Prefer NTPC Over Power Grid? Kotak Says Investors May Be Ignoring One Key Factor
Domestic investors prefer NTPC Ltd. over Power Grid Corp. in the power sector, perhaps because of its cheaper valuation, according to Kotak Institutional Equities. But the long-term prospects of the two are “vastly different”.
Domestic institutional investors' faith in NTPC remains firm, the brokerage said in a Nov. 30 report. That's when it has underperformed compared to Power Grid in the past few years. And NTPC is likely to face "significant disruption risks" from transition to clean energy even as Power Grid may benefit, Kotak said.
NTPC's Pain…
India's accelerated transition to clean energy will result in a meaningful negative shift in NTPC's return and risk profile, the report said. That's because:
Low free cash flow generation: NTPC will have to invest cash flows from extant coal plants into new solar capacity for it to stay relevant and protect its terminal value. The brokerage estimates a total investment of Rs 6.08 lakh crore required to convert NTPC's entire thermal power capacity to solar.
Limited growth in generation capacity as new solar capacities incrementally substitute extant thermal capacities over a period of time; solar tariffs are already cheaper than thermal.
Higher risks to cash flows of solar assets given free-market tariffs versus extant guaranteed regulated returns of thermal assets.
Solar plants generate high-single digit IRR (internal rate of return, or a metric to estimate the profitability of potential investments) under current tariffs, which are significantly lower than the guaranteed return on equity of 15.5% (of regulated equity) for NTPC's thermal assets.
…Power Grid's Gain
The shift towards clean energy, according to Kotak, will offer new growth opportunities for Power Grid after a slowdown in the pace of capacity addition in recent years.
Its core electricity transmission business will likely thrive as the nation makes large investments in new transmission capacity to modernise its national grid and connect to new solar electricity sources.
The company faces lower financial risks as it operates in a largely regulated industry with 96% of its asset base being regulated as of September 2021.
Ownership
NTPC and Power Grid have similar market capitalisations. Domestic investors favour NTPC, while their overseas counterparts are betting on Power Grid.
Domestic mutual funds own 18.4% of NTPC and only 8.2% of Power Grid as of September.
Of the 18.4% in NTPC, CPSE ETF, HDFC Balanced Advantage Fund and ICICI Prudential Value Discovery Fund account for 13.78%. On the other hand, Nippon India Arbitrage Fund and SBI-ETF Sensex each own more than 2.5% in Power Grid.
NTPC's weight in domestic investors' portfolio was twice as much as Power Grid's between 2018 and 2022.
Foreign institutional investors, however, are more inclined towards Power Grid.
Valuation
Power Grid's stock has traded at a premium to NTPC over the past 18 months, unlike in the past when their valuations were very similar, the report said.
“Power Grid's relative premium to NTPC is justified, as NTPC's return profile has deteriorated significantly compared to Power Grid in the past few years and it faces meaningful long-term disruption risks.”
NTPC's return on equity, according to the report, declined from 23.4% in 2016 to 12.8% in 2021. Its return on capital employed fell from 14% in 2016 to 5.7% in 2021.
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