Struggle to keep LIGHTS ON in Utility sector: IIFL Capital Services

1 Jun 2023 , 10:37 AM

As Power demand outlook is strong, govt is promulgating measures to improve supplies. CEA is also suggesting the need for additional thermal capacity. Analysts of IIFL Capital Services expect CERC to adopt an accommodative stance while setting tariff norms for FY25-29; for which they continue to like NTPC (top pick) and PWGR. CESC can re-rate materially, if state implements reforms (tariff hike). Investors averse to owning PSUs will find TPW attractive (bestin-class ROCE + cash flows) regardless of its premium valuation.

Expect favourable policy framework: 

Analysts of IIFL Capital Services see Power demand growing at 5-7% in FY24, even if some industrial load switches back to captive units. In the medium run, supply < demand, for which CEA has advocated additional 13GW thermal capacity by 2030. The need could be even more if RE targets are not met (50GW p.a.). Govt is taking steps to ease out capacity adds (RE: possible cut/ lowering of import duty on panels, etc.), scheme to extend PPAs, etc. Analysts of IIFL Capital Services also see CERC adopting a more accommodative stance in its review of tariff regulations (FY25).

States need to accompany reforms: 

One can play the improving fundamentals of Power sector either through vanilla ROE utilities, or ancillary revenue models such as fuel suppliers etc.; while ROE models do not offer any operating leverage, cashflow visibility is one of the highest and to that extent, we prefer them over others. We are also monitoring reforms across states; inadequate / no tariff hikes, calibrated pace of smart metering (seemingly beneficial scheme), etc., do not bode well for sustaining recovery in the sector.

NTPC – top pick: 

NTPC is analysts of IIFL Capital Services top pick in the sector, given its 14% p.a. earnings growth on the back of capacity additions (9 GW thermal+ 2GW hydro + 5GW RE by FY26 – implying ~25% growth in portfolio) and unchanged regulatory framework. PWGR should also gain from the need to construct transmission lines; capitalisation should pick up >FY25, until which higher payout makes it a great yieldco (~6%). Analysts of IIFL Capital Services also like Torrent Power with its distribution heavy earnings (68% share), best-in-class return ratios (15-16% ROCE) and cashflows. CESC can offer alpha play, if state reforms catch up and translate into tariff hikes. For others, one can await better entry point.