Power Grid FPO – Can it be a powerful investment?

Three years after its phenomenal debut in the capital market, power transmission giant Power Grid Corporation of India (PGCIL) is back with a Follow-On Public Offering. The company is looking to raise about Rs. 7,600 Cr. through a 10% stake dilution by the Government and a 10% fresh equity issuance.  The Government and the company will split the raised funds in equal proportion since half of the total 84.2 Cr. shares are being freshly issued by the company.

So, what’s the offer for subscription?

The price band for the follow-on public offering has been fixed at Rs. 85-Rs. 90. A further discount of 5% on the final issue price will be given to retail investors and Power Grid’s employees. The subscription period is from 9th November to 12th November 2010 and the lot size for bidding is 65 shares.
At the upper end of the price band, the issue will fetch up to Rs 7,600 crore.

How will Power Grid use the raised funds?

PGCIL has planned to use fresh equity proceeds of around Rs 3,800 crore to fund the equity portion for 13 transmission projects which is expected to enhance the transmission network by ~19,000 circuit km (ckm).

Tell me more about Power Grid…

Power Grid Corporation of India Limited (PGCIL), a Navratna PSU, is one of the largest transmission utilities in the world. The Company was incorporated in 1989 as the National Power Transmission Corporation Limited with the responsibility of planning, executing, owning, operating and maintaining the high voltage transmission systems in the country. Its core operational area includes development of inter-state transmission systems and grid management. The important segments in which PGCIL operates are : Power Transmission and Telecom.

Power transmission contributes about 95% of the total business.  It wheels about 51% of the total power generated in the country (100% of inter-regional transmission) on its transmission network. The company has also diversified into Telecom business and has established a telecom network of 20,000 km across the country. This business vertical, though contributing only 5% in total revenue, is expected to offer very good growth prospects with improving margins in the years to come.

What sets the company apart?

Huge Transmission Network & Massive Capacity Addition:

As of September 2010, PGCIL has a transmission network of 79,556 ckm and 132 substations with capacity of 89,170 MVA. The company plans to invest Rs. 55,000 Cr. on transmission infrastructure during the 11th five-year plan. Its inter-regional transmission network, where it has the monopoly position, will go up to 37,000 MW by end of the 11th Plan (2012) and to 75,000 MW by end of 2017 from current capacity of 22,400 MW (March 2010 end). During this period, PGCIL will also increase its transformer capacity by 29420 MVA and will add another 39,000 ckm of transmission network. PGCIL is also strengthening its existing transmission networks. This alongwith the higher shares of high voltage transformers will not only allow higher transmission but also reduce transmission losses, thereby improving efficiencies.

PGCIL has been continuously getting new contracts, which will continue to generate revenue for the company in near future. PGCIL has been awarded Rs. 7000 Cr. worth of project in FY10 and is expected to bag about Rs. 14,000 Cr. worth of projects in FY11.

Analysis of the financials reveals good performance:

Financial Track Record:

Analysis of the 10 YEAR X-RAY (10 year financial track record) of PGCIL shows that the company did not put up an impressive performance in the initial years. However, it has witnessed a turn-around in performance post FY 2005.

Over the last 5 years, Net Sales have grown from Rs. 2513 Cr. to Rs. 7127.5 Cr. with 23% CAGR and earnings (EPS) have grown by more than 15% CAGR (5 years). Return on Invested Capital has been moderate with an average of 11% in last 6 years; affected mainly due to the high debt on its books.

The major concern for the company is its very high debt of Rs 36,600 Cr. as of September 2010. As a result, around 20% of its operating profit is spent on servicing this debt itself (i.e. interest payments). The current Debt-to-Net Profit stands at a high level of 16 indicating that the company will take around 16 years to repay its debt at the current levels of Net Profit. However, the Debt-to-Equity ratio (adjusted for the proceeds from the FPO) is more favourable at around 2.

Performance in FY 2011

For the first half of the FY2011, PGCIL’s profits have grown by 34%, mainly due to the implementation of new projects and higher income from consultancy, telecom and short-term open access. These business segments give higher returns as compared to the returns from other regulated segments. PGCIL has also improved its share of power transmitted as a proportion of total power generated to 51% during the first half of FY2011 from 47% in FY2010. The company has maintained an impressive average of 99.8% availability (an efficiency indicator for the transmission & grid business) during the first half and has been earning incentives due to higher operational availability.

