India Clean Energy Transition led business model upgrade, rising peak deficits to drive re-rating – EQ Mag

We see two key themes playing out in India’s power sector –

1) Economics-led Renewable (RE) transition being driven by viability of Round-the-clock Renewables (RTC RE), which has the potential to unlock a superior business model for traditional utilities, offering higher returns and access to a better customer base, and

2) Simultaneously, the onset of a peak power deficit cycle caused by a secular rise in peak demand being met by inadequate ‘firm’ capacity addition.

We initiate coverage on NTPC at Buy (12-month TP of Rs265/sh; +42% upside) as our top pick in the sector, given its exposure to both themes. In our view, NTPC will emerge as a winner in this transition, as its ‘structural advantage’ of low cost debt will provide a strong moat. At the same time, rising peak shortages will re-rate its legacy thermal business, like in the previous cycle. We also like SJVN (initiate coverage at Buy; 12-month TP of Rs55/sh; +18% upside), for its exponential RE growth targets backed by low cost of debt, medium term earnings boost from commissioning of 2 large plants and material growth optionality from hydro and pumped hydro projects. We initiate coverage on Tata Power at Sell (12-month TP of Rs190/sh; 15% downside), given the medium term earnings headwind from global coal cost decline and limited growth catalysts in the renewables business since its partial monetisation in FY23.

Our FY24E/25E coverage earning estimates are 9%/6% below consensus, mainly as we expect a larger impact of global coal price reduction on Tata Power’s profitability and earnings slippage for SJVN on some delay in the commissioning of 2 large projects. For FY26E, ex SJVN (for which consensus estimates are not available), our coverage earnings estimates are 7% above consensus as we build in a sharper profitability ramp up for NTPC, especially in its RE business.

Given the significant differences in business models and risk-return profiles of traditional cost plus fossil plants and competitively bid renewable assets, we deploy

PM Summary

Why do we expect power PSUs (Public Sector Undertakings) to be the winners of India’s RE transition story?

For their ability to raise low cost debt.

Both, NTPC and SJVN can raise long term debt at 200-250bps lower cost than their private counterparts, in what is essentially a funding game. We view this gap as a structural advantage for PSUs, since it was largely maintained even in a low interest rate environment.

Further, the RE transition allows the PSUs to offload execution risk to EPC providers at the cost of sacrificing some EPC margins. This was the reason why a solar EPC provider like TPWR had to book provisions in FY22-23 when solar module prices surged while PSUs which had awarded these contracts were largely protected.

As per our estimates, this advantage translates to a c.150bps equity IRR benefit for PSUs while quoting the same tariff as non-PSU competitors or allows them the ability to corner disproportionate market share by quoting tariffs up to 5% lower than their private rivals.

What fuels our belief that RE transition will drive a structural upgrade in the ‘Utility’ business model?

The viability of RTC RE coinciding with the decarbonisation drive of corporates.

The corporate RE transition, in our opinion, offers a unique, economics-led c.300GW RE capacity addition opportunity. The shift of corporate consumers to RTC RE to meet decarbonisation targets, while ensuring reliable power supply at a cost lower than grid tariffs will turn ‘utilities’ into providers of ‘energy-as-a-service’. We estimate RTC RE to earn superior returns vs. plain vanilla solar or cost plus thermal coal projects, while at the same time witnessing an upgrade in offtaker profile from financially weak state DISCOMs to corporates with better credit profiles.

How will NTPC benefit from peak shortages despite having no untied capacity?

NTPC will not be able to benefit from the pricing arbitrage available in an under-supplied market, but we anticipate it to corner the bulk of the 23GW incremental coal capacity addition which we estimate will be needed over and above the government’s FY32E coal capacity addition targets, to avoid peak deficits. While the lack of private interest in thermal capacity addition is helpful to NTPC, what really works in its favor is: a) its de-risked cost plus business model, which is comforting in an era where new fossil capacities run the risk of becoming stranded before the end of their economic technical life, and b) its 20-30GW brownfield pithead coal capacity addition potential.

How SJVN’s inability to get a long term off-taker for its upcoming hydro plant can be a blessing in disguise

Firstly, we expect SJVN to sign long term PPA for Arun-III sooner rather than later given:
a) worsening peak demand supply situation, and b) it being a cross-border project requires the involvement of governments of both India and Nepal. Even in the event of the plant not finding long term offtakers, we believe open hydro capacity will allow SJVN to participate in the high margin RTC RE market, earning better returns than standalone cost plus hydro projects.

Why aren’t we constructive on TPWR’s RE business and what can change our view?

1. Lack of foray / plans to foray in large scale cost effective pumped hydro storage projects limits TPWR’s ability to participate in complicated RTC RE projects for both, corporates and DISCOMs. This, in our view, will be a relative negative, given its peers will be able to access the superior business model (for more details, see here) unlocked by RTC RE, thereby witnessing an improvement in returns and customer profile. In fact, the Average Gross Fixed Asset to EBITDA ratio of TPWR’s self developed RE portfolio is almost a notch higher than those of its listed peer, Adani Green, and that reported by JSW Energy for its recent RE asset acquisition (Exhibit 50), indicating lower capital efficiency. Incremental expansion in this performance gap could lead to a valuation de-rating.

2. Unlike its listed peer JSW Energy, Tata Power Limited management has provided little visibility on the scale and type of opportunity from Tata Group’s decarbonisation plans. It has not yet been appointed as the designated green hydrogen capacity developer for the group either. We view this opportunity as a significant lever in TPWR’s larger RE growth story and its firmer sizing / materialisation plans could be a catalyst for re-rating.