After the recent correction in NTPC’s share price,we upgrade it to buy as valuation at 1SD below mean could rerate on the back of: a potential cut in interest rates; & initiation of two structural reforms –policy mandating shut down of inefficient and old power plants,and policy permitting optimisation of coal usage.
However, decline in interest rates could persuad the Central Electricity and Regulatory Commission to cut FY20- 24 regulated RoE, and thus, we build 100 bp cutin regulated RoE to 14.5%. Despite lowering our RoE estimates, we expect EPS growth of 20% in FY19E/20E, RoE of 12% by FY 20E led by 19 GW capacity addition in FY18-20. Our India economist expects a final 25bp rate cut on February 7, 2017, which could further pull down the 10-year g-sec yield by 20bp to 6.6%.
Valuation of NTPC,an electric utility with an assured RoE, tends to be inversely correlated to 10-year G-Sec yields. Thus, in our view, further decline in 10- year G-Sec yield could rerate its valuation of 1.2x FY18E P/B, 1SD below mean. Once in every five years, CERC reviews the power tariff regulations (including regulated RoE) for generating stations.
Historically, CERC has changed regulated RoE thrice in the last four regulations: (1) 16% during FY01-04, (2) 14% during FY0 -09 and (3) 15.5% during FY10- 14/FY15-19, considering: (1) change in interest rates; & (2) internal accruals required to fund capacity addition.