Event: The CERC (Central Electricity Regulatory Authority) earlier today released draft regulations for power trading margins (open for public comments till 10th Nov.,2009).

Impact: We expect this to have a neutral to positive impact on all power trading companies.
The key take-away from these regulations is increase in margins for power traders, from the present flat rate of 4 paise per unit to 1.5% of the purchase price (subject to a maximum of 7 paise per unit – if sale price is more than Rs3 per unit, and maximum of 4 paise per unit – if sale price is less or equal to Rs3 per unit). These regulations are applicable for short-term trades, either through bi-lateral agreements or through any of the power exchanges.

PTC India (Not Rated)
We believe that these regulations, if finalised, would be positive for the company. PTC India is the largest power trader in India with a huge ~40% share. The company derives 44% of its volumes from short-term power trades (FY09: short term power traded volume: 6,064 mn units; total power traded volume is 13,825 mn units). The average selling price for the company was Rs4.60 per unit in FY09, and the average margin was 3.66 paise per unit. Given the company’s revenue and volume composition, we believe that these new regualations can only help the company increase its profitability as all the increases in the regulated margins would flow directly to the bottom-line.

Note: Our assumptions include increase in average trading margins from 3.66 paise per unit to 6.0 paise per unit, and a 20% growth in volumes. In Q1FY10 PTC India’s power traded volumes were up 56% YoY to 4,204 mn units, with average realisation at Rs5.64 per unit and margin at 5.21 paise / unit.

PTC current trades at ~25x the FY11 consensus EPS of Rs4.22. We expect these estimates to be upgraded by at least 60%-70%, indicating that even after the today’s run-up in the stock price, PTC India trades at ~14.8x FY11 estimated EPS.

The other players that could benefit include Tata Power.

The Cabinet to approved changes to the mega power policy, with the modifications focusing on ensuring simpler procedures giving benefits to economies of scale and harmonizing this policy with the National Electricity Policy and Tariff Policy.

The key changes are as under:

• All power projects with a capacity of 1,000MW and above would now be classified as a Mega Power Project. The earlier policy stated that projects with capacity of 1,000MW and above and supplying power to more than one state would be eligible for classification as a mega power project.
• All the benefits of the Mega Power Policy would also be extended to projects using super-critical technology provided these are awarded through the International Competitive Bidding (ICB) route and the equipment supplier sets up indigenous manufacturing facility.
• The mandatory requirement of awarding equipment order through ICB would be waived provided if the project has been awarded through tariff based competitive bidding or the supply of power is tied up through tariff based bidding.
• All benefits, except basic customs duty of 2.5%, would be available for brown-field expansion of existing mega power projects. This would apply even if the capacity expansion is less than the qualifying threshold for mega power projects (700MW in J&K, 1,000MW in other states). However, the unit size/s should not be less than the earlier phase.
• While the present 15% price preference to domestic equipment suppliers for cost-plus projects of PSU’s will continue, an exception has been introduced in the form of projects which are awarded on tariff based bidding. A committee under the Planning Commission would be set-up to suggest options and modalities to access and rectify the disadvantages that the domestic equipment industry may suffer as a result of this change in policy.
• Mega power projects would be allowed to sell power outside long term PPA/s, in addition to having tie up power supply through Long Term PPA/s.
• The existing condition of distribution privatization by power purchasing states will be replaced by the condition that power purchasing states would be required to undertake distribution reforms as laid down by the Ministry of Power. Thus, as against the earlier policy of distribution reforms being mandatory at the state level, these can now be undertaken by the states in a phased manner as permitted by the Ministry of Power.

We believe that these changes are a welcome step in attempting to ensure faster generation capacity additions to meet the country’s power requirements. However, we also believe, and reiterate, that generation side reforms would aid the economy only to a certain extent. Without adequate transmission capacity and distribution network upgradation, either through reforms or privatisation or a combination of both, the generation side reforms will not yield the desired results.

We expect all the domestic equipment players, mainly BHEL and L&T, to benefit from these changes. Also, most of the existing power projects with capacity of 1,000MW of more do comply with the earlier policy, however these changes would spur some of the projects being planned for the 12the five year plan to change tack and sell power to a single state. Apart from the state utilities, all the major power companies, including Adani Power, JP Associates, NTPC, Reliance Power, Tata Power etc., could revisit their capacity addition plans.

