Sunday, September 13, 2009
Investment with a long-term horizon can be considered in the stock of Power Trading Corporation of India. PTC is India’s largest power trading company promoted by PSU majors NHPC, NTPC, PowerGrid and Power Finance Corporation; it has a 46.5 per cent share of traded electricity volumes.
The Electricity Act defines power trading as “Purchase of electricity for resale thereof”, which means the company facilitates flow of power from surplus generators to electricity deficit customers.
An early mover in power trading, PTC has built a presence across the entire energy value chain, which includes advisory services, investments in power projects, power tolling and fuel intermediation. At the current price of Rs 87, the company trades at a trailing price earnings multiple of 20.
The chronic shortage of power has led to higher peak and energy deficits in recent times, prompting many merchant power and captive capacities, with higher return on equity, to be commissioned. This is likely to increase the trading volumes and offers immense scope for companies involved in power trading.
PTC’s nodal agency status for cross-border trading may also add to its trading volumes. Sums raised through Qualified Institutional Placement (QIPs) are likely to be deployed in acquiring equity stakes in captive and merchant power projects in the private sector, which will also aid volumes.
PTC has already signed around 37,133 MW of power purchase agreements/MoUs with various power generators for the long-term. PTC has also signed 5,990 MW power supply agreement/MoUs. PTC’s increasing focus on long-term trades reduces the seasonality factor inherent to short-term agreements. A presence across the entire energy value chain may also lift overall margins, which are thin in power trading.
At present, short-term trades contribute 52 per cent of the company’s power trading volumes and 80 per cent of the value. The CERC (Central Electricity Regulatory Commission) norms cap trading margins on this segment at 4 paise/unit; only the rest of the volumes came from medium- and long-term trades, where margins are unrestricted.
In this respect, entry by a host of new players into the power trading business could affect PTC’s short term trading volumes. It needs to be noted that the market share of PTC has already fallen from around 70 per cent in FY’06 to 47 per cent in FY’09.
Apart from energy exchanges such as IEX and Power Exchange of India, as many as 43 other players, mainly from power generation and distribution, have also bagged trading licences to enter power trading.
Power generators, such as Tata Power, Reliance Energy, have opened their own trading arms mainly to deal in the power produced by the parent companies. However, PTC’s attempts to step up volumes through long term power purchase agreements, is expected to be a mitigating factor.
If the regulatory change of removing the cap on trading margins comes through, it could trigger much better margins and earnings. This may give scope for unrestricted margins and bring in sustainable revenues. Cross-border trades for which PTC is a nodal agency, are expected to increase as more projects come up in Bhutan and Nepal. Apart from trading, the company’s forays into other related businesses also have the potential to prop up revenues and margins. The company has made an entry into fuel intermediation (procuring fuel and selling it to thermal projects) and recently signed an agreement with power projects in AP for power tolling.
Power tolling is a new business where the company supplies fuel to a power plant and sells the resultant power to other users. The company has raised around Rs 1,700 crore through QIPs in the last two financial years, helping it to invest in subsidiaries such as PTC India Financial Services and PTC India Energy. The company also plans to acquire coal mines in Indonesia which will help in supporting its fuel intermediation and power tolling businesses.
PTC India’s sales grew at 28 per cent annualised during 2006-09 driven mainly by an increase in trading volumes. The sales momentum is expected to pick up as trading volumes get a boost from new merchant power and captive projects (India has 19,509 MW of captive capacity and more than 7,000 MW is expected to come up by 2012). Increased popularity of the open access system and strengthening of the national grid will also help improve the volumes.
Thanks to strong sales growth, profit grew by 31 per cent compounded annually during the period 2006-09. For the quarter ended June 2009, net sales grew by 97 per cent, thanks to 56 per cent increase in the trading volumes owing to better realisations on long-term contracts and gaining new clients. Due to a rise in employee costs, profits lagged topline growth with a 76.8 per cent growth.
Apart from investments routed through subsidiaries, which include stake in India’s first energy exchange (IEX), it also holds part-stake in Athena Energy Venture, Teesta Urja and Barak Power (JV with BHEL). These investments will support its trading volumes. PTC plans to unlock value in its subsidiary, PTC India Financial Services, by listing it.
Delays in power projects due to various reasons are a key risk, in the light of long-term contracts PTC has signed with the generating company. Specialised energy exchanges such as Power Exchange of India, IEX (in which PTC has a stake) pose a competitive threat to PTC.
Markets were in a buoyant mood with key indices posting gains throughout the week. The Sensex reclaimed the 16,000-mark on Monday, and continued its upward journey to finish with a gain of 3.7 per cent (575 points) at 16,264. The BSE benchmark index touched a fresh 15-month high of 16,435 during the week.
