Core growth in capacity and regulated equity to drive earnings
Major capacity addition plans: The NTPC annual analyst meeting had three interesting takeaways: (i) a major foray in 3 GW (giga watt) solar power and a bunching-up of 16 GW capacity additions could result in a 75-80% increase in regulated equity over FY15-FY18e; (ii) the regulatory cycle is easing – a new grid code and tariff policy should jointly provide Rs 5-6 bn (6% of profit after tax) relief from earlier regulations; (iii) operating costs are being reduced-this imported coal target is down due to improved domestic output. With the stock trading at a 35% discount to mean, the risk-reward appears favo-urable —NTPC is our top pick with 28% upside potential to our R173 target price.
NTPC getting its strategy right: The company has realised the futility of IPP (independent power producer) acquisitions, and now prefers solar for faster capital turns. NTPC is partnering with states to acquire a few reasonable assets such as in Jharkhand, DVC and Rajasthan and a few others. It has reduced opex (operating expenditure) and improved efficiencies by about 1% (heat rate and aux power consumption) in FY15.
Also, the regulator has moved a note to allow 3-5% (R5.5 bn) compensation for heat-rate degradation for partial utilisation if there is low demand. It will likely be cutting its costs through reduced coal imports in H2 (target reduced to 12mt from 16 earlier) given better domestic coal availability, also leading to higher utilisation for non-pithead projects.
Capacity addition driving earnings growth of 70%: NTPC gets cost and RoE (return on equity) recovery based on 83% plant availability (PAF).
PAF improved due to higher domestic coal availability. Incentives are earned on >85% utilisation (PLF)— but this is now reduced to just 2% of profit after tax. Hence, core growth in capacity and regulated equity- more than utilisation—will likely drive earnings (70% in three years) and the share price. Capacity addition is a
long-term strategic decision that is not altered by short-term demand shocks.
Risk-reward turning favour-able: Valuations are reasonable at 1.2x FY16e P/B (price-to-book ratio) with RoE forecast to improve from 10.5% in FY15 to 14.3% in FY18e due to a 21% CAGR (compound annual growth rate) in the regulated equity base over the period. We use an average of DCF (discounted cash flow) and P/B SOTP (sum of the parts) valuations to arrive at our target price of R173. Risks include the resolution of private IPP issues and hence comp-etitive pressures, as well as earnings downside from coal quality related issues.