Further, deferral of the mandatory distribution reforms is likely to have a negative impact on the companies banking on distribution reforms. Equipment companies in the transformers segment were banking of large-scale distribution reforms and privatisation to boost growth. Utilities such as Torrent Power and Reliance Infrastructure were aggressive in bidding and winning distribution frachanise’s, a newly emerging segment which could see a set-back.

We have already witnessed this to a small extent in the form of announcements for setting up new power projects. PowerGrid too has placed large equipment orders, on the back of increased funding availability. We reiterate our stand that continued increase in order flows for power equipment, including BTG and transmission equipment, could lead to an upward re-rating of the sector.

In line with the objective to attract new investments in the power sector, and specifically, to promote renewable energy, the CERC, which regulates inter-state power sector, announced new tariff regulations for grid-connected renewable energy power projects. These regulations assure developers of a higher return on the equity invested and indirect incentives if the developer can contain capital and operational costs.
In India, only 8.7% of the total grid-connected power capacity is attributable to the renewable energy segment. Thus at an installed base of 13,242MW, this segment constitutes merely 21% of the potential 62,853MW from only small hydro and wind power. The potential of solar, biomass and waste-based power projects is estimated to be a further 625,500MW, of which solar-based projects alone contribute 600,000MW. Thus, the solar segment alone has the potential to fuel India’s entire present electricity requirement.
We believe that the overriding philosophy of these new regulations is to promote power generation from renewable energy sources by giving a preferential/differential tariff to such projects. This, we believe, will go a long way to help achieve the target of 15% of total generation from renewable energy sources by 2020, a target set under the National Action Plan on Climate Change.

Full Report is available here.

The Pipavav Shipyard, jointly promoted by SKIL and Punj Lloyd, has set-up an integrated shipbuilding and fabrication facility. Once the fabrication facility is completely operational, Pipavav Shipyard would be the largest shipbuilding site in India capable of manufacturing ships up to 400,000 DWT (dead tonne weight) and fabricate and construct offshore supply vessels (OSVs). Pipavav Shipyard comprises two sites. The SEZ unit is located on ~95 hectares of land and an EOU located on ~103.92 hectares of land (benefits of which are available till FY12). The construction of the shipyard (excluding the offshore yard) is expected to be completed in Oct-09.

Key Data

Project Costs (Rs Mn)

Order Book

• Pipavav Shipyard has a current order book of Rs44,596 mn (USD931.63 mn). This order book requires the company to deliver a total of 34 vessels, including 12 OSV’s for ONGC.
• Of the below detailed order book only Rs23,234 mn are firm orders. These firm orders are for 10 panamax size vessles and 12 OSVs. Of the balance Rs21,362 mn, orders for 8 panamax vessels worth Rs14,469 mn are under re-negotiation and an order worth Rs6,893 mn (4 panamax size vessels) is under arbitration.

Subsidy on Shipbuilding
The Government of India had instituted a shipbuilding subsidy scheme wherein shipbuilders could avail a 30% subsidy on the cost of the ship being built from the government. The caveat is that the shipbuilding order should have been placed before 14-Aug-07. Based on this criteria, all of the present order book of Pipavav Shipyard qualifies for this subsidy. This subsidy is available only on vessels ordered through the ICB (International Competitive Bidding) route, and hence the government has assurance of the subsidy demanded being within reasonable parameters. Further, the benefits are capped at 30% of the order value, thus benefits accruing on account of the SEZ / EOU status would decrease the actual cash subsidy that the company is eligible to receive.

The cost advantage that India offered, along with the subsidy provided by the Government (up to August 2007) helped improve the order inflow in the past 2-3 years. In addition, the Indian shipbuilding industry benefitted from orders being passed on from the traditional shipbuilding countries – Korea, Japan and China – as these were fully booked. In the near future, the capacities at these shipyards is likely to be freed up, resulting in increased competition. But most importantly the 30% subsidy incentive will not be available, and hence force the Indian shipyards to compete on a purely cost advantage basis, if any.

