Power Grid Corp of India: present perfect, future tense

Power Grid Corp. of India Ltd, seen as the best utility stock till some time back, is getting the cold shoulder from investors. After delivering strong returns in fiscal year 2017 (FY17), the stock trailed the benchmark Sensex by a notable margin in FY18.

What gives?

The primary concern is the pace of asset addition, especially in the context of slowing investments in the interstate transmission sector where Power Grid has a strong foothold.

Validating investor concerns is a sharp slowdown in ordering activity by the company. Elara Securities (India) Pvt. Ltd and Motilal Oswal Securities Ltd estimate the contract awards to have declined 67-68% in FY18 to the lowest level in the recent past (see chart). The ordering activity indicates the capex (capital expenditure) movement and likely pace of capacity additions in the future.

To recap, Power Grid earns a regulated return on equity (fixed by the regulator) on its commissioned projects, making asset addition crucial for earnings growth. Over the five years to FY17, the company capitalized Rs1.17 trillion and profits on an average expanded by 18%.

To be sure, Power Grid still has sizeable projects pending execution which should help maintain the earnings growth momentum for at least three years, points out Motilal Oswal Securities. However, the Street is looking beyond them.

With generation capex not happening in a big way (a major driver for transmission capex) and majority of the planned capex for interstate transmission infrastructure already incurred, analysts fear transmission capex may take a back seat, crimping opportunities for Power Grid.

The management tried to allay investor concerns by referring to opportunities in intra-state projects. But conviction among investors remains low. Poor financial discipline and lack of precedence about how states want to go about such investments is not helping.

Still, as studies by Motilal Oswal point out, even matured networks in developed countries need investments. India with increasing energy usage and changing energy mix can be no exception. “Experience from China and the US suggests that the transmission infrastructure continues increasing in tandem with generation (demand) growth. Renewable generation capacities, flexibility and redundancy requirements also aid transmission investment,” Motilal Oswal Securities said in a note.

But what is uncertain is the timeline. “In our view, the situation (slowdown in transmission orders) is likely to remain the same, at least over the next few years, until demand catches up with the capacity being added,” added Motilal Oswal Securities.

Overall, while Power Grid has nothing to worry about in the immediate future, more clarity is required on long-term prospects and how the earnings growth momentum will pan out. This is weighing on the stock.