IIFL sees further 10-15% downside in Lanco, GMR, GVK

In an interview to CNBC-TV18 power analyst Harshavardhan Dole, IIFL shared outlook on the power sector. He also citied power stocks that he is bullish on.

From a valuation perspective, he sees another 10-15% downside in stocks like Lanco, GMR, and GVK. However, the upside potential according to him would depend on reforms announced by the government over the next two months.  Meanwhile, he expects private sector players like Reliance Power, Lanco, Adani to see some uptick in their earnings once much awaited fuel supply agreements (FSAs) are signed up. On a stock specific note, Dole would prefer mid cap power companies like CESC, GIPCL and SJVN compared to riskier private sector companies like Adani, JSW and Lanco. Below is the edited transcript of Dole’s interview with CNBC-TV18. Also watch the accompanying video. Q: The first question to you is with respect to these highly liquid stocks, Lanco, GMR, and GVK. Over the last few months with the initiatives taken by the government, have these stocks become therefore more attractive now? A: Certainly, from a valuation perspective as compared to what the stocks were trading couple of years ago and what they are trading now there is a huge discount to the historical valuations. But their rerating from hereon will depend on in what format the changes that the government wants to intend will actually get rolled out. For example we have been hearing about government rolling the coal sector availability reforms, making coal available to these companies on a priority basis. What needs to be seen is how quickly these will come through and how the earnings of these companies will shape up in the new regime. So, certainly from a valuation perspective downside is maybe another 10-15% or so but the upside potential will really rest upon how the scenario will unfold over the next two months or so. Q: Specifically with respect to the power sector initiatives taken forcible signing of FSAs, are you seeing any beneficiaries, are you putting out any buys? A: Certainly this initiative is appreciable, what will distinguish the winners and losers is who has got what access to coal and how strong the PPAs that they have entered into are. Based on the newsflow so far, PSUs like NTPC or the state PSUs who are putting up projects and whose projects are up and running and who have vanilla ROE models will be clear beneficiaries. Among the private sector, players like Reliance Power, Lanco, Adani certainly will also see some of uptick in their earnings if the FSAs are signed up. The problem with the private sector is that the PPAs they have entered into are more of a fixed price PPAs, where coal availability will just ensure that their plants will keep on running. But the bottomline impact will be derived by the kind of PPAs and the cost escalation that you have built into while signing the 25 year contract. So from FSA perspective, I think the big winner should be someone like an NTPC, which is the largest genco in India. Q: You came out with a report as well where you have mentioned that stocks such as Satluj Jal Vidyut Nigam Limited (SJVNL) and CESC would be resilient in terms of earnings. Just give us your rationale on these two picks. A: The rationale is pretty simple. If you look at the sectoral headwinds these are namely three, firstly companies with no access to fuel are struggling to pass on the incremental costs, ACVs are not buying expensive power and thirdly the balance sheets of most of the newly listed gencos are pretty weak. These two entities are pretty much insulated from these sectoral headwinds. For instance Satluj is the largest single asset hydro power company in India and with pretty efficient operations. They have a 25 year log stock barrel PPAs whereby they get assured returns. CESC similarly has complete control over the distribution of power in Kolkata, so the receivables from ACVs which is the key issue with power sector; they are completely insulated from that. So the earnings predictability of these two stocks is one of the highest when you compare across the spectrum. Therefore, in the midcap space in addition to CESC, SJVNL where the valuations are pretty attractive, we also like Gujarat Industries Power Company Limited (GIPCL) which in terms of market cap is pretty insignificant but pretty efficiently managed company. It has earnings yield close to about 12-13%, dividend yield of 4%, its earnings is compounding at 7-8%, so we like these three companies a compared to riskier private sector companies like Adani, JSW, Lanco, etc. Q: There have been news reports that merchant power tariffs have gone in some places to even Rs 7 per unit, is that making you rethink your buy positions in any of them? Also, we are seeing the first moves towards cleaning up the balance sheets of SEBs, would it make sense to get into the power sector stocks, the power generators at these extraordinarily cheap valuations in the hope that these will fructify the SEB moves? A: If the balance sheets are getting cleaned up, the biggest beneficiaries will be banks, someone who is lending to these SEBs on an incremental basis and some entities which have been dealing with them and whose receivables have stuck with these companies. So REC, PFC are set to benefit the most. PTC whose receivables are also with Uttar Pradesh and TN discom should see a major benefit coming out of the incremental cash flows. Rather that betting on the gencos, I would look at the ancillary plays to play this whole theme.