The country’s largest power generator with a 31 GW capacity, recently managed some firsts to its credit. It was the first PSU follow-on public offer of the year. It was also the first public offer to opt for the auction route. (Under this the highest bidder gets the entire amount of shares asked for.) And it was the first fast-track issue of the year, with the company going public on filing its prospectus, sans the market regulator’s approval. Aside from this, there is nothing new about the 35-year-old state-owned Navaratna, which accounts for 19 per cent of the nation’s power generation capacity of 1.53 lakh mw and 29 per cent of the total electricity generated in the country.

Even as the country’s demand for power grew at 6 per cent annually between FY93 and FY07, the average peak deficit over this period hovered at 14-15 per cent. In fact, capacity addition over the last three five-year Plans has consistently fallen short of the target by around 50 per cent. The net result: the country still faces a peak deficit of around 13 per cent (as of November 2009). Against such a backdrop, it’s not surprising to see that NTPC too has been a laggard. Of the targeted 22.4 GW capacity addition in the 11th plan ending FY12, the state-owned power company has managed only 4.2 GW to date.

Given that the tariff for the sale of power is governed by the Central Electricity Regulatory Commission, which provides for a mandated return of 15.5 per cent and an additional 0.5 per cent on timely completion of the project, most of the operating cost for tariff determination is based on operating norms. Therefore, maintaining better operating performance is vital.

Past not perfect

Despite the robust demand for power, NTPC’s capacity expansion has been slow

Source: Company; *BU is billion units

Notwithstanding the shortcomings, NTPC’s stock performance has been impressive. Since its listing in 2004, the stock has quadrupled, outperforming the Sensex and leaving private players like Tata Power behind. However, analysts believe that the valuation gap between the company and its peers is likely to come down owing to the increased risk appetite of investors and NTPC’s track record of capacity addition. With the government, which is selling its 5 per cent stake, pricing the FPO at Rs 201 a share, there is practically nothing left on the table for investors. Importantly, given that the money is not flowing into the company, but into government coffers, it does not materially impact the PSU’s prospects.

While investors cannot ignore the largest player in the Indian power sector, analysts believe that the valuations are stretched and that the stock is unlikely to see a re-rating in the medium term.

Beneficiary by default

NTPC, the fourth-largest power generation company in Asia, will be a natural beneficiary of the government’s focus on power. Under the 11th Plan, the power sector is expected to attract 30.4 per cent of the total investment in infrastructure. Of the expected investment of Rs 7.25 lakh crore, investment in generation is expected to grab a 56 per cent share, or about Rs 4 lakh crore.

The company plays second fiddle to state electricity boards, which dominate the Indian power sector with a capacity of 76,627 mw. As on September 30, 2009, NTPC’s installed capacity of 28,350 mw (excluding 2,294 mw in joint ventures) constituted 19 per cent of the country’s total installed capacity. NTPC has 22 plants, of which 15 are coal-based and seven gas- and naphtha-based. Moreover, the plants are located at diversified locations, but mainly concentrated in the north (including NCR), where 33 per cent of total capacity is located, followed by the west and the east at 27 per cent and 26 per cent, respectively.

Slow and steady

Despite being in the high growth power sector, NTPC is expected to report a modest financial performance

Source: Prabhudas Liladher, Goldman Sachs

According to R S Sharma, chairman and managing director, NTPC’s share of the country’s total installed capacity will go up to 25 per cent when it achieves the target of 75,000 mw by FY17. “Our experienced management – with a majority of them having more than 30 years experience in the industry – and our capabilities will help us deliver,” says Sharma.

Efficiency gains

Though NTPC accounts for 19 per cent of the country’s total installed generation capacity, its share of the total power generation is much higher at 29 per cent, or 206.94 billion units (FY09). A K Singhal, director-finance, attributes this to efficient operations. Over the past 15 years, the availability factor of coal-based stations has increased from 86.5 per cent (FY94) to 92.5 per cent in (FY09), while that of gas-based stations has jumped from 60.2 per cent to 86.7 per cent in this period. Similarly, the average plant load factor (PLF) of coal-based stations has increased from 78.1 per cent to 91.1 per cent and that of gas-based stations has increased from 50.3 per cent to 67 per cent. A heartening fact is that NTPC’s availability factor and plant load factor has been higher than the industry average. Availability factor is a measure of how often a station is available to generate power and PLF is a measure of how much of the capacity a plant actually uses to generate electricity. While higher availability results in incentives from the regulator, a higher plant load factor means higher output, and in turn a better financial performance. But a lot of that hinges on the fuel security.

