Subscribe to Power Grid FPO - Emkay

• Power Grid Corporation of India Limited
• Price Band - Rs.85 to Rs.90
• Recommendation - Subscribe

• FY10 actual core ROE of 21.3% - (1)18.9% from regulated business, (2) 1.1% from STOA, (3) 1.3% from consultancy and (4) -1.7% reduced by deferred tax accounting ¾
• Core ROE to increase by 1% to about 22.5% in next two years led by Short Term Open Access volumes; Potential of further 1% ROE upside if assume likely numbers on volumes
• ¾ FPO at 1.5xFY13E Book, cheap on absolute basis with core ROE of 22.5% and relative basis – NTPC core ROE at 24% (including 3% from UI) and P/BV at 2.1x
• ¾ Operating cash flow yield of 16% in FY12E; November 11 target of Rs128/Share; Sure Shot returns; Subscribe

Core ROE of 21.3% in FY10, helped by regulated equity calculations on gross block and negative working capital
PGCIL's core ROE jumped from 17.5% in FY09 to 21.3% in FY10. This was mainly because of (1) change in regulated ROE from 14% to 15.5%/16.0%, (2) change in other norms, (3) 0.7% increase due to STOA and (4) 0.3% increase due to consultancy. The core ROE (21.3%) is higher than regulated ROE (17.0%) in case of PGCIL due to (1) regulated equity calculations on gross block and actual equity calculations on net block and (2) negative working capital. Further on reported basis the core ROE appears lower because of deferred tax accounting eating away 1.7%. Seeing the capex quantum, we believe that PGCIL is likely to remain under MAT for the foreseeable future and the deferred tax liabilities created, practically are not likely to result in actual tax payments.

Assuming half of the volumes expected in short term market - core ROE to further increase by 1% led by STOA

PGCIL has earned its share of gross income of Rs1.2bn from STOA in FY10. This resulted in ROE upside of about 1.1%. Based on our analysis of upcoming short term capacities and assuming only half of the volumes, this income would increase significantly. We expect a ROE contribution of 2.1% from this source in FY13E. Again highlight that if we consider all the likely volumes, the ROE upside would be further 1%.

FPO at 1.5x FY13E book; cheap on absolute as well as relative basis

At higher band of Rs90/Share, the PGCIL FPO is valued at 1.5x FY13E Book. This is cheap looking at core ROE of ~22.5% in FY13E. Also PGCIL FPO is significantly undervalued compared with the current valuations of other regulated utilities like NTPC. NTPC is trading at 2.1xFY13E Book value with core ROE of 24%. However we highlight that 3% of NTPC's core ROE is from UI which is linked to short term prices. Whereas in case of power grid, the core ROE of 22.5% is totally dependent on volumes and not on prices.

With (1) Operating cash flow yield of 16% in FY12E, (2) regulated monopoly business with certainty of numbers, (3) execution track record of nearly 100% and (4) further potential of 1% REO upside from STOA - we see PGCIL as a much better investment option.

We have valued PGCIL on SoTP of its core Book and cash and investments. The (1) regulated equity of Rs182bn at the end of FY13E is valued at 2.5x and (2) equity funded cash and investments are valued at 1x (no option value considered). We recommend subscribe to the FPO with November 11 price target of Rs128/Share. We even remain positive on the stock at CMP of Rs98/Share at which the stock trades at 1.7x FY13E Book.

Source : Equity Bulls

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