NTPC remains our top pick in power utility space. With sector macros turning positive and core RoE improving, we expect valuations to be re-rated
NTPC’s recurring PAT at Rs 26.4 bn was 15/8% below our/consensus. Dark spread rose 9% – implying fuel under-recovery not entirely gone. Q1 was weak: (i) 28% rise in interest cost on working capital, railway advances; (ii) higher DSM-related loss (Rs 1.3 bn) in Q4/Q1 from 4th regulation; (iii) Lesser GCV on carpet coal stock at Vindhyachal, Rihand, Kahalgaon, and Farakka led to Rs 1.5-bn SHR negative impact.
DSM was a procedural issue; however, its financial impact to this extent was beyond anticipation. We also spoke to CERC and it corroborated 5th DSM regulations on 28th May’19 should bring in relief. Company clarified DSM regulations have been amended in Jun’2019 and impact would recede from Q2. Cut FY20/21e EPS by 2% each on higher interest cost; retain Buy with TP of Rs 164 on recovery trend pushed to Q2 on interim regulatory issue.
Positives from new regulations to play out in Q2: Ebitda/unit improved 10% aided by benefits arising from GCV relief—full benefit to reflect from Q2 as few plants continued to use old coal stock. Expect under-recoveries to be eliminated with 500 bps improvement in PAF to 91% in Jul’19.
Achieves 30% of FY20 capacity addition target: Added 1.5 GW in Q1; FY20 target of 4-5 GW. Net regulated equity grew 4% to Rs 531 bn; impact of regulated equity on old plants was ~Rs 4 bn (3% of PAT) – as expected.
Core RoE to normalise to 22%; valuation compelling: We expect regulated business to grow at 10% CAGR on 4-GW capacity addition p.a. for next 3 years and FGD to add 13-15% to incremental regulated equity base with Rs 260-bn additional capex over four years. This coupled with reduction in under-recoveries should drive higher PAT growth of 15% CAGR over FY19-22E. NTPC remains our ACE pick in the power utility space. With sector macros turning positive (6-7% power demand growth, payment security through LC) and core RoE improving, we expect valuations to rerate to 1.4-1.5x P/B. At CMP, NTPC trades at 1.1x P/B on FY20.
DSM violation charges – as high as ~Rs 1-2 bn/quarter
As per 4th DSM amendment issued on Nov’2018 – “The change of sign should take place at least once after every six time blocks. Accordingly, the entity, starting from time block t1, should change the sign after time block t6. In case, sign change does not take place immediately after time block t6, but takes place from time block t7 up to time block t12, additional charge shall be levied equivalent to one violation.” – Direction change after 6th block.
As per 5th DSM issued on May’2019— additional time limit till 12th block for reversal of sign and range of +/- 20 MW should be able to bring down the DSM penalties completely, as per the company.