Companies that have firm expansion plans, better execution capabilities and high fuel security will outperform.
India could once again miss its revised power generation target as major companies slip up on project execution plans. Earlier, for the eleventh five-year plan, the power generation capacity addition target was bought down from 78,000 Mw to 62,000 Mw. Now, reports indicate the country will further miss the target by another 4,000 Mw at least. Recently, government-owned hydro power major NHPC also said 3,000-4,000-Mw of its new capacity would be delayed for reasons beyond its control.
No wonder then that the power sector as a whole has underperformed the broader indices, which analysts say has led to many of these companies now trading at valuations below those enjoyed by their regional peers. (Click here for table & graph)
“I think the underperformance of the sector is mainly due to the under-execution of projects and significant drop in the merchant power rates,” says Rabindra Nath Nayak, senior research analyst, SBICAP Securities.
Low voltage
During the last three five-year plans, the government has achieved only 50-54 per cent of the targeted capacity. This time, too, it was expected that the targets would be missed. However, thanks to the private sector, wherein the execution has been relatively better, the country could end up on a better note with a target achievement of 74 per cent or 58,000-Mw of the targeted generation capacity.
Meanwhile, the industry is still facing several challenges. The execution risk, which is at the top of the mind of analysts, is the biggest risk considering it will not only impact the financials in terms of lower than projected growth in revenue and profits of these companies, but will also hit their stock valuations. Analysts say delays in land acquisition, problems related to environmental and forest clearances, higher coal prices, delay in the equipment supply and inadequate availability of technical manpower could act as barriers in achieving such targets. Earlier, the environment ministry had indicated that India may sign a binding agreement to cut emissions. In such a case, a majority of the new projects (80 per cent of new capacity), which are coal-based and are in the sub-critical segment, could face huge challenges.
In the medium-term, the rising interest rate scenario will make it increasingly difficult to achieve financial closure of upcoming projects. There are other issues as well. “The financial closure for power plants is increasingly becoming challenging, with financial institutions and banks hitting individual and group-level lending limits along with the overall sectoral limits,” says Ram Modi, analyst at Dolat Capital.
If this is not enough, the decline in merchant rates has only added to the woes of the power sector. If the current rates prevail, the companies which were hoping to earn a higher return on equity of over 40 per cent may not earn more than 20-30 per cent.
“The merchant power rates have dropped significantly from an average Rs 3 per unit last year to about Rs 1.8 per unit in the current financial year. Even some of the companies are selling merchant power at below their cost of generation. Though these are not sustainable rates, margin pressure will continue for the merchant power producers,” says Rabindra.
According to analyst reports, companies like JSW Energy and Adani Power have large exposure to merchant power (based on the operating and under construction capacities) at about 47 per cent and 27 per cent, respectively.
How companies stack up
Analysts believe that given the ongoing concerns, the sector may not do well or the share price may remain flat in the near term. However, within the sector, there could be a few companies that could deliver better performance and stock returns. They say it is better to invest in companies that have firm expansion plans, better execution capabilities, high fuel security and a well-diversified off-take agreement.
On the back of these reasons, as well as given the low risk, strong execution capabilities, firm pipeline of projects and relatively better valuations, companies like Tata Power and NTPC are among the preferred picks of analysts. Lanco Infra and CESC also figure on top of the ‘buy’ ratings of analysts. For Lanco, it is because of its fourfold expansion of capacity to 9,200 Mw by 2015. For CESC, the company is also present in the distribution space and is trading at attractive valuations despite a good pipeline of projects and better financials. On the other hand, analysts have a ‘sell’ rating on JSW Energy due to a higher merchant component and Reliance Power due to its rich valuations. For Adani Power, many are cautiously bullish due to a high exposure to merchant power as well as high valuations.
