>NHPC (CLSA)

Initiating coverage with U-PF

With 5.2GW installed capacity and another 4.6GW under construction NHPC is the largest hydro power company in India. It earns fixed regulated returns (15.5%) like its peers (NTPC and Powergrid), however given the long gestation period of it projects, higher susceptibility of delays and sub –optimal capital structure its return ratios are much lower. At 1.7x FY11 P/B for 6-7% RoE and 25x FY11CL EPS for its EPS growth (13% cagr over FY10-12) we believe the valuations are demanding. Our 12m target price, based on DCF is Rs26/share; we initiate with an Underperform.

Largest play on hydro power
NHPC is the single largest play on hydro power in India with an installed capacity of 5,175MW (including capacity of 51% subsidiary NHDC) and has another 4,622MW capacity currently under construction. ~6,700MW power projects are currently under approval stage and will add to the pipeline of projects going forward.

FY10-14 tariff order – mixed bag for NHPC
CERC (central regulator) has increased the base RoE from 14% to 15.5% (to be grossed up by tax rate) for all central power utilities which is the biggest positive in the FY10-14 tariff order. NHPC should benefit from the way the O&M expenses are being calculated under the new tariff regime and it should reduce its under recoveries going forward (NHPC had Rs1.2bn and Rs4bn under recoveries related to O&M expenses in FY08 and FY09 respectively). The new tariff regulations however increase the volatility of NHPC’s earnings since capacity charge will not be fully recovered during dry periods and there is no provision for “deemed generation” unlike the previous tariff order.

No significant upsides from CDM benefits/merchant power in near term
NHPC has registered two of its smaller projects (45MW each) under the CDM and will be earning ~Rs170m annually from these which will be shared with beneficiaries. We don’t expect any meaningful impact on the financials in the next 2-3 years from the CDM benefits for NHPC as it is unlikely to get any benefits for the existing/under construction capacity where CDM benefits are not part of the feasibility report. Hydro policy 2008 allows upto 40% of the saleable energy to be sold as merchant power from a hydro project. However NHPC can benefit from this only for new projects being planned as it has 100% PPA for it’s existing/under construction capacity.

Valuations are expensive. Initiate with a U-PF
NHPC’s returns profile is much inferior to its PSU peers (NTPC and Power Grid), even though regulation provides for the same 15.5% return on equity investment in projects. Given the long gestation period of its projects and higher susceptibility to delays, capital work in progress (CWIP) has tended to be high. With cost under recoveries in recent years and sub-optimal capital structure, ROEs have remained in the 6-7% range during the last few years. At 1.7x FY11 P/B for 6-7% RoE and 25x FY11CL EPS for its EPS growth (13% cagr over FY10-12) we believe the valuations are demanding. Our DCF based target price is Rs26/share which implies
1.25x FY11 P/B. Underperform.

To see full report: NHPC