Among the index stocks — Hindalco zoomed over 18 per cent to Rs 124. ICICI Bank, Sterlite, Tata Steel, SBI, Tata Motors and Reliance surged 8-12 per cent each. On the other hand, Hindustan Unilever shed 6.3 per cent to Rs 256. Maruti, Mahindra & Mahindra and DLF declined 4-5 per cent each.
Positive cues from the global markets improved sentiments and strong industrial growth numbers might become a trigger to support the current upmove going forward. As mentioned last week, the Sensex is now likely to face resistance at multiple junctures. Currently, the index is testing the 16,400 resistance, above which it will target 16,800, and 18,000 further ahead. In case of a downside, the index is likely to find support around 16,170, below which the index may dip to 15,950.
The NSE Nifty moved in a range of 210 points, touched a high of 4,889, and finally settled with a gain of 3.2 per cent (149 points) at 4,830. The Nifty seems to be on course to its target of 4,950-5,000.
From a slightly medium to longer term prespective, the Nifty, after crossing the 5,000-mark, will aim for its next target around 5,350 and 5,500.
The Sensex ended the week on a positive note amid strong global cues, revival of monsoons and as industrial production expanded for the second month in a row.
The Sensex crossed the 16,00 mark on Monday, a 15-month high, tracking strong global markets as China allowed more foreign portfolio investments and amid signs of monsoon revival. Finance Minister Pranab Mukherjee's statement in the G-20 meet signaling they would not end stimulus measures also helped market sentiment improve.
As the week progressed the Sensex held on to its gains due to positive news flow. India's monsoon remained above average for the second week in September. In addition to that, the factory output as measured by the index of industrial production (IIP) grew by 6.8% for the month of July primarily guided by the growth in the mining sector. The high growth rate comes even as the core sector grew at a low rate of 1.8% for the month.
The 30-share benchmark Sensex yesterday maintained its upmove for the sixth straight session. The Sensex gained 3.67%, or 575 points over previous week to close at 16,264. The Natinal Stock Exchange Nifty ended above the 4,800 level for the last four trading days. The Nifty advanced 3.19%, or 149 points to close at 4,829.
Jitendra Panda, Sr Vice President, Motilal Oswal Financial Services said, "Markets in the last four days have consolidated within the range of 30-50 points on Nifty. However, derivatives open interest have slowly and steadily increased. Implied volatility remains low indicating short term upside in the market."
Foreign institutional investors (FIIs) remained as buyers of stocks this week. They had purchased stocks worth Rs 2,940.05 crore this week, according to provisional data by BSE.
Among the sectoral indices, BSE metal index gained the most this week with a surge of 7.71%, owing to higher base metal prices. It was followed by Bankex (6.78%), Oil & gas (4.63%). The FMCG and the realty index were the losers with declines of 2.98% and 1.18%, respectively.
Hindalco jumped 18.07% over previous week close. ICICI Bank climbed 12.32%. Sterlite rose 11.25%. Tata Steel (9.07%), SBI (8.78%), Reliance (8.08%).
Among the frontliners, Hindustan Unilever slipped 6.28% this week, followed by Maruti Suzuki (5.12%), Mahindra & Mahindra (5.10%).
Dilip Bhatt, joint MD, Prabhudas Lilladher said, "Stock markets having moved up to this level, volatility will increase in coming days because valuations are not cheap and markets have become vulnerable. Nifty is expected to correct at this level and the correction is expected to be more than markets have moved up."
The Sanghai Composite and the Hang Seng gained after August data showed that Chinese industrial production grew more quickly than expected in the month. The Shanghai Composite rose 2.2% to post its biggest weekly gain in seven weeks.The Hang Seng Index gained 92 points, its highest closing level since August 2008. The index gained 4.5% this week, the best weekly performance since late July.
Reliance topped the value chart this week with a turnover of Rs 5,882 crore, follwed by Unitech (Rs 4,220 crore), DLF (4,043 crore), ICICI Bank (Rs 3,349 crore) and HDIL (Rs 3,030 crore).
IFCI led the volume chart with trades of over 427.03 million shares, followed by Unitech (376.30 million), NHPC (313.58 million), Ispat (293.68 million) and Suzlon (255.04 million).
The stock of Maruti Suzuki is one of the outperformers in the BSE Sensex basket over the past year. But the stock remains a preferred exposure to capitalise on the recovery in automobile sales. Though concerns about a deficient monsoon and a slowdown in exports next year have tended to impact the stock’s performance in recent weeks, the company appears well placed to weather both risks and still deliver strong growth.
