First mover advantage

PTC's float offers cheap entry into new industry

There were two principal questions on everybody's lips at the Power Trading Corporation road show on Monday. One of them was fundamental "" why does a power trading firm (essentially a broker matching buyers and sellers) need to raise funds from the capital markets? The other issue concerned the steps being taken by PTC to meet emerging competition.

Company officials say that they are planning to expand their trading operations and as part of that strategy, they need additional funding to enhance their energy buffer.

It has been observed that the power requirements from companies has been subject to wide fluctuation. Hence PTC's strategy appears sound, as a larger energy stock would help the company meet any sudden large order.

To PTC's credit, it has been able to ramp up its core operations rapidly - from Rs 11.39 crore in FY01 to Rs 923.37 crore in FY03.

Also, while trading operations are characterised by shrinking margins, PTC has been able to build withstand that trend. Operating profit grew threefold to Rs 17.43 crore in FY 03 and operating margins were 30 basis points higher at 1.88 per cent.

In the short term, PTC is also expected to benefit from a hike in unscheduled interchange charges (UI charges) of grid operators, effective from April 1, 2004. UI charges become applicable when demand for power exceeds the levels planned the previous day.

The highest UI charge will be hiked from Rs 4.50/unit to Rs 6/unit. As users would be hesitant to pay such a large increase in UI charges to grid operators, the demand for power supplied by PTC is expected to rise.

However, it remains questionable whether PTC would be able to sustain the rapid growth in profits over the next 3-4 years. PTC's shareholders NTPC and Tata Power have set up wholly owned trading firms and they could eat into its market.

PTC officials counter that argument and point out that their services have been well received in the market and it should help them maintain a loyal customer base.

Also, the entry of new players could help to create a new dimension in the market "" profitable trading among traders "" that could expand the market.

Despite the risk involved in selling power to state electricity boards, PTC has been able to keep credit risks at bay and 80 per cent of its receivables are paid within a month.

Taking post-issue diluted earnings, PTC's offer, at a band of between Rs 14 and Rs 16, would be at a multiple of around 8.That's a cheap price to get into an entirely new industry.

Derivatives lot sizes

The Securities & Exchange Board of India has finally taken action on the long pending issue of high derivatives contract sizes. It has instructed stock exchanges to get contract sizes back to the Rs 2 lakh mark by adjusting the underlying's lot size.

The earlier stipulation that the lot size/multiplier should be in the multiple of 100 for stock based derivatives stands revoked.

This is an issue that needed to be addressed as long back as two years ago, when some contract sizes were well over Rs 4 lakh, hindering participation from retail players.

The situation has now got much worse, with almost half of all the derivatives contracts valued at close to Rs 4 lakh. What's more, 42 of the 55 contracts available are valued at close to Rs 3 lakh.

In some cases like Tata Motors and M&M, the contract size is as high as Rs 18 lakh and Rs 12 lakh respectively. It was clearly high time an adjustment was made to bring back the contracts to the Rs 2 lakh mark, as was originally intended.

However, what's interesting is that the high size of a derivatives contract has, in the past, not impacted liquidity. Surprisingly, Tata Motors, despite being the highest valued derivatives contract, is also the most liquid (after the Nifty) in terms of turnover.

Similarly, M&M is also part of the top ten most liquid contracts in terms of turnover. It's clear that a high contract size hasn't impacted liquidity. What it does impact is participation from smaller retail players.

Currently, much of the derivatives market is made of high networth individuals. Once the contract size is lowered, participation is bound to increase, now that the derivatives market is already a very liquid market.

A high contract size can accentuate volatility in the markets, since each trade is of a very high value. Once contract sizes are brought to more reasonable levels, volatility can be expected to decrease.

With contributions from Amriteshwar Mathur and Mobis Philipose