Sound Defensive Play

Power Grid is not a growth stock. It is not a stock for investors looking for rapid appreciation of their investment. But for those looking for a defensive play in the current wildly fluctuating market, Power Grid Corporation of India Ltd. (PGCIL) is a good option. Why should you look at PGCIL? First, it has a stable business. Its business model is based primarily on the capacity it builds and operates — and it’s still building it fast. Second, it has government-regulated returns that afford earnings visibility. And finally, unlike other defensives such as those belonging to sectors like pharma and FMCG, you can still buy PGCIL at a reasonable valuation.
PGCIL is one of the few government-regulated monopolies still in existence in India. It has a monopoly over long-distance high voltage power transmission in the country. PGCIL owns and operates most of India’s inter-state and inter-regional power transmission network. With a capacity of over 80,000 ckm (length of circuits in kms), Power Grid carries around 55 per cent of India’s power supply; the balance is carried by state electricity utilities. It has an inter-regional transfer capacity of 22,400 MW which it plans to increase to 37,000 MW by FY12.

Strengths and opportunities
Stable business model. Around 93 per cent of Power Grid’s revenue comes from transmission. PGCIL has been constantly adding to its transmission capacity. The key thing to watch out for regarding PGCIL is the pace of capitalisation of this capacity. As projects get capitalised, it can then start earning its regulated returns. PGCIL is mandated to earn a fixed return on equity of 15.5 per cent. This single factor affords earnings visibility. Other business verticals like consulting and telecom help the company bolster its RoE to 17-18 per cent.
High-margin business. By virtue of its business model, PGCIL’s expenses are mainly incurred on employee remuneration and maintenance. Earnings are not adversely affected by factors like fuel cost hikes that affect power generation companies. As a result, PGCIL is able to enjoy high operating margins in excess of 80 per cent . Net profit margin over the last five years has been in excess of 27 per cent.
Rapid expansion on the cards. Power Grid has a target capex of Rs 55,000 crore for the 11th five-year plan. During the current year, it will invest Rs 17,900 crore to reach this target (it invested `12,000 crore in FY11). PGCIL’s capital work-in-progress stands at around Rs 26,500 crore which would lead to additional asset formation in the next two-three years, thereby adding to revenue visibility.
PGCIL has guided for capex of Rs 1,00,000 crore in the 12th Plan. According to the company, it expects to capitalise projects worth Rs 10,000-12,000 crore every year over the next couple of years.
High speed corridors. The Central Electricity Regulatory Commission (CERC) has given its nod for the installation of nine high-speed transmission corridors (HSTCs) at a total investment of Rs 60,000 crore, higher than the Rs 55,000 crore invested in the 11th Plan. This will directly augment PGCIL’s revenue over the next couple of years.
Niche operations. Apart from mainstream transmission, PGCIL has two other niche verticals that hold promise for the future. Its telecom and consultancy verticals together account for a little less than 5 per cent of its revenue currently.
The telecom vertical, which has been operational since 2007, has grown at a compounded annual growth rate (CAGR) of 27 per cent. PGCIL has installed 1,50,000 towers over a network of 21,000 kilometres across the country, which it plans to start leasing out from the current year.
The consultancy vertical has grown at a CAGR of 17 per cent over the last five years. Over this period, PGCIL has provided its services not only to domestic clients but also to overseas ones in the Gulf countries, Africa, Sri Lanka, Bhutan, and so on.
PGCIL hopes to scale up its telecom and consulting businesses so that together they account for around 15 per cent of its total revenue in the next five years. What whets the company’s appetite for these two segments is that both are unregulated businesses, which means that the company can earn higher margins from them.

Weaknesses and threats
Weak capitalisation. PGCIL capitalised assets worth Rs 801 crore in the first quarter of the current financial (lower by 31 per cent y-o-y). This was way below the market’s estimates that ranged between Rs 1,500 crore and Rs 2,500 crore. This was primarily due to lower power generation by NTPC, which was down 2 per cent y-o-y due to lower utilisation, despite the addition of 2 GW to its total capacity in FY11.
Consultancy drag. PGCIL’s consultancy income declined 23 per cent y-o-y in Q1FY12 as a number of R-APDRP projects set for completion in FY12-13 enter their final stages. The Restructured-Accelerated Power Development and Reforms Programme (R-APDRP) seeks to improve urban power distribution and minimise transmission losses across the country. However, with the company signing a consultancy agreement in Kenya and looking to tie up more projects in Myanmar and Sri Lanka (for an undersea transmission project with India) in FY12, this segment should start looking up.
Huge financing requirements. PGCIL’s business model requires it to invest huge amounts of capital on a regular basis. This the company does through a host of avenues: bond issues, follow-on public offer (FPO), internal funding, and international financing. For the 12th Plan, PGCIL plans to raise $1 billion (Rs 4,573 crore) from the World Bank and $750 million (Rs 3,430 crore) from the Asian Development Bank. Additionally, the company plans to do another FPO (in addition to the one it did last year) by around 2013-14 in a bid to raise Rs 5,000-7,000 crore.
In the current year too financing takes centre stage. PGCIL plans to raise Rs 11,000 crore via domestic bonds. It has already raised Rs 2,000 crore in the first tranche. Every quarter hereafter it will raise Rs 2,000-2,500 crore.
The company’s net debt-equity ratio stood at 1.74 at the end of FY11. This figure could inch higher as it borrows more funds for its capex. Payment towards interest expenses, which stood at Rs 1,711.8 crore in FY11 (36 per cent of Ebit), could consequently go higher in future.
Other risks. Delays in commissioning of new projects (like those of NTPC) would have a negative impact on the company. The financial health of state electricity boards could also impact PGCIL’s regulated returns. Finally, coal shortages could potentially affect power generation by new projects and could end up delaying power transmission capex till such bottlenecks are resolved (as happened in the case of the Barh-Balia and Kudankulam transmission networks coming up online even before power generation commenced at these sites).

Financials
PGCIL reported a topline growth of 10 per cent (y-o-y) at Rs 2,202.49 crore for the quarter ended June 2011. Profit after tax growth was flat at Rs 705.29 crore, mainly on account of a high base in the previous year, which also saw non-recurring income of Rs 143.11 crore.
Sales growth in Q1FY12 was attributed to growth in transmission income. Transmission income for the quarter was up 11 per cent to Rs 2,044 crore. Telecom disappointed with growth of only 3 per cent at Rs 45.41 crore, while consultancy was down 23 per cent.

Valuation
At the current market price the company trades at a price-to-book value of 2.07 times. This is lower than its three-year median price to book value (P/BV) of 2.54.
The stock is currently trading at a 12-month trailing PE of 16.93. This is lower than its three-year median PE of 19.11. Over the past three years, the company’s EPS has grown at CAGR of 18.97 per cent. This gives it a price-earnings to growth (PEG) ratio of 0.89.
For those looking for a safe and stable investment, Power Grid is a good option. It is a low beta stock. Compared to the 21 per cent decline in the BSE Sensex year-to-date, Power Grid has held up well with a decline of just 2 per cent. Consider buying this stock to help you ride out this choppy market better.