Power Grid Corporation of India FPO Analysis

Powering India

Due to jump in commissioning of projects, there will be accelerated growth in the short term and steady growth thereafter

Power Grid Corporation of India (PGCIL), a mini ratna public sector undertaking under the ministry of Power, is the country's central transmission utility (CTU). The company owns and operates more than 95% of India's interstate and interregional electric power transmission systems (ISTS). As principal electric power transmission company of the country, it owns and operates 79,556 circuit kilometers of electrical transmission lines and 132 electrical substations as end of Sep 30, 2010.



As central transmission utility of the country, PGCIL is responsible for the planning and development of the country's nationwide power transmission network, including interstate networks apart from undertaking transmission of electricity through ISTS. As CTU it is also required to facilitate non-discriminatory open access to available capacity in the ISTS.

The company initially engaged in management of transmission assets owned by the central generating companies such as NTPC, NHPC and NEEPCO etc. But with GOI's initiative to consolidated all the interstate and interregional electric power transmission assets including transmission lines and substations of the country in a single entity, it was vested with the transmission assets of NTPC, NHPC and NEEPCO with effect from April 1, 1992 by GOI, which has acquired the same through an ordinance which was enacted in Jan 1993. Similarly the transmission assets of Neyveli Lignite Corporation and other central utilities were also vested with the company.

PGCIL was entrusted by GoI with the further responsibility of controlling the existing load dispatch centres in the country in 1994, with a view to achieve better grid management and operation. Pursuant to this decision, the control of the five regional load dispatch and communication centers (RLDC) was transferred to the company in a phased manner between 1994 and 1996.

As the RLDC operator, the company has modernized the regional and state load dispatch centers and their communication networks. In Fiscal 2009, the National Load Dispatch Centre (NLDC) was established. The NLDC is responsible for monitoring the operations and grid security of the national grid and supervises the scheduling and dispatch of electricity over inter-regional lines in coordination with the RLDCs. All bilateral transactions are undertaken through the RLDCs, while transactions facilitated by the power exchanges are undertaken by NLDC.

Power System Operation Corporation (POSOCO), a wholly-owned subsidiary of the company was established in March 2009 to oversee the grid management function of the RLDCs and NLDC and the company is in the process of transferring the movable assets of its power system operations segment to it.

The company, leveraging its strength as India's principal power transmission company, has diversified into the consultancy business. Since Fiscal 1995, PGCIL's consultancy division has provided transmission related consultancy services to over 115 clients in over 330 domestic and international projects. The domestic clients are mainly the SEBs and in international projects they are respective State Governments and local private companies. The company has an order book of more than Rs 13000 crore of projects and it works with margins of around 10-12%.

Similarly the company has diversified into the telecommunications business in 2001 by leveraging/ utilizing its nationwide transmission system to create an overhead fibre-optic telecommunication cable network using optical ground wire on power transmission lines. As at September 30, 2010, the network consisted of 20733 kilometers and connected 129 Indian cities, including all major metropolitan areas and equal presence in remote and rural areas. Currently the company has been leasing bandwidth on this network to more than 70256 customers, including Bharti Airtel, Bharat Sanchar Nigam, National Informatics Centre,Dishnet Wireless, and Tata Communications.

While the proceeds from offer for sale will go to GoI the proceeds from issue of fresh shares to the tune of Rs 3800 crore will be used to fund the capital requirements of 13 identified transmission projects.

Strengths

As transmission utility the company charges the customers a transmission charge for recovery of annual fixed cost consisting of components – return on equity, interest on outstanding debt, depreciation, operation and maintenance expenditure and interest on working capital. The return on equity is on pre-tax basis at the base rate of 15.5% grossing up the base rate for the tax factor. Thus the company's cash flows is steady with minimum downside risks. In addition to 15.5% ROE, the company is also eligible for incentives for completion of project within timeline, availability of transmission network above specified levels etc. The company's system availability in any year since its incorporation has been more than 99% as against 92% specified in the norms for eligibility of incentives. That means, every year, Power Grid's ROE is higher than the 15.5% fixed by the CERC.

