PTC India - Skewed Business Model + Rich Valuations =>Sell - Centrum

Rating: Sell; Target Price: Rs48; CMP: Rs70.9; Downside: 32.3%

We maintain SELL on PTC India with a PT of Rs48 (32% downside). Our rating and PT are strongly anti-consensus. We find the current valuations too expensive at 10.7x FY16E EPS and 0.8x BV considering (1) RoE of 7.4%, core RoE of 9% vs CoE of 15.8% and trading at near par with NTPC and Power Grid on PE(x) basis; (2) negative free cash flow over FY15/16E; (3) weak earnings outlook -EBITDA/EBIT earnings CAGR of 6%/7% vs 35% over FY11-13; (4) unlikely monetisation of investments over next 2-3 years; and (5) skewed business model. Historically, 85% of consensus have rated it a BUY at all stock prices between Rs40 and Rs140. The recent run-up in stock is unexplained, except for its high beta of 1.5.

Skewed business model: The business model is skewed owing to (1) Working capital and group company investments driving book value which are non-remunerative keeping RoE subdued; (2) higher treasury income propelling RoE by 36%/25% to 7.7%/7.4% over FY15/16E. When compared to cost of equity of 15.8%, core RoE of 9% and government bond yield of 8.8%, PTC is not a compelling investment idea; (3) Persistent balance sheet exposure towards risk of receivables and contractual disputes; and (4) Though we have not factored in the mismatch between its Power Sale Agreement (PSA) and Power Purchase Agreement (PPA), eventuality will drag down earnings and FCF and hence is negative.

Current rich valuations vis-a-vis NTPC and Power Grid unjustified: Over FY11-YTD, PTC had traded at an average 50% discount to both NTPC and Power Grid (Not Rated) on 1-year forward P/Bx. However in recent times, the discount band has been narrowed. Also, considering PTC's core RoE of 9% vs core RoE of NTPC/Power Grid at 18%/16% for the forecast period, PTC certainly does not merit a P/Bx of 0.8x vs NTPC/Power Grid's P/Bx of 1x/1.4x FY16E. On dissecting PTC book value (BV), +33% of it is driven by investments in group companies which are non-remunerative whereas in case of NTPC and Power Grid, BV is driven by revenue generating fixed assets that earn minimum RoE of 15.5%.

CMP factors-in optimism on positive FCF & surge in volumes: Expect disappointment going forward: The street is jubilant over the recovery of dues of Rs4.5bn from UPPCL and although we built-in recovery of overdues of Rs2.5bn from TNSEB, which is disputed, we believe that a significant part of incremental cash flow would be utilised towards working capital to meet 17% CAGR in volumes over FY13-16E. We believe FCF will be the appropriate measure to be jubilant. Free cash flow would peak in FY14E and turn negative in FY15E/FY16E. As evident from historical trends, even if we were to assume GDP of 9% in medium term, we do not expect a surge in volumes beyond 17% CAGR factored-in over FY13-16E.

Valuation and key risks: We maintain SELL with a PT of Rs48 which has been derived from (1) average of value on fair multiple assigned to EPS and book value on FY16E basis; (2) investments in PFS with a 20% holding company discount; and (3) other investments at 0.34x BV. Key upside risks are (1) higher trading volumes and margins; and (2) higher share in profits from long-term PPAs. Key downside risks are (1) skewed working capital cycle which may lead to steeper negative FCF; we have built in optimism in working capital cycle; and (2) lack of buyers for its long term PPAs that could lead to lower volumes and earnings.

Source : Equity Bulls

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