When the non-compete agreement between the Ambani brothers was scrapped, Mukesh was quick to outlay his plans for the power sector. Power seems to be the most attractive segment in the infrastructure sector, with a host of companies — both public and private, busy announcing either a foray in power or their expansion plans in the sector.

Among the power companies to have hit the market over the past six to eight months are NHPC, Rural Electrification Corporation, NTPC and Satluj Jal Vidyut Nigam; while Jindal Power, Sterlite Energy and Power Grid have lined up their IPOs.

It is the huge demand-supply gap for electricity in the country that makes the sector a logical and lucrative investment option. During the April-May period, the country witnessed a supply shortfall by 14.3 per cent.

Sector outlook

For retail investors, although the sector looks a good buy, they must keep in mind the risks of investing their hard-earned money in power stocks.

Jagannadham Thunuguntla, head of research at SMC Capitals, said, “There is no denying the importance of power pro­jects in India, considering the demand-supply mismatch in the sector. However, the power projects come with a set of ris­ks ranging from the sector’s capital-int­ensive nature to problems in acquiring la­nd to environmental issues, execution risks, etc. Investors should be aware of these risks before investing in the power space.”

Power projects are highly capital-int­ensive. Producing one megawatt of electricity costs between Rs 5 crore and Rs 6 crore. Also, they have a long gestation pe­riod, with an electricity generation pr­o­ject taking an average of four to five ye­ars to get commissioned, and another 10 to 12 months to generate positive cash flows.

Development of hydroelectric power projects takes even longer when compa­red with thermal power projects.

The government had planned to add 80,000 mw under the eleventh five-year plan (2007-2012) to the present inst­al­led capacity of around 1,60,000 mw. However, at present, various pr­ojects wh­ich are under development aim at a ge­neration capacity of only 40,000 mw. In line wi­th this, the government has alr­eady cut the capacity target to 55,000 mw for the eleventh plan ending March 2012.

Roadblocks

Coming to the various problems faced by the sector, it is subject to extensive government regulation, which wastes a lot of time by way of seeking various app­rovals, licences, registrations, etc. The ap­p­rovals are subject to fulfilment of certain conditions, and even a single glitch can result in scrapping of the proposed project. Besides, the developers are required to consult the regulatory bodies every time the original cost estimate has to be increased.

Among other problems is the environmental issue. The ministry of environment and forest is getting stricter by the day in enforcing laws like keeping a rigid cap on the discharge of pollutants into air, land and water. Although a welcome move, this requires substantial capital ex­penditure by the developer. Adding to the woes, a developer also requires clearances from respective state pollution co­n­trol boards, the ministry of water res­ources ... the list is long.

Besides, they don’t even have a choice to set the tariff, which is determined by the Central Electricity Regulatory Com­mission (CERC).

However, in what co­mes as some reprieve — for the period be­t­ween April 1, 2009 and March 31, 2014, CERC has raised return on equity (RoE) for power units from 14 per cent to 15.5 per cent. If the project is compl­eted on time, the RoE is at 16 per cent.

Although there are several factors wh­ich can delay a project, like below par per­formance of contractors, unforeseen engineering troubles, disputes with wor­kers, non-availability of finances, delays in entering into definitive power purch­ase agreements and unanticipated cost increases, etc — land acquisition remai­ns the biggest cause.

Power companies generally finance 70-80 per cent of the total capital expenditure by way of raising debt. This exposes them to an interest rate risk as most of the debt facilities have variable interest rates.

Vaibhav Sanghvi, director at Ambit Re­­search, said, “Investors must look at the company’s valuations, its management capabilities and the time book of the previously executed plans. Since po­wer projects are time-consuming and ca­p­ital-intensive, each and every aspect sh­­o­uld be valued thoroughly before any investment is made in the sector.”

Raw materials used in construction of power projects, including cement, steel and other equipment, form a significant part of the overall project cost.

The price and supply of equipment and other raw materials depend on various factors including general economic conditions, competition, production levels, transportation costs and import duties. One of the things the success of a power project depends on is the sourcing of fuel at a competitive price.

Weather woes

Water is a key input for both hydroelectric and thermal power generation. He­nce, the generation capacity is highly de­p­e­ndent on unconstrained and undimi­nished availability of water during the entire life span of the power stations. A change in weather patterns and inconsistent rainfall thus becomes a big hindrance at the power stations.

Evacuating power from plants poses si­g­nificant challenges due to transmissi­on constraints on account of congestion in the transmission system, among other th­ings. Evacuating power depends on the te­rms of the power purchase agreement entered between the purchaser and generator.

Transport troubles

Promoters of power projects depend he­avily on different modes of transport — roadway, railways and pipelines, to receive fuel, raw materials and water du­ring the construction and operations of the projects. Building of transportation in­f­rastructure entails obtaining app­ro­vals, rights of way from the central and st­ate governments.

If these risks emerge, they amou­nt to delays, cost overruns, lower or no retur­ns on capital, erosion of capital and red­u­ced revenue for a company.

Besides, there is an intense competition for experienced senior management and other key personnel with technical and industry expertise in the power generation industry. Companies are finding it difficult to retain their manpower.

Stock review

Since May 20, when the last power sector IPO hit Dalal Street, the BSE power in­dex has returned 5.19 per cent. Among the newly listed stocks, NHPC and JSW Energy jumped 9.03 per cent and 7.22 per cent. Adani Power and Indiabulls

Po­­wer climbed 8.42 per cent and 5.22

per cent.

However, SJVN stock has struggled to break even its listing price of Rs 26 and is trading down 2.40 per cent since it commenced trading from May 20.

Thunuguntla believes while the capital markets have seen a series of power se­ctor public issues in the past couple of years, it is yet to be seen how these companies handle these inherent risks of the power sector.

DD Sharma, vice president (retail) at Anand Rathi, cautioned, “Investors shou­ld in­vest only in those companies, which are op­erating various plants. Retail invest­ors, since their investments are less and the fact that they cannot wait for holding stocks more than two to three years, can only generate returns, when investments are made in well-established companies. The risk associated with new entrants, de­­lay in the completion of projects and th­us delays in materialisation of their ach­­iev­ements in their fundamentals, are so­me factors which retail investors would never like to factor in.”

“We would never advice investors to invest in the companies which are new to power space,” he said.

Meanwhile, stocks of Reliance Power jumped 26.33 per cent during the period (since May 20) thanks to the merger plan with RNRL.