Comparative Valuations

On a comparative basis, though Pipavav Shipyard’s superior dockyard, product facilities as well as business potential from Punj Lloyd – a co-promoter – do deserve some premium to the peer-set, we believe that the inherent nature of the business continues to be cyclical, and the lack of proven execution (vessel delivery) track record correspondingly requires a discount to the same peer-set. We thus, believe that the premium demanded is unjustified, and the stock would be available at more reasonable valuations in due course.

Since CERC’s order to cap to the day-ahead power tariffs, these have been averaged to Rs2.91 per unit. On Friday evening, CERC issued its final order in this matter and has tightened the price cap from Rs11 per unit in its draft order to Rs8 per unit now. The present order is valid for a period of 45 days.
The change in pricing for the day-ahead tariffs is shown in the graph above. Since the earlier order, the highest price has been Rs10.5 per unit, and this too was on the day after the order. If this is excluded, the highest tariff was Rs6.00 per unit. We believe that this clearly highlights the effectiveness of CERC in curbing the abnormal tariffs at which power was being traded.

Given that since the draft order power traded has been at a maximum rate of Rs6.00 per unit, we believe that this final order capping the day-ahead power tariffs at Rs8 per unit for a period of 45 days would not have any impact on the stock prices of companies selling merchant power. The companies dealing in merchant power are the likes of GMR Infra, JSW Steel, JSPL, Nava Bharat, etc. We reiterate our sell recommendation on GMR Infra with a target price of Rs110. We do not expect power trading companies, like PTC India, to be impacted by this order as their margins are independent of this order, and capped at 4 paise / unit, irrespective of the power tariff or the volume.

In a related move, the CERC has permitted the power exchanges to introduce new contracts. The IEX is hence introducing the following contracts from 15-Sep-09:

• Region-wise intra-day contracts: are contracts for delivery of power on the same day. These contracts would be avaiable on a hourly-basis from 19:00 hours to 24:00 hours only. Thus, only six hourly contracts would be available in this product.
• Regional day-ahead contingency contracts: These are similar to the existing day-ahead product, except that these would be traded at the end of the day (between 3:00 PM and 5:00PM). We believe that this would help those buyers / sellers who otherwise were not able to buy / sell during the normal segment, or received late instructions from their PPA counter-party with regard to power supply the next day.
• Region-wise daily contracts: These are week-ahead contracts for supply of daily/hourly power. These contracts are available for the following blocks: (a) 8-hours night period; (b) 11-hour day period; (c) 5-hour evening peak; and (d) full day or 24-hour period.
• Region-wise weekly contracts: There would be contracts specifc to each region (north, south, east, west and north-east). In addition, these would be available in four time blocks: (a) 8-hours night period; (b) 11-hour day period; (c) 5-hour evening peak period; and (d) full day or 24-hour period.

It should be noted that all these new contracts are also based on actual delivery and cannot be settled in cash.

To us the biggest take-away is that the regulator is open to introduce longer duration contracts in power trading. We believe that more longer duration contracts would be permitted sooner rather than later ensuring a deeper power trading market.

GMR Infrastructure Analyst Meet Update

We attended GMR Infra’s Analyst Meet yesterday. Mr GM Rao address the analysts’ after a gap of about three years, i.e. the first time after the IPO. The key takeaways from the analyst meet are:

• Mr GM Rao gave the gathering a detailed view of the group from the beginning to date, and his idea of building a strong and long-lasting institution which could continually grow.
• He also mentioned that the group has an internal benchmark hurdle rate of at least 16% IRR for all their projects.

• The presentation mainly concentrated on a brief about the various operational and the under-development projects.

1. Airports – Delhi, Hyderabad and Turkey
2. Power – 823MW of operational power projects, 5,610MW of under development thermal power projects, and 1,190MW of under development hydro power projects. These include two hydro power projects (550MW) in Nepal. In addition, GMR Infra has acquired a 800MW under development gas-based power plant in Singapore.
3. GMR Infra’s parent company has acquired a 50% stake in InterGen which operates 8,086MW of power plants in various locations across the globe (UK, Netherlands, Mexico, Philippines and Australia).
4. Roads/Highways – six operational highway projects (three annuity-based and three toll-based), and two recently awarded under development projects.
5. Urban Infrastructure – this vertical mainly centres around developing SEZ’s. The group is developing a SEZ at the Delhi International Airport, two at the property around the Hyderabad Airport, and one near Chennai.

