The Hindu Business Line : NTPC: Invest at Rs 62

INVESTORS can consider subscribing to the IPO of National Thermal Power Corporation (NTPC) at the higher end of the price band with a long-term holding perspective. NTPC is a fundamentally strong company with an established presence in the power generation business.

Its plans for capacity expansion and diversification into allied areas such as power trading, distribution and coal mining augur well for its long-term prospects.

The large equity base can act as a drag on valuation in the short-term but this handicap may be overcome with earnings growth largely driven by new capacities to be commissioned in the next few years.

Leading generating utility

NTPC is a central power generating utility with a capacity of 21,435 megawatt (MW), representing approximately 19 per cent of the total capacity in the country. The company operates 13 coal-fired and seven gas-fired power stations apart from three joint-venture projects.

NTPC is a highly efficient generation company with average plant load factor (capacity utilisation) of 84.4 per cent compared to the all-India average of 72.7 per cent. In fiscal 2004, it accounted for about 27 per cent of the total power generated in the country though its share of the installed capacity is 19 per cent.

The company's average tariff per unit is a highly competitive Rs 1.47 only and this includes the more expensive gas-based power.

This advantage stems from a few factors such as the high capacity utilisation of all its stations that helps almost complete absorption of fixed costs; ensuring location of generating stations close to the coal mine enabling low transportation costs; and high operating efficiencies.

Though NTPC is mainly a thermal power generator, it has now entered hydroelectric generation in a big way. It is implementing an 800 MW hydro project at Koldam in Himachal Pradesh and has lined up three more in Uttaranchal. NTPC has long-term power purchase agreements with buyers which are mainly State electricity boards. There was a historical problem with realisations from these customers, but with the signing of the tripartite agreement between NTPC, the SEBs and the Reserve Bank of India in 2003 this problem has been sorted out. The accumulated dues from these customers to NTPC, amounting to Rs 16,400 crore, were converted into tax-free bonds carrying 8.5 per cent interest rate.

The agreement also has stiff penalties for future payment defaults including stoppage of supplies ensuring that the SEBs pay their dues on time. This has had the necessary effect as NTPC has reported 100 per cent collection for its billings in 2003-04.

The company recently ventured into allied areas of business such as power trading and distribution through two subsidiary companies. These are emerging areas with high potential for an established generating utility such as NTPC.

To integratevertically, NTPC also proposes to foray into coal mining and washery mainly to protect its raw material supply and have control on its prices.

What augurs well...

NTPC is on a major capacity expansion programme — the next three years will see the company adding another 7,370 MW to existing capacity. A further 11,558 MW is planned for execution between 2007 and 2012 taking total capacity to over 40,000 MW.

There is clarity on the regulatory front with the Central Electricity Regulatory Commission (CERC) issuing its tariff norms valid till 2009. As per this, NTPC has been assured a 14 per cent post-tax return on net worth with raw material costs and finance charges being passed through to customers, as usual. The lack of regulatory clarity especially on tariff was a major handicap till now.

As per CERC norms, all new projects are to be funded on a 70:30 debt-equity ratio which ensures minimal equity dilution in future. NTPC has healthy cash generation from operations (Rs 5,800 crore in 2003-04) which can be used for the equity contribution.

Interest on debt is a pass-through item to customers. Therefore, the large capacity expansion programme may not exert pressure on NTPC's balance-sheet.

NTPC has a good mix of coal and gas-fired projects. The finalisation of the gas supply agreement with Reliance Industries at a highly competitive price for the expanded capacity at two of its existing stations, augurs well. Of course, it remains to be seen how the agreement pans out in execution. The entry into hydropower will be a plus in the long-term as tariffs in hydropower typically decline over the years. This will be a major competitive advantage for NTPC.

The company is highly competitive in its tariff at an average Rs 1.47 per unit. This will be a major advantage in the emerging competitive scenario as the cheapest source of power will get sold first.

NTPC has a strong balance-sheet with a debt-equity ratio of 0.43, weighted average cost of borrowing of 6.95 per cent and strong cash generation from operations.

... and what to watch out for

The biggest risk stems from regulatory moves in the sector. For instance, the CERC has reduced the post-tax rate of return on equity from 16 per cent to 14 per cent from April 2004. This is expected to have an impact on NTPC's profitability and cash generation from operations. As the regulatory environment matures, more such changes in regulations can be expected, the impact of which is difficult to envisage at this point in time.

The passage of the Electricity Act last year has set free competitive forces with strong private players such as Tata Power and Reliance Energy planning major projects.

While there is enough and more room for all given the basic energy deficit of 8 per cent in the country, the key differentiating factors will be fuel sourcing and costs of generation. While NTPC appears well placed on both fronts at the moment, the picture can change.

NTPC's planned expansions involve an outlay of Rs 88,500 crore over the next decade. As per CERC norms, only 30 per cent of this, or Rs 26,500 crore, can be equity contribution, that is internal generation and fresh issue of shares. The remaining Rs 62,000 crore has to come from borrowings. A significant upward movement in interest rates in the long-term could impact the borrowing programme and, thus, affect capacity increase.

The latter can also be affected by a knock on profits and cash generation either due to competition, regulatory requirement or pressure from the government for higher dividends.

The most critical risk factor is fuel availability and pricing over the medium-to-long term. Though fuel costs are a pass-through item in tariff, high prices can push up the cost of NTPC's power, making it uncompetitive in the market.

The offer is at a price band of Rs 52-Rs 62. It opens on October 7 and closes on 14.

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