Fuel for thought

Fuel security is the most critical aspect for any power generation company. Currently, NTPC sources more than 95 per cent of its coal domestically, for 12 of its 15 coal-based plants. This is based on long-term power supply agreements of about 20 years, mainly with subsidiaries of Coal India. The three other stations receive coal according to coal supply linkages allocated by the coal ministry. Similarly, it has also entered into agreements with several gas vendors such as GAIL and Reliance Industries for a fixed supply of gas. While the company’s coal-based plants are located within 80 km of the coal mines, the seven gas-based stations are located along major gas pipelines. This means lower transportation costs as well as minimal supply interruptions.

Missing the bus

As in the past, the company is unlikely to meet its targeted capacity addition in the 11th Plan

Source: Company, Goldman Sachs

However, to sustain its expansion plans, the company will have to gone in for higher imports. NTPC imported 4.2 per cent of its coal requirements in FY09. “Our coal imports are likely to increase from 8.25 million tonne to 14 million tonne by FY11,” says Singhal. But in order to save on import costs and secure fuel supply, the company intends to develop captive coal mines, either on its own or through joint ventures, both in the domestic market and abroad. Around 20 per cent of its total coal requirements of about 300 million tonne will be met through captive mines. Given that 86 per cent of its total generation capacity is coal-based and 14 per cent comes from gas and naphtha, the company wants to diversify across different fuels. Says Sharma, “By FY17, coal-based generation will be 70 per cent, 14 per cent will be gas-based, 12 per cent hydro, 3 per cent from nuclear power and the balance 1 per cent will be from other renewable sources.”

Diversifying revenues

Besides de-risking fuel supplies, the company also intends to strengthen other areas of business such as consultancy, power trading and equipment manufacturing. The company’s consultancy business, which it had developed to leverage on its technical and operational skills, has grown by 31 per cent CAGR to Rs 132.5 crore in FY09 from Rs 34 crore in FY04. Its subsidiary, NTPC Vidyut Vyapar Nigam (NVVN) has emerged as the second largest power trader in India with a 16 per cent share, after PTC India, which has 33 per cent. NTPC has formed joint ventures with various companies such as BHEL and Bharat Forge for equipment manufacturing, to ensure supply of critical equipment and spare parts. It is also planning to invest further in electricity distribution, through its subsidiary NTPC Electric Supply Company (NESCL).

Attractive peers

NTPC is a suitable investment for risk averse investors seeking steady growth

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Source: Bloomberg. *Reliance Infrastructure holds a 45 per cent stake in Reliance Power. **FY10 is likely to be the fi rst year of revenues (Rs 909 crore) and profi t (Rs 544 crore).

The company has a strong track record in turning around inefficient plants and enhancing their efficiency significantly. The best example is the troubled Dabhol power plant, now known as Ratnagiri Gas and Power, having an operational capacity of 1,480 mw that is likely to go up to 1,900 mw by March 2010. In 2005, NTPC and Gas Authority of India each acquired a 28.33 per cent stake in the power company. Thereafter, the company acquired four underperforming plants, namely Unchahar, Talcher, Tanda, Badarpur and successfully improved their PLFs substantially from around 20 per cent in the early 1990s to 90-94 per cent in FY09.

Safer strategy

Today, all the power generated is sold to state electricity boards and state-owned distribution companies through long-term power purchase agreements (PPAs). As a part of its strategy, it will continue to pursue PPAs and sell only a small part of the power generated on a merchant basis. Sharma says, “Merchant power will be only around 6,000 mw (8 per cent) of the 75,000 mw capacity by 2017.” Right now, the company’s average selling price hovers at about Rs 2.2-2.3 per unit. “If we assume Rs 5 per unit in the open market, we can earn additional revenue of Rs 8,000-10,000 crore over the next few years,” he says.

The markets are bullish about the power ministry’s proposal that a part of the government’s discretionary quota at central generation stations be allowed to be sold through open access. Right now, the central government has discretion over 15 per cent of the output, which is kept as ‘unallocated’ for distribution within the region or outside, depending on the overall requirement. The ministry has suggested 25 per cent of this discretionary quota in the case of existing capacity and 50 per cent for new capacity to be free for open access. Though this will be a big positive for NTPC and would lead to a re-rating, it is too early for exuberance as the union cabinet approval is pending. Moreover, some analysts feel that the approval
is very unlikely as there might be opposition from respective states.

