IIFL expects power sector to perform well over 6-12 months

Further Dole is bullish on a few power stocks like Tata Power in private sector and Power Grid along with NTPC within the PSU pack.

Below is an edited transcript of Harshavardhan Dole's interview on CNBC-TV18

Q: In the past couple of weeks the advantage for retailer to get into National Thermal Power Corporation (NTPC) is dwindling. Do you see that affecting the stocks prospects? Do you still expect that it to be over subscribed at the divestment?

A: Well, the issue will be subscribed given the participation so far. The issue is more than 50 percent subscribed and so the full issue will go through. In the long run if someone buys the stock between Rs 145 and Rs 148, you are well poised to get about 12-15 percent compounded return over a period of next three-four years at a risk which is far lower than what the private sector independent power plants (IPPs) offer at the moment.

Also Read: NTPC's weight in MSCI India to rise post share sale: Citi

Q: What is your target price for NTPC and what is your fundamental call on the stock in terms of earnings going into FY14-15?

A: Our target price is Rs 170 and we have a positive bias on this stock. The hypothesis is simple that worst for NTPC is behind us. The key issues such as pick up in capacity addition and fuel shortages are behind us. Yesterday, we saw that the pooling of coal price has been cleared.

Going forward, they should be able to sign the FSAs with Coal India and that should ensure that the plants are available at a benchmark availability of more than 85 percent which should allow them to earn their benchmark 15.5 percent return on equity (Roe). NTPC has been one of the most efficient power generators in India so pickup in capacity addition and assurance of coal supply will ensure that their earnings will compound at least at 10 percent over the next two-three years. So our target price of Rs 170 is based on 2015 price to book value at 1.5 times.

Q: Because of this pooling imported coal and domestic coal would not the coal prices go up for NTPC which as one of the oldest power generators would be enjoying better supplies from Coal India?  We have started looking at improving the fortunes of the state electricity boards (SEBs) only now. Are there are a couple of quarters when the stock will linger before it gets to the price that you are speaking about?

A: Of course, this is 12 month forward target price and stems from the belief that while the worst is over, for the best to come it is going to be a prolonged recovery period of around 12-15 months. But the advantages that NTPC enjoys with the private sector player are three folds.

Firstly, it has a solid balance sheet, the debt equity is less than 0.5. If you compare that to any private sector player, the debt equity is far more than 2:1. So, the balance sheet is pretty robust. Secondly, the existing operations are efficient which will ensure that even if SEBs delay the payments, NTPCs ongoing operations as well as the projects under construction are not at substantial risk.

Thirdly, since they have 100 percent power purchase agreements (PPAs) in place, power offtake is not as big a concern as majority of the private sector players that are facing right now. So from these three perspectives the stock offers a long-term play on the power sector and if one holds the stock for next three-four years then returns which are more than cost of equity, one is here to earn.

Q: What are the key risks to your target price and the key risks with regards to the fundamentals for NTPC as a whole?

A: The target price is vulnerable to two issues. One is the expected addition in capacity. We are building about 2500 megawatt each year for next three years. If that slows down, the growth outlook for the stock changes and then the 1.5 times price to book multiple that we are basing upon may see some compression.

Secondly, if the risk premium in the market goes up then the cost of equity in general goes up and that should lead to some de-rating of equities in general. So these are the two key principle risks that we see in terms of our target price.

Q: Is this the sole power stock you like?

A: Recently, we came out with a detailed report on power sector and at this juncture every power stock offers, with a two-three year view, reasonable risk reward opportunity. Our top pick within the private sector players is Tata Power and within the PSU pack we like Power Grid along with NTPC.

Q: A lot of these power stocks are underperforming except for Adani Power . Any news on power or any thoughts with regards to this decline or is it just routine profit booking?

A: I would suspect that it is more of a routine profit booking. This is because if you look at the developments which have happened in the past 6-12 months and are likely to happen over the next 6-12 months, we are heading towards recovery in the power sector in general. These regular movements in the stock price largely reflect the sentiment involved with respect to investors rather than anything macro which is expected to go wrong at this juncture.