'No change in Tata Power earnings estimate on CAG audit'

Meanwhile, he expects state electricity board (SEB) demand to pick up closer to summer season and adds that revival in industrial output will be key to improvement in SEB offtake.

Also Read: Exposure to power Discoms at Rs 10,000 cr, says  Andhra Bank

Below is the edited transcript of Harshavardhan Dole’s interview with CNBC-TV18

Q: It is Tata Power which has clearly been the big drag and the biggest loser in the last few days, could you tell us how significant is the Delhi as well as the Mumbai electricity system important for Tata Power, how much of their revenues come from Delhi as well as from Mumbai?

A: In Delhi, it is a 51 percent company owned by Tata Power. 49 percent still is with the Delhi Distribution Company. In Mumbai, the entire operations are undertaken by Tata Power. On annual basis, profits of Delhi Distribution Company are about Rs 300 crore - it is on a profit of close to about Rs 1,500-1,600 crore and to that extent, it is a fifth of Tata Power’s profits.

But rather than looking at profit contribution, what investors are very clearly worried about is the cash flow impact of this particular scrutiny. Although these companies are reporting profits, there is a huge regulatory asset, which is getting accumulated both at Reliance as well as Tata Power’s end and that is impacting the free cash flow generation from the business as well as the consolidated entity at Tata Power.

Q: What do you mean by the regulatory asset? If there is an audit done or when there is an audit done now, what might be the impact? Do you think that something will be discovered which will force the distribution companies (DISCOMs) to bear a part of the subsidy that is make some repayments to the Delhi government?

A: Subsidy and regulatory assets are clearly two different things. Regulatory asset is an approved figure by the regulator while ascertaining the tariff for next year, the way in which the process works. If I set a tariff for this year and there are some unrecovered costs, the regulator audits these numbers and gives a provisional recovery mechanism for subsequent years.

If there is an audit, I suspect the audit will be more towards the capital expenditure side where one may expect some amount of gold plating done by these companies. Majority of profit and loss (P&L) figures are approved and audited by the regulator. So, there is hardly anything that can be assessed by Comptroller and Auditor General (CAG) or any discrepancy could be noted by CAG in that regards. If at all there is a scrutiny, it should be more towards the balance sheet side rather than the P&L, which is more determined by the regulator.

Q: Some gold plating on the capital costs is what you fear might be impacting the next year’s P&L?

A: That is the worst case scenario. I am not saying that that is the certain scenario, but if at all an audit is done and if at all there is an area to be skeptical about, it is the capital expenditure side and particularly for the historical period.

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Q: Considering that one is only speculating at this point in time, I assume that you don’t have a possible earnings per share (EPS) or profit impact of this CAG audit, the other big fear could be that now the Haryana government has said that they have also announced a rebate and they are not going to allow further tariff hikes, is this seen as a potential negative if the Central Electricity Regulatory Commission (CERC) were to rule in favour of Tata Power, is the situation such that now it is almost clear that the Haryana government will not fall in line?

A: For Haryana, the good part as of now is six electricity boards have filed for tariff revisions pertaining to FY15 and the proposed tariff revisions are ranging anywhere between 0 percent and 55 percent. About 50-55 percent is what state like Bihar has claimed. I suspect the state electricity boards (SEBs), which have undertaken debt restructuring, have anything to say when it comes to raising the tariffs. Otherwise, the incremental working capital availability from the banks will completely dry down. I suspect that is not what the state governments want at this point in time. This tariff revision should be completely delinked from what is happening in one particular state.

Q: Do you expect it to work that way? earlier today we had the Andhra Bank chairman telling us that banks will be able to enforce that discipline but are you sure that tariff hikes will happen according to the cost claimed by the SEBs, are you sure of that process?

A: The way in which the whole process has worked – the Reserve Bank of India (RBI) has played a key role in tightening incremental working capital needs for the SEBs. Therefore, at this juncture even the states are very limited bandwidth left to interfere while setting up the tariff for the electricity boards. If you segregate out the problem, four-five problematic SEBs clearly Uttar Pradesh (UP), Rajasthan, Tamil Nadu to an extent even Haryana, these are the SEBs who are aggregating or rather contributing to more than 60-70 percent of the cumulative losses.

If these SEBs are stick to the discipline or rather banks enforce discipline on these SEBs then sectoral problems may not accentuate from hereon. To me there is a greater discipline likely to be exhibited both by the banks as well as the state governments incrementally because they have very little bandwidth left to manipulate the tariff from hereon.

Q: We have already seen Tata Power slipped Rs 10 or close to about 12 percent just in the last few days on the back of this overhang. If someone has a short-term outlook or maybe just a month or three months time horizon, what should they do in terms of Tata Power with this overhang remaining, do you think it makes sense for your investors to just exit out?

A: I wouldn’t want to comment what will happen over the next three-six months. I would look at the things in a completely different perspective particularly for a sector such as power. What is key, is which is the company, which has got balance sheet and the execution capabilities and if I do that, there are only few companies which are remaining on the radar and surely Tata Power will score high when it comes to execution. Short-term is anybody’s guess, how the stock will behave to what particular newsflow, but risk reward is in favour of medium-term investor as the stock inches below Rs 80 per share.

Q: Do you think with so much scrutiny around the power space and with a few governments at least have started to show a little bit more of populism, the long-term story or perhaps the investment by the power companies by the likes of a Tata Power etc might get halted, they will not do that in the next one-two years which will affect the long-term story of these stocks?

A: That is what the fear in the minds of the investor is. That is what the long-term investors are evaluating right now as to what extent the state government could get populist. But like I said, right now, the financial muscle of the respective states are also relatively weaker and given the fact that incremental working capital needs of distribution companies are far higher than what they are now, going forward over the next two-three years, they would also take a very cautious view, they would rarely try and do anything adverse which will ensure that the working capital doesn’t come in to the system. Till these issues are resolved, there is no reason for long-term investors to buy these stocks immediately. There will be time whereby these stocks will be available even at a far lucrative price and what they are.

Q: The short point which I couldn’t get across to you, no earnings impact that you are factoring in because of the audit?

A: As of now, nothing. What we will surely wait and watch is what are the points of contention or what discrepancies if at all the CAG notices in this particular audit and probably at that point of time, we will take a call.