• The last few slides on the presentation detailed the present debt-equity position of the group. The presentation states that the present Networth is Rs84.25 bn, while its debt stands at Rs123.38 bn, indicating a debt-equity ratio of 1.5. It was further highlighted that on a standalone basis GMR Infra has a net cash position of Rs3.23 bn. The debt on the books of the various project SPV’s is Rs126.61 bn.
• To underscore the debt position, the management then highlighted the debt in each of the various project SPV’s and mentioned that the debt is largely on a non-recourse basis to GMR Infra, with the door-to-door tenor varying from 10 years to 17 years.
• Lastly, and in our view most importantly, the management indicated that they would be required to raise equity of Rs60.0 bn in the current fiscal, and another Rs15.0 bn within the next two years. This equity is planned to be raised as under:

It may be recalled that during the FY10Q1 results conference call the management has stated that they would not be raising any equity in the current fiscal and the funding requirement was not immediate (with the exception of small equity infusion required in the recently awarded road / highway projects). We, however, have estimated that the group would need to raise Rs45 bn in equity and another Rs182 bn as debt over the next three years.

Our estimate for the equity requirement is lower as it is based only on the existing projects at hand. We believe that the incremental equity issuance would partly take care of the funding requirements stemming for newer projects.

At current valuations, we do not believe the market factors in the risk associated with multiple projects, and execution issues therefrom. We find it difficult to justify the growth premium accorded by the market to the stock.

P.S.: The shareholder’s have approved a stock split from a face value of Rs2 per share to Rs1 per share. The record date for the stock split is 3rd Oct-09

CERC has, through a draft order, annouced that power tariff for all day-ahead transactions is capped at Rs11 per unit (kWh). This cap is applicable to all merchant power transactions whether through the power exchanges or on a bi-lateral basis. The CERC has also stated that this order is valid for the next 45 days, during which time (on 8th Sept, 2009) it would hold a public hearing. The commission would review it’s decision after these 45 days.

As of now, the power exchanges trade only in the day-ahead segment, all transactions for longer durations are on a bi-lateral basis. We do not rule out CERC capping these rates in the near future.

Since the beginning of the current water year (June 2009 to May 2010) the power tariff on the IEX has been higher than Rs11 / kWh on 20 days, with the max price reaching Rs17 / kWh on 13th Aug., 2009. Similarly, in the current water year there have been 9 days when the average price has been higher than Rs11 / kWh. Today the power day-ahead rates on the IEX was Rs3 / kWh to Rs12 / kWh.

As mentioned in our earlier reports (see below) this would be negative for players with large merchant / captive capacities. Further, we do not expect this to have any impact on power traders such as PTC as their margins are capped at 4 p/kWh, irrespective of the purchase / sale price of power.

We expect this to be negative for GMR Infra which sells merchant power from its Tanvir Bawi power plant. The other stocks which could be negatively impacted are JPSL, JSW Steel, Nava Bharat, etc.

Links: (1) Draft Order, (2) Public Notice

We released a short thematic report on the impact of rainfall on hydro power generation and merchant power rates. The key highlights are:

• Hydro power generation continues to be lower (-14% in July 2009 and -11% YTD FY10) than that in the previous fiscal.
• Hydro power generation, though lower than in the last fiscal, was maintained on account of drawal from the reservoirs. This had resulted in the reservoir levels depletion to precariously low levels of 9.9% of the full potential.
• However, rainfall deficiency, as measured by the deviation from the normal rainfall, has reduced by the end of July 2009.
• However, the distribution continues to be uneven, with the north and north-east regions facing more deficiency than the western and southern regions.
• We believe that if the rainfall quantum and pattern stays on tracks as at present hydro power generation could improve.
• We note that the short term merchant power tariffs quoted on the power exchanges are not a benchmark. This is so because of (a) the power traded on these exchanges is on a day-ahead basis, i.e. based on power to be delivered the next day. We do not yet have longer duration power trading contracts on these exchanges, and (b) the total volumes on both the operational power exchanges constitutes only 0.7% of the total power generation in India.