Investors with a moderate return target (10-15 per cent) can consider buying the stock currently at Rs 1467. This translates into a PE multiple of 32 times trailing 12-month earnings, but one should keep in mind that earnings for the company remained depressed for most part of last year.
The company’s formidable array of products not only shielded it from the slowdown in demand last year but also helped expand its market leadership in the A2 and A3 car segments. The strong financial performance despite the input cost continuing to remain stiff is yet another comforting factor for investors. However, given the way the stock price has shot up in recent times, it may be ambitious to expect big returns in the near future.
Line ‘em up
From enjoying a 51.3 per cent market share in the A2 segment in 2007-08, Maruti Suzuki saw its market share dipping to 46.8 per cent last year. However, the launch of A-Star and Ritz has helped Maruti quickly regain lost ground and its market share now stands at 53.3 per cent in the A2 segment. This apart, the company also holds leadership in the A3 or the entry-level sedan segment, with models such as the SX4 and Swift Dzire keeping demand buoyant. Maruti’s market share in this segment is 42.7 per cent.
Though Tata Nano was perceived to be a big threat to Maruti initially, by taking away entry-level car buyers, concerns on this front have been reduced by the fact that most of the bookings for the Tata Nano have been for its high-end variant.
With the price differential between high end Nano variants and Maruti’s basic Alto quite narrow, a drastic shift to the former appears unlikely. Diesel cars, which are grabbing an increasing share of the A2 and A3 car segments, may have also helped the company maintain its position, given that Maruti’s top selling models such as Swift, A-Star, Ritz and Swift Dzire come in diesel variants.
Year 2010 may see the unveiling of Suzuki Kizashi in India. This will mark the company’s entry in the premium sedan or the A4 segment. Given that Kizashi is pitched against cars such as Toyota Corolla Altis, Honda City and Skoda Octavia, breaking into this segment may take time.
With small cars hogging the limelight world over, Maruti plans to expand its production capacities and invest more on its research and development activities. The company will deploy Rs 1,000 -Rs 1,500 crore, for the R&D unit with a dedicated suppliers’ park and test-track in Rohtak. The company’s low debt:equity ratio and annual cash flows of over Rs 1,000 crore from operations, suggest that the funding may not impose much of a burden. The recently developed Manesar plant will see an increase in its production capacity, as the company proposes to gradually shift some of its output from the Gurgaon plant.
Rural and semi-urban demand played a crucial role in Maruti weathering a tough market last year. Currently rural and semi urban markets contribute 12 per cent of the company’s total sales. While the deficient monsoon may impact rural sales temporarily, this impact is likely to offset by improved agricultural credit, the NREGA programme and accelerated government spending on rural infrastructure projects.
The payment of the second tranche of Pay Commission arrears over the next couple of months, combined with currently low interest rates, may also give a renewed boost to urban demand.
Exports account for 10 per cent of the company’s total sales and have been a growth driver for Maruti in recent months.
At present, over 90 per cent of the cars are shipped to Europe. This trend may sustain till December 2009 or possibly till March 2010, aided by the scrappage incentives currently being offered by Governments in many European countries.
However, Maruti may face some uncertainty next fiscal, once these incentives are withdrawn. The company’s strategy of expanding its target markets into Australia, West Asia and parts of Latin America may help reduce a huge blip in exports.
The first quarter of FY-10 saw the company deliver strong profit growth after closing the previous fiscal year with a 30 per cent profit decline. Aided by excise duty cuts, net sales grew by 34 per cent, while net profit expanded by 25 per cent.
In terms of risks, the company will continue to face operating cost pressures, as the cost of raw materials such as, aluminium alloys and rubber have gone up by more than 50 per cent from their lows. A change in product mix in favour of diesel variants will also add to cost. A sharp upward spiral in interest rates may also curb demand in the hatchback segment.
Investors with a low risk appetite can give the initial public offer (IPO) of shipbuilder Pipavav Shipyard a miss; the offer does not appear to be a compelling investment option at this point in time given the lack of an operational track record, relatively attractive valuations of listed peers, pricing pressures and risks of vessel order cancellations.
The shipbuilding sector is reeling under stress as a result of the downturn, with no clear signs of revival in orders.
The offer is being made at a price band of Rs 55-60; the price discounts the estimated per share earnings for FY-11 by about 18-20 times. This is at a steep premium to the listed peers ABG Shipyard and Bharati Shipyard that are currently trading at single-digit valuations.
While a premium to peers may be justified given Pipavav’s superior dock facility and multi-product capabilities, the premium demanded may not be warranted at this stage for the following reasons: One, shipyard is a sector with high cyclical risks and has traditionally traded at a discount to the broad market. Two, lack of operational track record and execution risks associated with Pipavav makes the pricing appear even more stiff at this stage. On an enterprise value to order book ratio too (as revenue is yet to flow), Pipavav is at 1.1, stiffer than the 0.3-0.4 times ratio of its peers. Earnings may however ramp up quickly post FY-11 when a good number of the vessels contracted now are completed.
