Power Grid Corporation of India: Buy

Investors with a long-term horizon can buy the stock of Power Grid Corporation of India (Power Grid), India’s principal power transmission company. Power Grid, a government-controlled entity, has near monopoly on the country’s inter-state and inter-regional transmission network. Last fiscal, it transmitted 450 billion units of electricity — accounting for half the power generated in the country.

Power Grid gets an assured regulated return on equity of 15.5 per cent on its commissioned projects. This enables the company to pass through most of its costs to customers. Besides, it is entitled to an additional 0.5 per cent return on equity on meeting specified timelines.

The company’s growth prospects thus primarily depend on an increase in its transmission capacity and volumes. With big capital expenditure (Rs 1.1 lakh crore) planned over the 12{+t}{+h} Plan period (2012-17), Power Grid is placed advantageously.

The tariff-based competitive bidding for power transmission projects introduced a couple of years back has seen the entry of some private players in the space dominated by Power Grid.

But this should not impact the company’s prospects, given its strong execution track record and competitive advantages which allow it to bid aggressively. In any case, projects based on competitive bidding should account for a minor share of the company’s planned capacity expansion.

Under the Central Electricity Regulatory Commission (CERC) regulations, the debt-equity ratio for funding new capacities should be 70:30 for the assured rate of return on equity. To fund the equity portion of the planned capital expenditure, a fresh issue of shares by Power Grid is on the anvil.

This entails a fresh issue of 13 per cent of the existing capital. Also, the Government plans to divest 4 per cent stake. While there has been pressure on the stock in the run-up to the follow on public offer, the company’s strong fundamentals, growth prospects, and attractive valuation should reward a patient investor.

Growing fast

At the current market price of Rs 98, the Power Grid stock discounts its estimated FY-14 earnings by around 10 times, and its estimated book value by around 1.6 times, at the lower end of its five-year valuation bands. These valuations take into account the expected expansion in equity. With the fresh equity infusion meant to increase the company’s transmission capacities, per share earnings should benefit rather than being impacted. Dividend yield of close to 3 per cent also provides comfort.

Power Grid has been increasing its transmission capacities strongly over the past few years. As of March 2013, it owned and operated more than 1 lakh circuit km of transmission lines (22 per cent higher than a couple of years back) and had an inter-regional transmission capacity of 29,750 MW (nearly a third more than in March 2011).

This has translated into impressive growth in project completion, the key driver of the company’s revenues. Project completion worth Rs 17,213 crore last fiscal was more than double the amount in FY-11.

The company’s project completion and commissioning should remain healthy in the coming years. Significant thrust in the country to increase transmission capacity to keep up with investments in power generation aids Power Grid. What lends comfort is the company’s strong track record on execution. In the last fiscal, its capital investment of Rs 20,037 crore was nearly a fifth of the investment planned (more than 1 lakh crore) in the 12th Plan period. Investments worth Rs 90,500 crore have been already approved and contracts worth Rs 80,000 crore have been awarded.

Strong operations

Capacity growth has been accompanied by robust operating parameters. The company has consistently maintained transmission network availability at over 99 per cent, above stipulated norms. Meeting project timelines has enabled it to regularly earn the 0.5 per cent incentive in addition to the 15.5 per cent assured return on equity. Also, in the past, there have been cases where Power Grid has been able to recover transmission tariffs retrospectively when power generation was delayed. This provides comfort on the revenue front.

Despite the difficult financial conditions of many State electricity boards (the company’s primary customer base), Power Grid has, in most cases, been able to recover its dues, although with a delay sometimes. The company has, in fact, been able to improve its debtor days from 138 in FY-11 to 41 in FY-13. The proposed reforms in the power sector, if carried through, should provide further comfort.

Stable margins

Almost 95 per cent of Power Grid’s revenues come from power transmission, under the regulated return model. This ensures stable margins. Projects under the lower-margin, competitive tariff-based model will start accounting for a portion of the revenues in the years ahead. But with the share of such projects in estimated capital expenditure likely to be quite small (less than 5 per cent), overall margins are unlikely to be impacted much.

Buoyed by transmission capacity growth, the company’s consolidated revenues have grown at an annual rate of around 24 per cent over the past two years to Rs 13,164 crore in FY-13. Profit at Rs 4,313 crore has grown at 27 per cent annually over the last two years. The net profit margin is at 33 per cent.

Power Grid’s other businesses (consultancy and telecom) which account for around 5 per cent of revenues currently are also growing at a good pace (revenues grew 10 to 15 per cent in FY-13). But it is the transmission business which will continue to be the key growth driver.

Risks

Regulations by the CERC which provide for 15.5 per cent return on equity are applicable till March 2014. A downward revision of the returns from next year, though unlikely, will have an adverse impact.