COMPANIES IMPACTED:

• Based on our analysis, we expect NHPC to be able to increase generation, particularly from its hydro-power plants in the north-eastern region. During Apr-Jun 2009, NHPC’s generation was 2.4% higher than that in Apr-Jun 2008, and 5.5% above the targets for the same period. Jaiprakash Hydro (JP Hydro), whose entire hydro capacities are in the northern region, was the worst affected with its hydro generation for Apr-Jun 2009 dropping 10.3% YoY to 946MUs. Tata Power’s all three hydro-power stations are in the western region and have largely not been impacted. Tata Power’s hydro-power stations generated 369MUs in the period Apr-Jul 2009, up 10.3% from the corresponding previous period.
• While utilities such as Tata Power & Torrent Power would benefit to the limited extent of merchant capacity, utilities such as GMR Infrastructure, Adani Power etc. which have larger merchant power capacities would benefit in the short term from higher merchant / spot prices. In addition, players in the metals sector such as JSPL, JSW, Nava Bharat Ventures etc., with large captive power plants, would also benefit. Power trading firms such as PTC would benefit only due to increased volumes, as their margin on inter-state power trading is capped by regulation.
• All the other major players in hydro-power generation are either unlisted or have projects which are still in the development/construction phase (GMR Infrastructure, GVK Power & Infrastructure, Lanco Infratech, NTPC etc.).

Merchant / Spot Rate on the Power Exchanges

Note: Spot rate on the power exchanges refers to the rates for power to be supplied the next day (day-ahead rates)
The spot prices of electricity had been trending downwards since the beginning of May, which was also the peak summer season when one would have expected the spot rates to rule higher. From Rs15.00 per unit at the high point on 1st May,2009; by the end of May, 2009 the scenario was such that there were no buyers (implying a zero rate) for a period during the day.
However, the past three weeks since 26th July, 2009 the rates for short-term power has shot up from Rs2.68 per unit to Rs12.83 per unit on 11th August, 2009 (yesterday). More significantly in the past week alone the electricity rates have increased from Rs6.36 per unit.

Spot prices since Jan 2009

Spot prices since May 2009

Given the operating mechanism of the power exchanges in India today, all the trades are based on actual delivery and on a day-ahead basis (i.e. for power to be supplied the next day), and hence it is difficult to precisely forecast what can it expected in the next fortnight or month.
We believe that concerns stemming from lower than normal rainfall, with a possibility of drought in substantial parts of the country, is driving short-term power rates higher. We also believe that if the rainfall situation does not improve, power shortages would increase over the next two months, resulting in even higher power prices.

While utilities such as Tata Power & Torrent Power would benefit to the limited extent of merchant capacity, utilities such as GMR Infrastructure, Adani Power, etc which have larger merchant power capacities would benefit in the short term from higher merchant / spot prices. In addition, players in the metals sector with large captive power plants such as JSPL, JSW, Nava Bharat Ventures, etc would also benefit. Power trading firms such as PTC would benefit only due to increased volumes, as their margin on inter-state power trading is capped by regulation. However, it should be noted that the power is not storable & that the total volume of power traded is still very low in India.

Thus, though these rates are not a benchmark, they do offer some indication.

Note: All analysis based on data from IEX, one of the two operational power exchanges in India.

GMR Infrastructure

GMR Infrastructure‘s holding company plans to list itself on the London Stock Exchange. We believe that this would be positive for the stock as it would ease funding pressure for the group. GMR Infrastructure is slated to deploy a total of about Rs227 bn over the next three years, of which about Rs45 bn would be GMR Infra’s equity contribution in various SPV’s, & an additional Rs182 bn would be raised as debt funding for these projects. This does not include the USD1 bn bridge loan availed to acquire a 50% stake in Intergen and is due for repayment in May 2010.
[Business Standard]