Emerging from shadows of thermal; initiating with Buy
Preferred pick in Indian power PSU utilities
We are initiating coverage on NHPC with a Buy. The investment case is premised
on:- a) 13% earnings CAGR over FY11-14E driven by bunching of 1,212MW
capacity addition and unprecedented reservoir levels, thanks to healthy monsoons;
and b) an attractive 8% earnings yield (in line with peers) coupled with reasonable
valuations at 1.1x FY12e BV (vs 1.8x for peers), post a 33% correction since IPO.
We note the regulatory framework is likely to turn favorable for the hydro sector as
India focuses on tackling peak-energy shortages in a coal-constrained
environment.
Hydro: low operational risk and working in a benign regulatory environment
Thanks to a rise in reservoir levels due to two consecutive good monsoons, we
find low operational risk for earnings in the medium term. The regulatory
environment also looks favorable as: (1) cost over-runs, if any, in delayed projects
have historically got approval for pass-through in tariffs; (2) the current cost plus
return framework of 19-20% RoE applies till 2015e vs 2011 for peers such as
NTPC, Power Grid; (3) The regulator has invited suggestions on enhancing returns
in the hydro sector to encourage investment, to reduce burgeoning peak deficits.
Bunching of new capacities could offset earnings risk from mean reversion
Our model factors mean-reversion of operating rates in FY13e/14e, as generation
in FY11/12 has been higher from good monsoons. Further, we assume 3-6 month
delays above guidance, but still have seven of its projects totaling 1,212MW
commissioning over FY12/13. Our estimates are in line with consensus.
Risk-reward looks favorable at 1.1x FY12E BV; Buy with TP of INR29/share
We value NHPC on a P/B and DCF approach, valuing operational assets at 2x P/B
(INR18/sh), and 1x for 30% equity in CWIP and cash/investments, to derive a
target price of INR29/sh. We initiate with a Buy, on 1.1x P/B, backed by 13%
adjusted earnings CAGR and the possibility of regulatory incentives (draft
regulation of Sept’10). While we build in 3-6 month delays, key risks are further
commissioning delays (9-12 months’ delay has INR1.5 impact) and generation
volume lower than design energy due to drought (INR1.8 impact). J&K govt and a
civil society group have earlier tried to take back the projects in state
Investment thesis
Outlook
We initiate coverage of NHPC with a Buy rating and a target price of INR29/share. We find
NHPC – India’s largest hydro power utility – to be amongst the better-positioned utilities in
the Indian power sector, thanks to the high reservoir levels, which should ensure high
availability and consistent returns at a time when fuel sourcing threatens to hurt thermal
producers. While so far, NHPC’s earnings have surprised investors largely due to better
water availability, going forward, we see a bunching of new capacity of 1,212MW between
FY12-13e, which would add 26% to overall capacity. More importantly, the company would
go into the next phase of earnings – which could improve RoE by 200-300bps by FY15-16e
and earnings are set to jump 45% by FY14e. We estimate EPS to rise by a 13% CAGR over
FY11-14e, which incorporates the current regulatory return norms being maintained.
However, going by statements made by the regulator, there seems to be a need to raise the
regulated returns for hydro power projects. Currently, PSUs get a RoE of 15.5% on original
equity invested and performance benchmarked incentives could vary between 1-3%. A 1%
higher RoE on equity invested could raise EPS growth CAGR by ~2%.
Valuation
We set our 12m target price of INR29/share for NHPC based on the average of price/book
(using the Gordon Growth Model) and DCF methodology. In estimating the exit price/book
multiple, we have split the book as follows: (a) Invested equity base, which gives 19-20%
RoE, growing at 12% on a compound basis over the next three years, at a price/book of 2x,
and (b) Net worth employed in CWIP and the balance, which matches the cash/investments,
both valued at price/book of 1x, as these would be invested either into assets to generate
regulated returns or be returned back to share holders in the form of dividends.
Our DCF methodology is based on a two-stage DCF method, wherein we have assumed
terminal growth of 3%, CoE of 13.0% (6.5% risk-free rate and 8.1% risk premium in line with
Deutsche Bank estimates) and with a Beta of 0.80. The beta looks reasonable to us given the
assured cash flow nature of the business, similar to other regulated utilities in India.
Risks
As it is in a project development phase, and with earnings largely being regulated in nature,
important downside risks are a monsoon failure which could impact PLF/PAF or project
delays (historically between 13-20 months). While our estimates factor in delays of 19-29
months, any additional delay could impact valuations by ~INR1.5/share on 6 months
(assuming the regulator approves the cost over-run). Further, if the PLF/PAF are lower than
our estimates by 2%, we estimate the impact on valuations could be about 5% or
INR1.5/share. Delayed payments, if any, could add to receivables and reduce the cash on the
books, which may impact dividend payments (see pages 18-19 for a detailed discussion of
risks).
