>NHPC LTD (BNP PARIBAS)

Hydro Ain’t Electrifying

■ Hydropower – a risky business
We Initiate coverage on NHPC Ltd with a REDUCE rating and TP of INR29.00. NHPC is a regulated government-owned hydropower generation utility with 13 existing plants and a capacity of 5.1GW (12% of India’s hydropower generation capacity). Hydro power projects have long gestation periods taking several years to plan and build. With potential opposition from environmentalists and people displaced by the project, they also face significant execution risks. Seven of NHPC’s 11 projects under implementation have been delayed by a year or more owing to natural calamities, opposition from environmentalists and locals.

■ Low returns for high risks
NHPC assumes a higher risk in building hydropower plants but the Central Electric Regulatory Commission’s (CERC) tariff regulations do not compensate it for the extra risk. Unlike the National Power Thermal Corp (NTPC), NHPC has lower levers to boost its ROE above 15.5%.
New regulated tariffs for the period FY10-14 are negative for NHPC as its profits could be hit if it can’t generate the stipulated amount of electricity owing to water shortages. We estimate every 10% shortfall in generation will lead to an 11.3% reduction in our FY10 EPS estimates.

■ High CWIP and low leverage depress ROEs
The long gestation period and high execution risks mean investor returns in NHPC are low. ROE in FY09 was only 9.1% due to low leverage and a low asset-turnover ratio. Presently 32% of its equity is stuck in capital work in progress, which earns no returns – due to the long gestation of
projects and execution delays, 8% in 8.5% tax-free bonds and 6% of equity is deployed in cash. We expect the same in FY12, when only 49% of the equity will earn returns.

■ Unattractive valuations: Initiate with TP of INR29.00/share
Our TP of INR29.00 is based on 1.4x our FY11 BV/share estimate, a discount to NTPC’s FY11 P/BV of 2.5x. We believe the valuation discount is warranted for the significantly lower ROE of 8.3% vs NTPC’s ROE of 14.6%. We expect upside if more NHPC projects are allowed to sell Carbon Emission Rights under the Clean Development Mechanism.

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