By Soumya Malini & Arun Mukherjee
(Kolkatas Arun Mukherjee, who dropped out of college to turn a full-time investor at an early age, and Soumya Malani, a London School of Economics alumnus, have come to be known as smallcap aficionados within Indias investor community. They would show up at most AGMs, visit the remotest factories of a company and go chasing end-users to understand their experience with a product in their passionate hunt for good smallcaps. Arun and Soumya share their experiences with such companies from the ground in this space every now and then.)
The power sector can be broadly categorised into four segments, power generators, grids and power distributors.
Lets start with companies like BHEL which constructs power plants. Valuations of this kind of companies depend on their order books/capex cycle. Then comes the power generation companies such as NTPC and JSW Energy for whom profitability primarily depends on utilisation given for PPAs. One major advantage of such companies now is that the cost of coal is getting passed on, which wasnt the case earlier.
Third segment consists of the grids, such as PowerGrids of the world, which are like nodal distributors from state to state. Last segment belongs to guys like Tata, CESC and Adani (earlier Reliance Energy), which manage last-mile distribution. It would be prudent to note that the grids get a stable ROE kind of return while the last-mile guys get an upside on volume growth.
Basic Thesis: It takes 3-4 years to set up a new power plant. Demand has been growing steadily at 7-8 per cent a year, which is in line with real GDP growth. Capacity addition was growing at around ~15 per cent for three years in a row i.e. FY11 to FY13, which led to overcapacity and supply glut. Supply addition has slowed down to 2-3 per cent over the past six years, so utilisations are inching higher for power generating companies.
PSU companies get preference in PPAs (power purchase agreements), hence the PLF (plant load factor) for them would always be higher than that of their private counterparts. On an average it would be close to 80 per cent. Which is why PSU generation companies have higher utilisation rates.
Let us consider a simple back-of-the-envelope three-year thesis on any operational power generation private company assuming PLF at 60 per cent and no increase in tariff. So revenues and Ebitda can go up by 50 per cent for private sector power companies on the same capacities with interest and depreciation either reducing or remaining constant. So for example, a JSW Energy would see revenues at Rs 13,500 crore by FY21 and Ebitda at a minimum of Rs 4,000 crore. Interest@ Rs 800 crore given the debt repayment schedule and constant depreciation at Rs 1,100 crore would give a profit before tax of Rs 2,100 crore and profit after tax of Rs 1,500 crore. If valued at approximately seven-times Ebitda, the market-cap would automatically double.
Thats the broad thesis for all such companies in the power sector. The same model can be applied to any power generation company.
First to benefit will be the power generation companies over the next 2-3 years. Post which when the next round of capex starts, guys like BHEL will benefit. For distribution and grid companies, it will be business as usual with steady growth. As in, no earnings inflection. They should see a steady 6-8 per cent growth on existing assets. New assets, of course, will come in at a 14-16 per cent ROE.
As a thumb rule for thermal power generation plants, it costs Rs 4.5-5 crore for each MW capacity. So a 1GW plant will have a capex of Rs 4,500-6,000 crore. So if you notice a capex of say Rs 7,500- 8,000 crore per GW, just understand that it is capex gold plating (which means inclusion of costly and Read More – Source