All eyes on Power Grid Listing

Power Grid Corporation of India (PGCIL) couldn’t have asked for a better time to make its debut on bourses. Power stocks are the toast of investors these days. Stocks of sector heavyweights like Tata Power, NTPC and Reliance Energy (REL) have been galloping in the recent past. While Reliance Energy has shot up nearly 80% in just one month, Tata Power and NTPC have gained 42% and 25%, respectively.

Power Grid Corporation of India (PGCIL) is expected to register decent gains on its debut day (Friday). Even the most conservative market players are betting on a listing gain of 15-20%. The company’s public offer, which closed on September 13, had received an unprecedented response, with the total subscription value touching Rs 1,90,000 crore. The issue was subscribed 64.50 times, with the QIB portion getting subscribed 115.47 times.

While the HNI segment was subscribed 39.75 times, the retail portion was subscribed 6.68 times. The issue price was fixed at Rs 52 per share. In a rare instance, the provident and retirement funds also bid for the PGCIL shares.

The company is India’s largest central transmission utility, handling around 45% of the power generation. It has been accorded a mini-navratna status by the government.

Meanwhile, power stocks have added sizeable chunk to investor wealth during the past one month. Tata Power, REL and NTPC have created over Rs 50,000 crore of fresh wealth. While this may still not sound too much in comparison to heavyweights like RIL, it is significant as the sector was considered a laggard until last year. While Tata Power is now trading at a PE of 30, REL is trading at 40, much above the earlier range of 15-20.

The sector came into the limelight late last year, with two ultra mega power projects being awarded and has been in focus since then. Both TPC and REL have been awarded one project each, requiring a total investment of around Rs 36,000 crore.

The project is likely to generate revenues of around Rs 6,500 crore for TPC and Rs 3,500 crore for REL. With a fresh capacity of 4,000 mw, these projects provide significant economies of scale.

The movement in these stocks seems to be a classic case of ‘irrational exuberance’ going by the numerous complexities attached to the projects and the longer-term horizon. Since it is the first time that such large projects are being undertaken in the power sector, there is a large degree of execution risk attached to it.

This contrasts with the fact that the largest-running power plant at a single location currently has a capacity of only 3,200 mw, which was commissioned in three phases over a period of 20 years. Further, since no plant based on super critical technology is in operation right now, there is a significant degree of technology risk, more so in the case of REL project, which would be using domestic coal with high ash content.

However, any downside for these projects could be limited on account of the government thrust. Since these projects have bagged the government approval, the latter has a significant stake in their success. Also, with power shortage being a critical bottleneck in the current growth cycle, the government has an interest in ensuring the success of these projects.

While that could be an important reason for these companies and investors to ignore the downside risk, the short-term prospects of these stocks from the current levels could be weak.

In fact, Credit Suisse is of the view that this sector is an ideal defensive play on account of the inelastic demand and assured returns. “These stocks are impervious to economic cycles and prone to neither big surges nor big drops in earnings, unlike growth stocks. The predictable nature of their business makes them ideal defensive plays,” adds the Credit Suisse report.

Meanwhile, NTPC is planning to double its capacity in the next five years while Tata Power will triple its capacity. Reliance Energy is also expecting to register a five-fold jump in capacity in the next five years. “While these capacities move towards market pricing, there is scope for earning more than the regulated 14% ROE, thereby enhancing the book value of these companies,” says Credit Suisse.

The power pricing formula in India is based on the total cost of the generation and a fixed rate of return. Under this mechanism, power plants are able to pass on fuel, operational and financing risk, and maintain a fixed return on equity of 14% for the generator.