The company is having about 68 transmission projects in various stages of implementation as end of Sep 30, 2010 and it has completed about 32 projects valued Rs 138.6 billion during April 1, 2007 to Sep 30, 2010 of the current 11th five year plan period. The company has spent about Rs 29,120 crore towards investment in transmission projects since the start of Eleventh Five Year Plan (2007-2012) till Sep 30, 2010 as against a target of Rs 55,000 crore for the full plan period. The company has commissioned new transmission assets worth Rs 5087.67 crore including Barh Transmission System, Kudankulam Transmission Project and Northern Region System Strengthening Scheme V in the H1FY11. This is much higher in comparison to Rs 3609.83 crore worth of assets commissioned in entire FY10 and Rs 3733.74 crore worth of assets in FY09. The company is expecting to add assets of more than Rs 5000 crore for the H2 FY'11 as well and subsequently about Rs 10000 crore worth of assets every year in next couple of years. The accelerated commissioning of new projects from out of the strong pipeline of projects going forward is expected to bring in incremental RoE in immediate term on year on year basis. The investment for 12th five year plan is expected at about Rs 110000 crore up from 55000 crore for the 11th five year plan period.

While the fixed users attached to a transmission line brings in steady revenue flow the company gets additional revenue from its transmission network by scheduling of short term open access (STOA) to non fixed users. With interregional power demand and supply disparity and increasing merchant power capacity etc there is surge in the bilateral power transactions as well as power trading through exchanges. Since the company chares a separate change / fee for scheduling such short-term open access this will be an additional source of income for the company from its existing network itself. Though such fee is determined by CERC as per its tariff norms, the rising volumes on the back of interregional power demand and supply disparity drives this stream of income for the company. Similarly the company is also expected to capture significant revenue from its large tower infrastructure in urban, remote rural areas by leasing it to the telecom service providers. Even a part of the telecom towers assets is shared with telecom players this brings sizeable additional revenue. Likewise the growing consultancy services provided to both domestic market and overseas are also to bring in good profits. Going forward, although, the revenues from Consultancy and STOA charges and Telecom business is expected to increase, the company has indicated that the core Transmission line business would continue to constitute more than 90% of total revenues.

Strong track record in project planning, execution and operation and maintenance. The availability of the transmission system of the company in the last three years being over 99.5%.

Weaknesses

As per CERC regulation the company gets return on equity in a transmission project only after the commencement of commercial operation of that project. Since the transmission projects are linked to power generation projects any delay in generation projects will result in delay in transmission projects or even in some case if the transmission projects got ready and generation projects not ready, the company will not be able to recover its fixed costs. Even if the company proves the delay is not on account of it and CERC agreed and declared the transmission project commercial, the recovery of the same until the completion of the generation project remains uncertain.

Projects such as Transmission systems for Barh Generation project, for Parbati III HEP as well as that linked to Sasan UMPP are delayed on account of generating projects getting delayed. Moreover Western Region Strengthening Scheme II and East West Transmission Corridor are delayed on account of right of way. The Western Region Strengthening Scheme IX has been delayed by 14 months on account of supplier (of transformer) side delays. Thus six out of 13 projects for which the company intends to use the issue proceeds are delayed.

The tariff policy notified by the GoI on January 6, 2006 provides that tariffs on all transmission projects to be developed after January 2011, or when CERC is satisfied that the conditions are appropriate, will be decided on the basis of competitive bidding. If the transmission projects are approved for the interested developer on the basis of competitive bidding as stated, the company's ability to adapt to such changed environment and competition has to be seen.

Under CERC tariffs, the company receives reimbursements for its operating and maintenance expenses at normative rates, rather than actual rates. As a result, if the actual operating and maintenance expenses exceed the reimbursements it receives the profitability will be reduced by the shortfall amount.

Valuation

The company's net profit has increased at a CAGR of around 20% over the past 3 as well as 5 years. For the fiscal ended March 2010 the revenue of the company grew by 7% (to Rs 7127.45 crore) and its net profit by 21% to Rs 2040.94 crore. The EPS works out to Rs 4.6 on post-FPO equity. The PE at the offer price band of Rs 85-90 is 18.4-19.6 times its FY10 EPS. The PE of NTPC which is operating in similar regulated power market is at about 18.2 times.

The company's IPO was in September 2007 at Rs 52. In the last three months, high/low and average price of PGCIL was Rs 121.25, Rs 95 and Rs 106.65, respectively. The stock's beta was low at around 0.5 which indicates low market related risks. Given the long-term growth prospects of the power sector and its dominant position and sound growth strategy, the company is a suitable low-risk investment option for investors seeking long term exposure to India's power sector growth story.