We believe NTPC and Power Grid (PGCIL) will double earnings during FY17e-24e even factoring a potential drop in regulated RoE (return on equity) from 15.5% to 14%. CERC’s suggestion of this drop for renewable energy is being seen as a read-through for NTPC’s and PGCIL’s FY20e-24e regulated regime. We believe NTPC’s FY17e-19e double-digit EPS CAGR and capacity addition delivery in tandem with gradual power demand recovery will see it move higher.
Regulated RoE has followed interest rate changes: Incrementally, large-scale, renewable energy projects are based on competitive bidding or state-linked feed-in tariffs. For FY18e-20e the draft paper is suggesting 14% regulated RoE based on 700 bps premium to recent 6-month G-Sec average rate. NTPC and PGCIL’s current regulated regime is for FY15-19e, with the next review expected in December 2018 for FY20e-24e. FY15e-19e saw regulation tightening on incentive structures with stricter norms. Our interactions suggest that for the next period, some leniency might come through. While it is too early to call, we found that even if the regulated regime changes to 14% ROE, FY20e should see +1% and +4% y-o-y EPS growth for NTPC and PGCIL.
NTPC — regulated equity to double in FY16-24e: NTPC
(NTPC IN, Buy, R162.15) is currently executing close to 28 GW of projects. Of this we believe 15.6 GW will be commissioned during FY18-19e, and will be its near-term double-digit earnings growth driver. R414 bn end-FY16 regulated equity should rise to R599 bn end FY19 and further to R850 bn by end FY24e. Management has been focused on improving operational efficiencies.
Power Grid — gross block growth to gradually slow down: PGCIL will also see its gross block double during FY16-24e, based on its existing planned outlay. However, earnings growth will peak for the company in FY17e as gross block growth has peaked in FY16. PGCIL also has limited incentive upside and will see earnings entirely impacted by change in regulated ROE.
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Focus on near-term earnings growth and valuations: Utility companies are typically valued on a P/B basis, given regulated RoE business nature. Theoretically a drop in regulated RoE should not see a company de-rate on a P/B, given lower cost of equity ascribed to new rates. We believe over the next 18 months focus will be on earnings growth and capacity expansion linked upside, with regulatory change moving to the background as RoE change is driven by drop in rates.