Execution risk

NTPC is engaged in the construction of projects worth 17,930 mw, while projects for 33,000 mw are at various stages. Of the total 75,000 mw to be added by the end of 12th Plan, that is FY17, 22,400 mw is to be added in the 11th Plan (by FY12).

The biggest worry analysts have over these gigantic plans, is the delay in project execution. (See table, Past not perfect.) Venkatesh Balasubramaniam, analyst at Citigroup Global Markets, said in a report dated October 23, 2009: “Of the total 22,400 mw in the 11th Plan, we expect a 55 per cent achievement rate at 12,300 mw.” Besides, analysts expect NTPC to miss the 11th Plan target due to a delay in commissioning of plants by Russian equipment suppliers, delay in gas-based projects on account of litigation with RIL, and the agitation by environmentalists at its hydro sites.

Matching with peers

NTPC plans to expand by as much as its current capacity

Source: Company . * Under joint ventures and subsidiaries. The figure in brackets indicates the number of plants

Even the management does not deny slippages. Almost all the power generated by NTPC is sold to state electricity boards (SEBs) that suffered losses of about Rs 34,095 crore in FY08. Payments of course are secured through letters of credit and tripartite agreements under which dues from SEBs were securitised by the issue of 8.5 per cent tax-free state government special bonds. Populist measures, such as free power to farmers, will further affect the financial health of SEBs, which in turn would adversely affect their ability to make payments, and that too on time.

Modest performance

From FY06 to FY09, NTPC reported a compounded growth of 18 per cent in revenues and 9 per cent in profit after tax. In the next few years, the company is expected to report similar growth – 14 per cent CAGR in sales and 8 per cent CAGR in profit. (See table, Slow and steady.)

As on September 30, 2009, the company had foreign borrowings of about Rs 10,900 crore, which is 10 per cent of total assets and 27 per cent of total debt. Rupee depreciation will put a burden on the financials. For example, in FY09, the unfavorable exchange rate variation led to an addition of Rs 269 crore in interest costs, against a reduction of Rs 126 crore on interest expenses in FY08.

Fairly priced but…

At Rs 206, NTPC trades at 17 times price to earnings (P/E) and 2.5 times price to book value (P/BV) for FY11. The government is looking to raise Rs 8,300 crore by offloading a 5 per cent stake at Rs 201 a share which values NTPC at 17 times P/E and 2.68 times P/BV for FY11. NTPC’s closest private peer, Tata Power (one-third in terms of sales and one-fifth in terms of profit), is trading at 16 times P/E and 2.4 times P/BV for FY11. Also, many other private players such as Adani Power and JSW Energy, which are expanding capacities, are trading at over 20 times P/E and 3 times P/BV. However, premiums are mainly due to their higher proportion of merchant power, which leads to higher ROE.

In fact Durga Dath, analyst with Goldman Sachs, has a sell rating on NTPC with a target of Rs 174. In her report, dated January 4, 2010, she says “NTPC is trading at a premium to its historical one-year forward average P/E of 17 times and P/B of 2.2 times.”

However, the company’s valuations look attractive when compared to the largest public hydropower producer, National Hydropower Corporation (NHPC). NTPC is almost six times bigger in terms of capacity and profit and has 12 times larger revenues than NHPC. But NHPC is quoting at a P/E of 31 times and 1.8 P/BV over the same period. Even on an FY11 EV/Ebidta of 14 times the thermal power behemoth (NTPC) looks cheaper than the 21 times given to the smaller size hydropower major (NHPC).

Analysts feel that the stock is unlikely to give any substantial returns over the medium term, say one year, as the entire power sector captures the growth momentum for the next few years and valuations look stretched. Also, analysts expect NTPC to lag behind private players such as Tata Power, Reliance Power, Adani Power and JSW Energy in terms of growth, largely due to the lower base of the latter. (See table, Attractive peers.) Thus, as discounting will be faster in case of private players and capacities will get larger, they will start looking cheaper. However, a section of the market believes that the stock is a low-risk play. Vinod Chari of RBS feels that NTPC is a defensive stock within the utilities space, given that it underperforms relative to the power index in a rising market, and outperforms in a falling market. “While the outperformance may not be high, the downside risk is equally low,” says Chari.