Powering ahead: Power Grid - Buy

The stock of Power Grid Corporation of India has had a stellar run, doubling in the past three years.

The company’s strong business model, nearly three decades of experience in transmission, healthy financials and order-book position, have driven performance.

At the current price of ₹202, the stock is trading at 15 times trailing 12-month earnings, a tad higher than its three-year historical average of around 14.8 times.

However, Power Grid, which enjoys a near monopoly on the country’s inter-State and inter-regional power transmission network, has a good track record of timely project completion and commissioning. This ensures good revenue and earnings visibility.

Further, the company has been earning an assured return, as determined by the Central Electricity Regulatory Commission (CERC), on its commissioned projects.

While there have been concerns on a likely reduction in the regulated return, a good mix of fixed and floating rate loans and reports suggesting a lower probability of a steep fall in returns should ensure profitability is maintained.

Given the growing prospects in India’s transmission business, investors with a long, two-three year horizon can invest in the stock.

Power Grid, a PSU Navratna company, owns and operates around 1,42,989 circuit kilometres (ckm) of extra high voltage (EHV) transmission lines spread over the length and breadth of the country and boasts of 226 sub-stations with a transformation capacity of 3,11,185 MVA.

The company continues to enjoy dominance — around 45 per cent share in the country’s overall power transmission. Around 85 per cent of the Inter-State Transmission System (ISTS) is owned by the company and it has 11 wholly-owned Tariff Based Competitive Bidding (TBCB) subsidiaries. The company generates revenue through transmission, consultancy and telecom.

More than 95 per cent of revenue contribution is from transmission segment, while telecom and consultancy contribute around 2 per cent each to the total revenue.

In India, there is a huge potential for power demand. The Centre’s thrust on bolstering the country’s power transmission network, and introduction of various schemes such as Deendayal Upadhyay Yojana and Saubhagya, augur well for Power Grid.

The company has a healthy order book of about ₹1,09,000 crore as of September 2017, which comprises of ₹88,000-crore ongoing projects and ₹3,000 crore new projects. The balance ₹18,000 crore is from projects auctioned under tariff-based competitive bidding. The company continues to bag projects through the competitive bidding process. Of those auctioned during April-October 2017, Power Grid has won 11 of the 25 projects it participated in.

However the company does not earn a assured return on all these projects. Hence, increasing competition and aggressive bidding can lead to lower returns on some of these projects compared to regulated projects. A chunk of the company’s revenue still comes from regulated projects.

The main concern for Power Grid in recent times has been the possibility of a downward revision in the regulated return from the current 15.5 per cent. However, a sound funding mix (between fixed and floating rate loans), offers some leeway to mitigate the fall in returns. Of the total debt in FY17, about 34 per cent is borrowed on floating rates and the remaining at fixed rates.

Some reports suggest that a steep fall in regulated return is unlikely as the regulator would like to keep returns attractive to draw fresh investments.

Power Grid’s revenue and earnings growth, depends on the pace of expansion of its transmission network. On this front, the company has delivered well. Capex under the 12th Plan (FY13-17) stood at ₹1,12,664 crore as against the targeted capex of ₹1,10,000 crore. Capex in FY-18 first half was ₹11,949 crore. Importantly, Power Grid also has a strong visibility, having commissioned or capitalised projects worth ₹13,516 crore in the first half of FY18.

The company expects around ₹25,000-30,000 crore capex each year from FY18-FY22. Power Grid has also been identified as a key player in railway electrification projects and is implementing a pilot project for 761 rkm.

With revenue and profit linked to capitalisation or commissioning of assets, operationalising such assets is key to revenue. Power Grid continues to operationalise more assets than the capex, which is reflected in capitalisation to capex ratio at 1.13 times in the first half of FY-18 (FY17: 1.27 times, FY16: 1.41 times). With the company having a good track record of project execution, the capitalisation to capex ratio is expected to stay above 1 time (ability to make more assets operational than its capex).

Consolidated operating revenue grew at a CAGR of 14.32 per cent in the past five years (FY13-FY17) to ₹25,703 crore in FY17.

Operating EBIT margin has been in the range of 56-59 per cent during the past five years and PAT margin in the 27-31 per cent band. Operating revenue grew by 16.6 per cent yoy in the first half of FY 18 to ₹14,434 crore. Operating EBIT and PAT grew 14.6 per cent and 14.1 per cent respectively in the first half of FY18.

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