Motilal Oswal picks NTPC, Powergrid in utilities space

Motilal Oswal has come out with its report on utilities.

• 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.
• We reiterate our sector view that fuel supply remains a key challenge to be addressed. We remain cautious on private IPPs and CPSUs remain our 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 our view.

LT capacity increase of 2x could curtail losses, focus on efficiency improvement critical: UP's long-term power availability would increase by 13-15GW over the next three years v/s FY10 power purchase of 56BUs (8-9GW), leading to increased self-sufficiency. Reported gap between aggregate revenue requirement (ARR) and aggregate cost of supply (ACS) remains at INR1.3/unit. This is largely due to constrained revenue collection and higher AT&C losses at 40%. As per FY10 tariff order, UPDISCOMs' underrecovery should have been minimal. Our calculations also indicate that an "efficient" UPDISCOM does not require meaningful tariff hikes.

Institutional holding more than 40% in Indian cos

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