Preferred pick in Indian power PSU utilities
We are initiating coverage on NHPC with a Buy. The investment case is premised
on:- a) 13% earnings CAGR over FY11-14E driven by bunching of 1,212MW
capacity addition and unprecedented reservoir levels, thanks to healthy monsoons;
and b) an attractive 8% earnings yield (in line with peers) coupled with reasonable
valuations at 1.1x FY12e BV (vs 1.8x for peers), post a 33% correction since IPO.
We note the regulatory framework is likely to turn favorable for the hydro sector as
India focuses on tackling peak-energy shortages in a coal-constrained
environment.
Hydro: low operational risk and working in a benign regulatory environment
Thanks to a rise in reservoir levels due to two consecutive good monsoons, we
find low operational risk for earnings in the medium term. The regulatory
environment also looks favorable as: (1) cost over-runs, if any, in delayed projects
have historically got approval for pass-through in tariffs; (2) the current cost plus
return framework of 19-20% RoE applies till 2015e vs 2011 for peers such as
NTPC, Power Grid; (3) The regulator has invited suggestions on enhancing returns
in the hydro sector to encourage investment, to reduce burgeoning peak deficits.
Bunching of new capacities could offset earnings risk from mean reversion
Our model factors mean-reversion of operating rates in FY13e/14e, as generation
in FY11/12 has been higher from good monsoons. Further, we assume 3-6 month
delays above guidance, but still have seven of its projects totaling 1,212MW
commissioning over FY12/13. Our estimates are in line with consensus.
Risk-reward looks favorable at 1.1x FY12E BV; Buy with TP of INR29/share
We value NHPC on a P/B and DCF approach, valuing operational assets at 2x P/B
(INR18/sh), and 1x for 30% equity in CWIP and cash/investments, to derive a
target price of INR29/sh. We initiate with a Buy, on 1.1x P/B, backed by 13%
adjusted earnings CAGR and the possibility of regulatory incentives (draft
regulation of Sept’10). While we build in 3-6 month delays, key risks are further
commissioning delays (9-12 months’ delay has INR1.5 impact) and generation
volume lower than design energy due to drought (INR1.8 impact). J&K govt and a
civil society group have earlier tried to take back the projects in state
Investment thesis
Outlook
We initiate coverage of NHPC with a Buy rating and a target price of INR29/share. We find
NHPC – India’s largest hydro power utility – to be amongst the better-positioned utilities in
the Indian power sector, thanks to the high reservoir levels, which should ensure high
availability and consistent returns at a time when fuel sourcing threatens to hurt thermal
producers. While so far, NHPC’s earnings have surprised investors largely due to better
water availability, going forward, we see a bunching of new capacity of 1,212MW between
FY12-13e, which would add 26% to overall capacity. More importantly, the company would
go into the next phase of earnings – which could improve RoE by 200-300bps by FY15-16e
and earnings are set to jump 45% by FY14e. We estimate EPS to rise by a 13% CAGR over
FY11-14e, which incorporates the current regulatory return norms being maintained.
However, going by statements made by the regulator, there seems to be a need to raise the
regulated returns for hydro power projects. Currently, PSUs get a RoE of 15.5% on original
equity invested and performance benchmarked incentives could vary between 1-3%. A 1%
higher RoE on equity invested could raise EPS growth CAGR by ~2%.
Valuation
We set our 12m target price of INR29/share for NHPC based on the average of price/book
(using the Gordon Growth Model) and DCF methodology. In estimating the exit price/book
multiple, we have split the book as follows: (a) Invested equity base, which gives 19-20%
RoE, growing at 12% on a compound basis over the next three years, at a price/book of 2x,
and (b) Net worth employed in CWIP and the balance, which matches the cash/investments,
both valued at price/book of 1x, as these would be invested either into assets to generate
regulated returns or be returned back to share holders in the form of dividends.
Our DCF methodology is based on a two-stage DCF method, wherein we have assumed
terminal growth of 3%, CoE of 13.0% (6.5% risk-free rate and 8.1% risk premium in line with
Deutsche Bank estimates) and with a Beta of 0.80. The beta looks reasonable to us given the
assured cash flow nature of the business, similar to other regulated utilities in India.
Risks
As it is in a project development phase, and with earnings largely being regulated in nature,
important downside risks are a monsoon failure which could impact PLF/PAF or project
delays (historically between 13-20 months). While our estimates factor in delays of 19-29
months, any additional delay could impact valuations by ~INR1.5/share on 6 months
(assuming the regulator approves the cost over-run). Further, if the PLF/PAF are lower than
our estimates by 2%, we estimate the impact on valuations could be about 5% or
INR1.5/share. Delayed payments, if any, could add to receivables and reduce the cash on the
books, which may impact dividend payments (see pages 18-19 for a detailed discussion of
risks).
No comments:
Post a Comment