What Power Grid Corp of India can do to rekindle interest among investors

After delivering handsome returns in 2016, shares of Power Grid Corp. of India Ltd began trailing the broader markets from mid-2017. Compared to a 15% rise in the Nifty 500 index, the stock lost 8% from July 2017.

The underperformance coincides with the moderation in asset growth. Capitalization, which reflects the project addition, eased from a peak of about ₹31,000 crore per annum in FY16-17 to ₹27,928 crore in FY18. The company aims to capitalize projects worth ₹26,000 crore in FY19.

As India nears universal electricity access, reducing the need for large investments in interstate transmission lines, many fear Power Grid is past its prime asset-addition phase. The company has projects of ₹77,000 crore, providing a good asset-addition pipeline for two-three years.

Further, the thrust on renewable energy and integration of green energy projects will require investments in the transmission sector, providing business visibility in the near term. However, investment requirement is seen to be much lower than what the industry saw in yesteryears. This is when India added copious amounts of conventional power capacities.

Further, projects are increasingly being awarded through competitive bidding. This generally crimps returns vis-à-vis the contracts received through the government and public sector entities. These concerns are weighing on the stock. Analysts see capital expenditure easing steadily, slowing capitalization and asset addition.

After delivering handsome returns in 2016, shares of Power Grid Corp. of India Ltd began trailing the broader markets from mid-2017. Compared to a 15% rise in the Nifty 500 index, the stock lost 8% from July 2017.

The underperformance coincides with the moderation in asset growth. Capitalization, which reflects the project addition, eased from a peak of about ₹31,000 crore per annum in FY16-17 to ₹27,928 crore in FY18. The company aims to capitalize projects worth ₹26,000 crore in FY19.

As India nears universal electricity access, reducing the need for large investments in interstate transmission lines, many fear Power Grid is past its prime asset-addition phase. The company has projects of ₹77,000 crore, providing a good asset-addition pipeline for two-three years.

Further, the thrust on renewable energy and integration of green energy projects will require investments in the transmission sector, providing business visibility in the near term. However, investment requirement is seen to be much lower than what the industry saw in yesteryears. This is when India added copious amounts of conventional power capacities.

Further, projects are increasingly being awarded through competitive bidding. This generally crimps returns vis-à-vis the contracts received through the government and public sector entities. These concerns are weighing on the stock. Analysts see capital expenditure easing steadily, slowing capitalization and asset addition.

Even then, one cannot deny that Power Grid’s earnings will continue to expand. The current project pipeline ensures growth for at least two years, albeit at a slower pace. Importantly, the company works on a regulated business model, where it is assured of fixed return on equity on commissioned projects. The reduced capex intensity means the company will see good cash flows.

Power Grid’s return on equity of 16-17% is among the best in companies that work on a regulated business model, according to analysts at Motilal Oswal Securities Ltd. At the current valuation of 1.5 times FY20 price-to-book value, the stock offers good dividend yield.

“If we were to assume no growth after FY20, which means profit after tax is available for dividend distribution, the stock is trading at an attractive dividend yield of approximately 11-12% for an assured-return business model, while revenues are backed by state-guarantees (government securities yield is ~7 to 8%),” said analysts at the brokerage firm.

The catch, of course, is the payout policy. Articulation of the cash-deployment road map in a reduced capital expenditure context will be key. With the company increasingly participating in competitive bidding, returns from new projects will also be key variable to track. Lower returns compared to the existing asset base will dilute the returns and heighten Power Grid investors’ concerns.