Street goes long on PowerGrid, NTPC

Strong financials, benign interest rate cycle & lower volatility in stock prices

When it was ‘all fall down’ for most stocks during the note-ban period (November ‘16-January ‘17), NTPC and PowerGrid stood as exceptions with a positive bias. These stocks gained 12-16 per cent in these three months. Perhaps for this reason, most brokerages preferred to bet on PowerGrid and NTPC as their picks for 2017. 

Another reason could be strong revenue visibility these companies offer. Despite the challenging times for the power sector, financial results of NTPC (India’s largest power generator) and PowerGrid (the nation’s largest power transmission player) have either met or exceeded Street expectations consistently in the past four-five quarters. The strong run is expected to continue in the next two financial year as well. Analysts estimate PowerGrid’s revenues and net profits to grow by 17-18 per cent annually in FY17-19, while for NTPC, the growth is likely to be 15-20 per cent. 

For PowerGrid, the pace of capital expansion (capex or constructing grid lines) in the past four-five years has been very strong. Around Rs 93,000 crore of projects are expected to yield revenues in the next three-four years as they become operational (capitalisation, in technical parlance). This results in more projects becoming eligible for assured regulated return on equity (RoE) at 15.5 per cent. Given that PowerGrid’s business works on a cost pass-through basis, the profitability in operations is likely to be maintained at over 88 per cent. If earnings support from consultancy and telecommunications business continues to flow in, investors could expect the earnings and profitability to receive a boost. 

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NTPC also enjoys the same advantages in terms of cost pass-through and regulated returns. Its earnings will get further fillip as more capacities are added — 6,860 megawatts (Mw) in FY18 and 8,760 Mw in FY19. Consequently, projects qualifying for regulated RoE will also increase. Efforts to increase operational efficiency could also result in higher earnings. Regulated returns are generated by plants which operate at over 86 per cent efficiency. Lower demand for electricity has reduced NTPC’s ability on this front, but as demand picks up, the situation could improve. 

On the macro front, a benign interest rate cycle also improves attractiveness of growing companies having a fixed-return business model.

But there are a few tricky points as well. For PowerGrid, investors await details on future capex. Currently, the Street is not factoring a reduction in capex plans. But a lower estimate could dampen sentiments. With NTPC, the risk of change in accounting for coal prices persists. While it hasn’t faced material cost pressures due to change in norms in December quarter earnings, clarity will emerge in the next three-six months. While these concerns aren’t priced in for now, analysts are of the view that even if the worst-case scenario plays out for these two firms, it won’t impact earnings in the next two-three years.