UP Discoms: Mounting cash losses; a technical challenge
Inefficiency is the main reason; revenue gap/unit near nil adjusted for inefficiency
- Uttar Pradesh, Tamil Nadu and Rajasthan contribute 50% of the total SEB losses. Past 3 months has witnessed concrete actions towards achieving financial viability, with Rajasthan raising power tariffs by 24% in September and Tamil Nadu proposing a tariff hike of 38% in November. The focus now turns to Uttar Pradesh (last tariff hike in April 2010), where the losses are largely due to inefficiency.
- Impending state elections and dependence on ST power (UP accounts for ~30% of ST market in YTDFY12) could mean that losses for UPDISCOMs may not reduce rapidly. Adoption of non-interference approach in the "commercial working' of CPSUs and Banking sector has expediated the pace of the change.
- Motilal Oswal reiterate their sector view that fuel supply remains a key challenge to be addressed. Motilal Oswal remain cautious on private IPPs and CPSUs remain their preferred sectoral theme. Buy NPTC/Powergrid.
UPDISCOMs - an overview: Uttar Pradesh Power Corporation Limited (UPPCL) houses the transmission and distribution companies, while generation is separate. Power distribution is through five DISCOMs - Meerut, Lucknow, Varanasi, Agra and Kanpur division. UP is the most populous state in India, accounting for ~20% of the population. But it accounts for just 8% of India's total power consumption. The share of the domestic segment in power consumption is high at 39% (v/s all India average of 24%), while the share of industry is low at 25% (v/s all India average of 33%). This pattern poses the key challenge. UP is among the highest loss-making states, accounting for 11.2% of commercial losses and 15.2% of cash losses in FY10.
Reliance on ST power, ensuing state elections could mean continued higher losses: ST power for UPDISCOMs has increased from 4% of total in FY09 to 10% in FY10. UP remains the highest procurer of ST power in 1HFY12, with market share at ~30%. State elections in early 2012 and higher ST power purchases could entail continued higher losses. There could be delay in tariff hike, as the petition is still not filed. Several power developers have already indicated delayed payment receipts from the state and PTC India recently stated that it is no longer taking counterparty risk for the state. Reduction in losses calls for structural improvement in efficiency more than tariff increases, in their view.
Sector view re-instated; CPSUs remain preferred sectoral theme
#1. Capacity addition not an issue: During YTDFY12, India has seen capacity addition of 7.5GW and expected to be in the range of 10-12GW for FY12, indicating second year of 10GW+ installation. Motilal Oswal believe that sizable capacity is already under construction and thus, capacity addition is not an issue over next 2-3 years.
#2. "Self Correction": Motilal Oswal had referred in their sector report that system is going under a self correction mechanism with DISCOMs putting their act in order through curtailment of high cost ST power, tariff increase, etc.
#3. Fuel supply an issue (only in near term), system not be starved of generation: In their view, the capacity addition from various sources of fuel (captive, imported coal, hydro/nuclear and limited contribution from linkage coal) could add ~40GW of capacity over next 4 years and thus, system would not be starved of generation. Increase in domestic coal production is inevitable and Motilal Oswal have already seen several interventions by Ministries (including PMO's office) to expedite the same and this, in their view, is next important leg of reforms.
#4. Focus on players with "robust" business model, post correction too, remain neutral on IPPs: NTPC (favorably placed on fuel front, strong capacity addition momentum), Powergrid (higher capitalization). CPSUs remain their preferred sectoral theme. While several private IPPs stock have seen corrections, Motilal Oswal believe that rigid PPA structures, continued uncertainty on fuel availability, regulatory headwinds, along with funding issues are likely to remain as key overhang on stock performance.
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Motilal Oswal was founded in 1987 as a small sub-broking unit, with just two people running the show. Today it has a 2000 member team with a networth of Rs7 bn and market capitalization as of March 31, 2008 at Rs19 bn.
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