September Quarter:

In the second quarter (Q2) the company has reported a 25% jump in sales and more than 41% jump in Net Profit mainly fueled by commissioning of more than Rs 4,000 crore worth of assets as compared to about Rs 1,000 crore in the corresponding period last year. The contribution from Consultancy and Short-term Open Access (STOA) business also increased to Rs. 143 Cr. from Rs. 74 Cr. in the corresponding quarter last year. The capacity expansion for the year is on track and is expected to accelerate further in the second half. We expect a net profit of Rs. 2700 Cr. for FY2011 with a diluted EPS of Rs 5.80.

Impressive Margins:

PGCIL has maintained very healthy Operative and Net Profit margins over the last ten years. Its net profit margin has consistently been more than 30% and is expected to increase slightly in the coming years on the back of rising share of merchant power and telecom segments. These robust margins will provide steady growth in earnings for the company in the near future.

Growth Powered by Power demand:

India is witnessing huge economic growth and the Indian Power industry is at the core of this growth story. Transmission is a strong stream of the power sector and will benefit the most in the coming years. With the demand for power expected to grow at 9-10% in the next decade, demand for transmission will also grow substantially. Total power generation capacity is expected to reach to 9,50,000 MW by 2030 from current capacity of 1,60,000 MW.

Given the growth potential of the power sector and the virtual monopoly situation that PGCIL has, it will continue to be a key beneficiary of the strong growth in power generation in the coming years.
Telecom & Consultancy Businesses: Aiming at diversified growth

India offers a huge passive telecom infrastructure opportunity. Considering this, PGCIL has entered into the telecom and consultancy businesses. Though these segments are in growth phase and contribute only a small proportion of PGCIL revenues, the unregulated nature of these segments offers huge growth opportunities. PGCIL’s telecom network is currently 20,000 ckm. Considering PGCIL’s envious past execution track record in power sector and its existing infrastructure support, the telecom venture will help to raise margins in coming years.

Analysis of Market share shows consistent rise:

PGCIL has been consistently increasing its market share over the years. The company increased its share from 45% in FY2009 to 51% in first half of FY2011. Its market share is expected to reach approximately 70-75% by 2015. This will lead to a steady increase in revenue and earnings for the company in the future.

But, are there any concerns?

Massive Debt:

PGCIL has a huge debt of around Rs. 36,600 Cr. (as on 30th September) on its books which is the result of contnuous capacity additions. It is expected to invest Rs. 55,000 Cr. in new projects in the ratio of 70:30 (Debt: Equity). The company has already arranged the majority of the debt funding and the current FPO issue will aid the equity funding requirement. But the increased debt on its book will lead to lower net margins in coming years.

High Capital locked in Work-in Progress:

Currently, more than Rs 20,500 Cr (more than 30% of the fixed assets) is locked up in the form of capital work in progress which indicates a larger proportion of long term projects. This large portion of the asset is not earning any return, and is infact depressing the overall return on equity. The company has generated an average ROE of 12% in last five years. Though ROE in recent years is showing marginal improvements, company needs to commission older projects faster to generate better returns in coming years.

Thus, we can conclude that PGCIL ‘s positives include access to stable earnings, rising market share and steady improvements in margins. It has also diversified its income streams in the form of consulting revenues and also telecom transmissions.  This coupled with the expected growth in power generation and transmission capacity in the country indicate a brighter future for the company. Thus PGCIL is a very good long term bet for retail investors.

So, should I subscribe for the Power Grid FPO?

Retail investors will get 5% discount to the issue price. With this 5% discount, the maximum price a retail investor would pay for the stock is Rs 85.5 per share. According to our analysis, the FPO looks very sensibly priced and is available at an attractive valuation. Considering the historical price performance for the stock, we can expect a limited downside from this issue price. Considering all the factors, we estimate that the company will continue to grow its EPS at a rate of 15-16% on an average, in the coming years. Considering the growth prospects, industry outlook and its Navratna  status, we expect PGCIL to trade at an earnings multiple of 18 going forward. Thus, considering a PE multiple of 18 and a revised EPS growth rate band of 15-16%, the MRP (Intrinsic value) band for PGCIL comes out to Rs. 111 – Rs.121. per share.

Thus, the subscription price of Rs. 85.5 for retail investors is at a discount of around 23%-30% to its MRP. Considering the very good future growth prospects and the attractive valuation, we advice retail investors to consider subscribing to the issue, from a long term perspective.

Disclaimer: This publication has been prepared solely for information purpose and does not constitute a solicitation to any person to buy or sell a security. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations or needs of an individual client or a corporate/s or any entity/ies. The person should use his/her own judgment while taking investment decisions.

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    Out of the six scrips trading above the listing price include success stories like CIlL, C Mahendra Exports, Moil and Gravita, as well as Power Grid’s FPO and none of them seemed to have banked on ‘anchor investors’. “Sebi had made this provision as