NTPC IPO: How good is it?

The key objective of this issue is to fund a part of the generation capacity expansion program that will require a capital expenditure of Rs 415 bn (1.6 times FY04 revenues). The issue size in the range of Rs 45 bn to Rs 52 bn will fund 10% to 12% of the estimated capex.

NTPC is the largest power generating company in India with a nationwide presence. The installed capacity of NTPC stands at 21,435 MW in FY04 which is around 19% of India's total installed capacity (the total capacity of the country is 112,058 MW).

Of this, 13 are coal-based power stations (82% of the generating capacity) and 7 are gas-based power stations (18% of the generating capacity). In FY04, the company generated 149.2 bn units of power and accounted for 27% of the total power generated in the country. This represents a growth of 5% YoY.

Talking about the performance of its power plants, the PLF (plant load factor or capacity utilisation in crude terms) of NTPC's coal-based plants in FY04 stood at 84% as compared to national average of 73%. The overall PLF of the company was lower at 80%, due to lower PLF of its gas-based plants (due to the shortage of gas).

The average selling price of electricity of the company in FY04 stood at Rs 1.47 per unit, which is extremely competitive in India (Rs 1.27 per unit for coal-based plants and Rs 2.41 for gas-based plants).

In the past, SEBs (the State Electricity Boards) have been buying more that 99% of the power generated by the company. As per the agreement (post the Securitisation Bill), each of the SEBs are required to establish LCs (letter of credit) with commercial banks in favour of the company, which covers 105% of the average monthly billing for the preceding 12 months of sale.

To that extent, the payment for power sold to the financially weaker SEBs is secured.

India has largely been a power deficient country, with the peak demand-supply mismatch running into double digits (11.2% power shortage in FY04). Though the generation capacity of the country has almost doubled in the last decade, it has not kept pace with the growth in demand, which is also a factor of economic growth (generally higher the economic growth, higher is the demand for power).

The per capita consumption of power in India stood at around 526 units by the end of FY04, which is abysmally low as compared to China's 1,470 units and world average of 2,300 units.

Demand for power traces economic growth (read GDP) in the long term. Just to put things in perspective, the Chinese economy grew at a CAGR of 10% over last 13 years and in the same period, generation capacity increased by 9%.

The same is the case with India. While the Indian economy has grown at a CAGR of 6% over the last 13 years, the generation capacity also grew at a similar rate, which substantiates our argument. In this backdrop, the long-term growth prospects of the sector remains promising and could potentially outpace GDP growth (given the power shortage and the lack of availability in the rural areas).

If we look at the power generation capacity break-up in India, the state governments dominate with almost 58% of the capacity, followed by the central government undertakings (32%) and the rest is accounted for by the private sector players (10%).

The government plans to add 150,000 MW of generation capacity over the next decade (including 100,000 MW of thermal capacity and 50,000 MW of hydro capacity). This is almost 1.5 times the current capacity.

Appetite for power yet to be addressed:  As we had mentioned above, India is largely a power deficient country. The table below shows the demand supply gap in the country over last 5 years. During FY04, the peak shortage of power stood at 11.2% (i.e. demand exceeded supply).

The government has set an ambitious target to improve the current per capita consumption of power (526 units) to over 1,000 units as per the 11th five-year plan (2008-2012). NTPC, being the largest power generation company in India, is likely to play a lead role towards achieving this target.

The point we are trying to emphasis on is that for a developing economy like India, despite the large-scale expansion plans, demand is not an issue at all.

Here is the gap...

Dominant player in the sector:  NTPC has installed generation capacity of 21,435 MW (Tata Power had 2,279 MW of capacity and Reliance Energy had 940 MW of capacity in FY04). The PLF of NTPC's plants is higher than the national average (around 79.5% as compared to 73% for the industry). Since the plants are present across the country, it does not depend on any one circle for selling its power (unlike Tata Power and Reliance Energy).

Since 82% of the generation capacity of NTPC are coal-based, the cost per unit is much lower than the national average, which is a competitive advantage in itself.

Expansion plans:  Of the targeted 41,110 MW capacity addition targeted under the 10th plan (2003-07), NTPC has been assigned around 9,370 MW (almost 23%). Of this, NTPC has already installed 2,000 MW and the rest are in different stages of completion. The company has also declared that it plans to add 11,558 MW capacity as per the 11th plan (2008-12).

That means, the total capacity addition in the next 8 years will be around 19,000 MW, which is 89% of the company's current capacity. Thus, it becomes clear that NTPC will continue to dominate the Indian power sector over the next decade.

Efficient player:  When one compares NTPC with one of China's major generation player, Huaneng Power, we found that NTPC compares favorably on all the broader parameters (table below). The PLF of NTPC is much higher as compared to Huaneng Power, which shows that NTPC utilizes its capacities in a better way.

PSUs are often criticized for over staffing, but it doesn't seem to be the case with NTPC. While the revenue per employee is also higher for NTPC as compared to Huaneng Power, it is lower as compared to Tata Power because Tata Power benefits from higher realisation in the Mumbai region. The per employee power generation figure is higher for NTPC.

Vis-a-vis: Among the best...

The default risk is reducing:  The company has PPA (power purchase agreement) signed for almost 99% of the power it produces with various SEBs. Post the amendment of the Securitisation Act, the recovery rate of dues from SEBs has improved significantly (100% in the last year). Defaults and delayed payments have been a big issue for generation companies, as they were unable to plough back the money into expansion in a planned manner.

We expect the benefits of the path breaking Securitisation Bill to accrue to players like NTPC, which will further reduce the risk of default. While this is on the customer side, on the supplier side, NTPC also has long-term agreements for supply of the key raw material (25 years for coal), which is a positive.

Lower D/E:  The current low debt to equity ratio of the company can be considered as a negative, given the fact that generation companies are guaranteed a 14% return on the capital employed on power projects (the suggested debt-equity mix is 70:30). But it also would enable NTPC to raise funds to finance its future expansion plans without delays (at cheaper rates too).

Government intervention (State and Central):  One of the biggest risks for generation players is that the Government decides the returns indirectly (tariffs). Recently, the post tax return on the equity of central power generating units was reduced from 16% to 14%. If it were to reduce further, it will have a negative impact on the NTPC's earnings (likely to have a negative impact in FY05 itself). Besides, policy decisions (say, free power) may affect the financial health of SEBs, which in turn could impact NTPC's profitability.

Limited gas supply:  Due to lower gas availability, the PLF of NTPC's gas-based plants (18% of the total capacity) remained very low at 68%, which ultimately impacted the company's overall PLF. If the gas supply remains irregular, the capacity utilisation levels may remain subdued.

Execution risk:  Considering the huge capex plans of NTPC (Rs 415 bn), if there are any delays in the execution of the same, profitability may suffer. Also, the company is planning to venture into power trading and power distribution in the future, which requires different skill sets. The decision to acquire coal-mines (for securing supply) has its own risks as well.

At the upper band of issue i.e. Rs 62, the stock trades at price to earning multiple of 12.8 times adjusted FY04 earnings. On a price to book value basis, the stock trades at 1.4 times. Though valuations look stretched as per FY04 financials, looking at the growth plans, we believe earnings will grow at a faster pace in the long-term.

As per our estimate, the per-share asset value of NTPC stands at Rs 72. And investors should keep in mind that it is just the asset value as on today. Besides, on a P/E multiple, the valuation of stock may look stretched. But investors should also consider the fact that NTPC's cash and investments per share stood at more than Rs 21 on the post issue equity base.

Overall, positives outweigh negatives from a three-year perspective.

A comparative view...