Power sector reforms have lately taken centre stage, especially after the Union power ministry took some tough decisions to streamline the sector and make it financially viable not only for new investments, but also for the capital already deployed. We have seen major power sector players both in public and private sectors underperform the broader markets over the past 4-5 years as the penultimate buyer, discoms, were reeling under financial stress, and payment delays to the gencos had led to cashflow stress. We believe implementation of some of the measures announced, such as: 1) prepaid metering, 2) privatisation of unprofitable discoms, 3) working capital availability from banks contingent to efficiency, and 4) maintenance of letters of credit (LC) will lead to a rerating of the sector as almost all the companies are trading at the lower end of the valuation range of the last decade.
Top picks: Power Grid (TP: Rs250/share) and NTPC (TP: Rs168/share). Beneficiaries of discom privatisation: Torrent Power (TP: 320/share), CESC (TP: 892/share), Tata Power (TP: 87/share).
Although UDAY was successful in bringing down AT&C and annual financial losses over the past four years, cashflow stress increased significantly in the past 4-6 months as government department outstanding dues to discoms increased to Rs400bn, which led to delay in payments to gencos (Rs506bn outstanding as of Jun’19). We expect the historical dues to be liquidated soon. Discom reform is a time-consuming process being a concurrent subject and needing active participation of the state governments. It also involves changing behavioral aspects of consumers towards paying for the power consumed and making them realise that power is no longer ‘free’. Also, the government is looking to achieve installation of prepaid smart meters across all consumer categories, which will help reduce the dependence on banks for working capital. We expect the impact of these measures to be visible over the next two years. As stern action has been taken against defaulting discoms, we might see some disruptions in power demand in the near term, which though will be beneficial for all stakeholders over the longer term.
Key decisions that will change the landscape of Indian power sector:
- LC mechanism implemented without much dilution: With one month having passed since implementation of the LC mechanism, our channel checks suggests that almost all the states have already opened LCs, not of 30-60 days as suggested but for 1-10 days, which is still a good start. The main issue faced by the discoms is that banks are not yet providing longer-tenure LC facilities to the discoms due to their ARR-ACS gap. These are revolving LCs; however, states like Uttar Pradesh, Orissa and Madhya Pradesh, etc. have started making advance payments for their power purchases. Hence, no new outstanding is being created. However, older dues persist. This change in payment mechanism may impact demand in the short term and also purchases on the exchanges.
- National Tariff Policy wherein some tough announcements are expected
o Liquidation of regulatory assets in a time-bound manner
o Penalty on non-supply of electricity if discoms resort to load shedding
o Mandatory late payment surcharge with no scope for negotiations
o Limiting cross-subsidy surcharge
o Subsidy payments to be upfront through DBT
o Imposing penalty for power cuts due to non-technical reasons
- Group all grants under various schemes like DDUJY, IPDS, etc. into one. Link Central fund disbursements and working capital funding from banks with achievements of AT&C and loss reduction targets.
- Prepaid and smart meters to be installed across consumers in the next three years beginning with government departments.
On the previous phase of reforms in the power sector, please refer to our report released in Jul’19 here.
Please find attached report.
Source: icicisecurities
