as transmission, telecom, power systems, railways and cable. Based on the relatively better order inflow expectations and order book, analysts are confident of strong earnings growth and improvement in the balance sheet after the leveraged buyout of SAE Towers. Recently, the promoters also raised their stake in KEC, boosting the share prices (currently Rs 71). Despite the 27 per cent run-up in the last one month, analysts have a buy rating as the stock trades at just 6.5 times its estimated FY14 earnings, good given the high return on equity (RoE).
Kalpataru Power
Kalpataru Power, largely a domestic player having a dominant position in the EPC of transmission lines and substation segment, could also see some re-rating of its stock. Among the trio, Kalpataru has relatively better visibility, with order book to sales at two times. While analysts expect steady inflow of orders, driven by Power Grid’s capex plans as well as improvement in the margins and return on equity (RoE) over the next two years, the margins and RoE are still lower than peers. These are partly reflecting in the stock (Rs 87) valuations of 5.5 times estimated FY14 earnings. Any higher-than-expected gains in margins or order inflows could prove to be triggers.
Jyoti Structures
This is a relatively smaller company in the sector but its growth prospects are equally good. Its order book-to-sales at 1.7 times is healthy and should help the company grow revenues by 12-15 per cent annually. While earnings are seen growing in single-digit in FY13, the next financial year would see strong growth. Jyoti is also a diversified player, having presence in different sub-segments of the T&D business. Even after the 35 per cent run-up of the past month, the stock trades at four times its estimated FY14 earnings. While the lower valuations could be partly attributed to the smaller size, analysts are positive on the stock due to reasonable return ratios.