Utilities- Valuation at lower end of historical range

Electricity generation growth in the first two months of FY19 has been tepid at ~3 per cent YoY. Conventional generation growth stood at ~2 per cent. Coal-based generation grew at a higher rate of ~4 per cent YoY due to weakness in hydro generation, which is down ~19 per cent YoY due to supply disruptions. Among the companies being analysed by Motilal Oswal, Coal India is likely to outperform, led by the price hike benefit. Power Grid’s PAT is expected to increase ~13 per cent YoY to Rs 2,420 crore on account of continuing capitalisation momentum. NHPC and JSW Energy’s PAT is expected to decline ~15 per cent and ~33 per cent YoY, respectively, due to lower hydro generation. CESC’s standalone PAT growth will be muted due to a delay in approval of tariff order. Tata Power’s adj. PAT is expected to increase ~165 per cent YoY to Rs 430 billion on a weaker base (had one-offs) and higher coal mining profit.

Utility stocks have de-rated over the last few months due to the reversal in the interest rate cycle, to which they have a negative correlation. However, at current valuations, the sector is trading at the lower end of its 10-year historical P/E and P/BV range. Valuations are heavily discounting the risk to growth potential. Top picks are Coal India – benefiting from strong earnings growth led by price hike and operating leverage, Power Grid – visibility of earnings growth and best-in-class RoE, CESC – high RoE, steady growth in distribution business and value- unlocking through demerger and NTPC – capitalisation-driven double-digit regulated equity and earnings growth.

Source: Motilal Oswal