The shipbuilding business of Pipavav Shipyard, no doubt, holds huge long-term potential, given the company’s well-integrated facility comprising docks, fabrication and block assembly as well as facilities for offshore products.
Business opportunity flowing from the co-promoter Punj Lloyd may also prove to be an added benefit. Investors can therefore wait out the IPO and look at buying the stock in the secondary market at a later date, when a lower price or a year or two of sustained financial performance, make the stock a more attractive investment.
The company and offer
Pipavav Shipyard is a shipbuilder with infrastructure facility to build commercial and defence vessels as well as fabricate and construct offshore rigs, platforms and vessels. With a dock capable of accommodating ships of up to 4,00,000 dead weight tonnage (DWT is the weight a ship can carry safely), the company claims to run the largest dockyard in India (on full completion).
The company commenced its commercial production only on April 1 this year and is at present building four vessels which it seeks to deliver by April 2010. It hopes to raise Rs 470-512 crore from the current offer, which would expand its existing capital by 15 per cent. A good part of the proceeds would be utilised towards working capital requirement and the rest towards capital expenses.
Huge order book but…
Pipavav has about Rs 3,800 crore of total orders in hand (excluding orders of Rs 689 crore under arbitration), including ONGC’s order of Rs 535 crore for offshore vessels.
While shipyard orders have dwindled in the recent downturn, most Indian shipyards have managed their business without facing cancellations.
Note that shipping orders are often subject to cancellations. Ship orders typically rise on the back of increasing freight rates or oil prices. However, given that the time lag between receiving a contract and delivery ranges between 22 and 45 months depending in the size of the carrier, the cycle of freight rates or oil prices may reverse, thus leading to order cancellations. Downward revision in price of vessels and insertion of clauses by clients to opt out of the contract are common.
Pipavav, too, is not devoid of these risks. For instance, of the Rs 3,800 crore of orders mentioned, the company is in discussion with a client to amend agreements for about Rs 1,105 crore of orders.
The client has sought unilateral rights after a certain date to terminate its obligation to take delivery of vessels if it is unable to arrange for funding for the vessels. The company is also engaged in arbitration for some orders to determine whether the customer has the right to cancel such orders.
These uncertainties leave about Rs 1,800 crore of firm orders in hand effectively. While all the above orders may yet sail through, revision of key commercial terms, such as price of vessel, options exercisable at the customer’s discretion and unilateral rights to terminate obligation to take delivery, pose huge risks to certainty in revenue flows for the company. Note that the company has already delayed delivery of two vessels.
This said, the uncertainty factor in defence vessels, for which the company has just bid, may be much lesser. While there are no orders from this segment at present, a ramp up in this segment could reduce the risk otherwise inherent in this sector. Further, that co-promoter Punj Lloyd has agreed to conduct offshore activities in India through Pipavav may provide some diversification in the product mix of the latter, thus mitigating risks.
Pipavav did not have any revenues until March 2009, pending commercial production. The company would have to deliver 10 Panamax vessels totally valued at Rs 1,788 crore between April 2010 and May 2012. This, together with the execution of the ONGC orders, would be the key sources of revenue over the next couple of years. Receivables from one of the carriers are, however, assigned to a bank. This could reduce cash flows.
As the company would have capitalised over Rs 2,000 crore of assets post March 2009, depreciation, pending revenue flows, would dent profits in the initial quarters. Interest cost of about Rs 90 crore paid in FY-09 is unlikely to reduce significantly, given that the facility has only been recently commissioned.
These factors could drag profits for the next 4-6 quarters. Pipavav’s key advantage would be the tax-free status of its SEZ fabrication facility (leased by subsidiary) and lower taxes for the shipyard, being an export-oriented undertaking. This is likely to ensure superior net profit margins for the company, even as the industry currently enjoys about 12-15 per cent. This status may nevertheless change post the implementation of the Direct Taxes Code.
Macro advantage, no longer
The Indian shipyard industry had the advantage of copious order flows in 2007 and up to mid-2008 as a result of the traditional shipbuilding countries of Korea, Japan and China being booked fully. India’s cost advantage, together with the subsidy provided by the Government for orders up to August 2007, have all aided order flows.
Going forward, the capacities of the above nations are likely to be freed up, given the downturn, thus intensifying competition for Indian players. Importantly, the 30 per cent incentive on shipping contracts provided by the Government has not been renewed so far. These factors may pose a challenge for the Indian players.
The offer is open from September 16-18.