NHPC IPO: Invest at cut-off
NHPC’s established record in implementing hydropower projects and its good operating performance are among its pluses.
The NHPC initial public offer (IPO) is ideally suited for long-term investors. Hydroelectric projects, by their nature, have long gestation periods of 5-7 years. On the existing generation capacity and financial profile, the offer appears to be fully priced. Valuations could, however, undergo a change as the company gradually commissions the different projects that are under implementation over the next four years and as the return on equity improves.
Positive features
There are a number of positives to recommend an investment in this IPO not the least of which is the 12 per cent gap between demand and supply of electricity in the country. NHPC’s established record in implementing hydropower projects, its good operating performance and the fact that all of its capacity has been tied up with different customers through power purchase agreements are pluses.
Existing capacity of 5,175 megawatt (MW) will almost double in the next four years as new projects totalling 4,292 MW are commissioned. With a further 4,565 MW of projects awaiting government clearances, NHPC is expanding rapidly in an industry that is set to undergo a lot of changes, mostly favourable to the generators.
For instance, some of NHPC’s future projects, either in whole or in part, will sell power on a ‘merchant basis’. Given the large deficit in availability of power and the active part played by traders such as PTC India, generators such as NHPC can hope for higher realisations.
Given that its fuel cost is next to nil, NHPC sold its power last year at an average price of Rs 2.03 per unit. Though this is an advantage in the merit-order despatch system where the cheapest power is picked up first, it also means that the company is not able to capitalise on the supply shortfall.
NHPC has the advantage of its projects being located on perennial rivers and it has managed a capacity index of 95 per cent on an average. This is a major plus given that the northern grid, where NHPC sells most of its generation, is extremely starved for power.
Not surprisingly, some of its projects such as Chamera II in Himachal Pradesh have managed to earn a handsome sum as fees for meeting excess demand over that projected by the consuming State electricity board.
Equity overhang
That said, NHPC also suffers from some blemishes that could, if not managed well, scar its financial performance and balance-sheet. Thanks to a historical reliance on equity funding through government grants, NHPC carries a huge equity base of Rs 11,182 crore that will increase to Rs 12,300 crore after the public offer now. A large quantum of equity funds is locked up at any given time in ongoing projects and this does not earn any return till the projects are commissioned.
The result is that the company’s return on equity is a poor 7 per cent despite it earning an assured return of 14 per cent on its equity till last year (15.5 per cent from this fiscal for the next five years) as per regulatory norms. Peers such as NTPC boast of a return on equity that is double that of NHPC’s.
The picture could change for the better in the next few years due to two reasons. First, NHPC has been off government grants since the last two years and its projects are now funded on 70:30 debt:equity with the equity coming from internal accruals. Second, as the projects under construction now start generating returns, the return on equity will gradually improve.
Cost and time overruns
NHPC’s projects are implemented in difficult physical terrain that are also often environmentally sensitive and hence require numerous government clearances. Given this, delays in commissioning projects are not uncommon, leading to big cost and time overruns.
For instance, the 2,000 MW Subansiri Lower project in Arunachal Pradesh was originally scheduled to be completed in September 2010 but the company now expects to commission it only by December 2012. The 240 MW Uri II and 160 MW Teesta Low Dam IV projects are also on a delayed schedule. Incidentally, these are among the projects that are proposed to be part-funded from the IPO now.
The increased costs have to be approved by the regulator, failing which the company will have to bear the burden.
Regulatory risk
The central electricity regulator issues a five-year tariff policy that governs NHPC’s tariffs. The 2009-2014 policy, while increasing the return on equity to 15.5 per cent from 14 per cent earlier, has changed the method of computation of annual fixed cost recovery in a manner that is adverse to NHPC. Incentives for generation beyond the design energy level have also been capped at Rs 0.80 per unit. Given the large public interest involved in the sector and also the huge demand-supply gap, it is likely that the regulator will play an active role which may not always work to NHPC’s interests.
Optimally valued
The offer price band of Rs 30-36 does not leave much on the table for investors in the near-term. The price-earning multiple of 30 at the lower end of the price band is almost the same as that of Jai Prakash Hydro and higher than NTPC’s PEM of 21 based on historical earnings.
In price-to-book-value (P/BV) terms though, NHPC’s offer price compares favourably with the rest. At the offer price band, NHPC has a P/BV of 1.8-2.2 times; JP Hydro’s, in comparison, stands at close to four times while NTPC has a P/BV of three.
Given the high institutional interest in the power sector and the company’s fundamentals, it is likely that the stock will attract much attention in the market. Investors with a long-term holding strategy can subscribe to this offer.
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