POWERGRID: FPO price attractive (37% upside), Fixed asset capitalization and higher incentives to drive 18% earnings CAGR till FY13; Maintain Buy

FPO Issue Details: Rs76b fund raising at FPO upper band

– The Government has announced the price band for Follow-on Public Offer (FPO) of Powergrid at Rs85-90/sh for issue of 841.8m shares. The issue comprises of fresh offer by Powergrid (fund raising) upto 50% of the size, and balance offer for sale by Government (Dis-investment).

– Current issue represents 20% of the pre-issue paid up capital of Powergrid and thus, the stake of GoI would come down from 86.4% to 66.4% (dilution of 10%).

Fixed Asset Capitalization of Rs180b during FY11-12 (vs Rs66b in FY09/10) to drive near term earnings; recent CERC precedent order for commercialization of transmission network irrespective of delays in generation capacity addresses a key concern

– We expect PGCIL to achieve Eleventh Plan targeted capex of Rs550b, despite meaningful delays in generation capacity additions, given incremental capex towards nine High Speed Transmission Corridors (HSTCs). During FY08-10, PGCIL’s capex stood at Rs254b and the targeted spending in FY11-12 is Rs286b. Also, for the Twelfth Plan (FY13-17), targeted capex stands at Rs1t+, which is ~2x increase over the Eleventh Plan capex.

– Fixed Asset Capitalisation would increase meaningfully, given the expected bunching up of generation capacity additions towards the end of 11th plan period. The fixed asset capitalization stood at Rs37b in FY09 and Rs36b in FY10; and was impacted given the delays in generation capacity additions. This had resulted in higher CWIP at Rs204b in FY10, at 47% of the Gross Fixed assets.

– Capitalisation for Powergrid is expected to accelerate as more generation projects are commissioned. Management expects capitalisation of ~Rs180b over FY11E and FY12E, much higher than historical averages of Rs36b pa during FY09-10. During 1HFY11 fixed asset capitalization stood at Rs51b, up from Rs24b YoY and Rs36b in FY10 as Rs39b of projects were commissioned in 2QFY11.

– As per recent CERC regulations, transmission assets can be declared commercial even in the case of delays in generation capacity, if the transmission project has been completed. In 2QFY11, Powergrid has received in-principal approval for Kudankulam nuclear power where the transmission capacity is declared commercial w.e.f. April 09, despite generation capacity still not operational. This precedent will now enable Powergrid to approach the regulator for several such instances, and thus the impact of transmission returns getting impacted given delays in generation projects will now be minimized. We believe that this addresses one of the key concerns for the company.

Capex spending on track, to achieve 11th plan target of Rs550b; IPP projects of Rs581b has improved the business visibility

– Till September 2010, PGCIL has incurred capex of Rs235b, representing ~56% of the budgeted capex of Rs550b for 11th plan. Also, Powergrid has been largely meeting its budgeted capex guidance, as 40% of the projects are linked to system strengthening and thus, are independent of generation projects. This provides flexibility in terms of capex spend based on the schedule of generation projects on its system strengthening work.

– For FY11, Powergrid has planned capital expenditure of Rs129b (vs Rs105b in FY10), up 23% YoY and Rs169b in FY12 (up 31% YoY). In 1HFY11, capex spent stands at Rs49b (38% of the FY11 target). Also, under the Twelfth Plan (FY13-17), targeted capex stands at Rs1t+, ~2x the Eleventh Plan capex.

– In July 2010, CERC had approved setting up of nine high speed transmission corridors (HSTCs) for evacuating 42GW of private capacity by Powergrid at cost of Rs581b. Since most of this ~42GW capacity is likely to be commissioned over the next 3-4 years, and transmission infrastructure needs to come up in tandem, it would necessitate accelerated execution by PGCIL. This has led to meaningful improvement in business visibility. Also, the management stated that cumulatively Rs15b of projects have been ordered till date and a large part of the ordering will be completed in FY12/FY13.

Core earnings growth robust, Maintain BUY

– We expect PGCIL’s RAB to increase from ~Rs113b as at March 2010 to Rs211b by FY13E (increase of 2.2x), as projects of ~Rs325b are commissioned and capitalized in this period. This will lead to corresponding increase in regulatory returns.

– We expect PGCIL to report net profit of Rs27b in FY11 (up 17% YoY) and Rs33.3b in FY12 (up 24% YoY). The earnings growth is being driven by a 21% CAGR in transmission earnings till FY13. The net profit CAGR is marginally lower than transmission earnings CAGR given (1) higher deferred tax liability (as company pays MAT, while provides for full tax in books) and (2) lower other income, given conversion of cash into CWIP.

– We have valued PGCIL based on average of DCF and SOTP valuation to arrive at a target price of Rs123/sh. Stock trades at a PER of 17x FY11E and 14x FY12E and P/BV of 2.1x FY11E and 1.9x FY12E. We have already modelled the current dilution in our estimates. Maintain Buy.

Source: agio

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