Unlocking Value: Why NTPC Might Be A Good Investment Option

National Thermal Power Corporation (NTPC) is reportedly planning a mega share sale for two of its renewable energy subsidiaries. With the current investor optimism in the markets, multiple companies have been looking to cash in on the initial public offering (IPO) boom. For NTPC’s investors, the move might be the catalyst that could put a stop to NTPC’s continuing underperformance.

So far, NTPC has been a disappointment for investors. It has been underperforming the indexes by a wide margin for a long time. In absolute terms, the stock provided a negative return of 15 per cent over the last five years, whereas the Sensex almost doubled in value over the last five years. The company has been punished for its public sector unit (PSU) status, its dependence on coal and sectoral issues.

With the recent move to unlock value, here are some other reasons why the stock might do well.

Strong Growth

During the past five-year period, NTPC’s total installed capacity has grown at a compounded annual growth rate (CAGR) of around 7 per cent from around 47,000 MW (megawatt) in financial year 2016 (FY16) to 66,000 MW in FY21. Sales and profits have grown by around 9 per cent CAGR during the same period.

The rate of growth is quite decent given the size of the company. Despite the Covid impact, the company has managed to grow its earnings during the fiscal 2021. As capacity utilisation and capacity addition pick up in the manufacturing sector, NTPC is bound to grow its volumes and revenues.

The secular growth story of the power sector has remained intact despite some minor hiccups. For the month of July 2021, India had already reached the pre-Covid situation during the first fortnight of the month.

Regulated Return On Equity (ROE)

The company operates under a regulated model where it earns a guaranteed 15.5 per cent return on its regulated equity base provided NTPC achieves a certain plant load factor. Its entire thermal power base is covered under long-term power purchase agreements (PPAs).The regulated ROE clause in the PPAs guarantees that the utility would earn a stable financial return after investing large amounts into building power plants.

Unlike other companies, NTPC is assured of earning a fixed return on its equity. Similarly, the tariff mechanism also has a provision for covering the large fixed costs in case the electricity distribution companies do buy the electricity they have contracted for.

The company also has a large part of its capital stuck in capital work in progress. As CWIP decreases and gets added to the regulated equity base, the company’s earnings will improve. The regulated ROE has been maintained at 15.5 per cent for a few years now despite the cost of capital consistently falling due to lower interest rates.

With a low cost of capital and a high rate of return, companies operating in the power sector are set to benefit. However, NTPC’s margins and returns also depend on capacity utilisation levels and operating efficiency.

Strong Financials

The company operates in a capital intensive sector where most power generation companies struggle with their finances. State-run distribution companies often delay paying power generation companies leading to cash flow mismatches and a greater financial burden. NTPC with its access to low-cost capital, superior execution skills and prudent financial management is among the stronger players in the power generation space.

In recent years, its debt has increased due to capacity expansions in the thermal and renewable space. It has also acquired the government’s stake in Tehri Hydro Development Corporation (THDC Limited) and North Eastern Electric Power Corporation for Rs 11,500 crore.

The capacity expansions and acquisitions have been partially funded by debt. As new projects come online, NTPC’s regulated equity base will rise, increasing its earnings. It has consistently generated strong cash flows, which have helped it maintain a comfortable liquidity position.

Value Unlocking

If NTPC is able to take advantage of the current optimism in the markets, it can certainly unlock value for shareholders. Most investors have written off public sector undertaking (PSU) stocks as wealth destroyers.

A catalyst such as a share sale of subsidiaries can help restore investor faith in the company. With economic incentives and high ESG score, well-run renewable energy companies can command high valuations in the markets. Apart from Adani Green and some small stocks, there aren’t many listed renewable energy players, which could result in a scarcity premium for the stock.

Cheap Valuations

The enterprise value to operating profit ratio is around nine. The price to earnings ratio of the stock is around seven. The price to book ratio works for companies with a high investment in fixed assets. In NTPC’s, the company trades at 0.9 times its book value, indicating that it might be an undervalued investment.

However, a company like NTPC which has averaged a 12 per cent return on equity is probably not a great investment above its book value. The company also has a dividend yield of 6 per cent, which is higher than the yield on savings deposits. Issues like fuel shortages, environmental concerns, etc, appear to be already priced into the stock.

Overall, an economic recovery with increased efficiency in the power sector should bode well for NTPC. So far, most infrastructure companies have been market laggards. But as consumption picks up, capacity expansion will also pick up resulting in better days for the infrastructure and power sectors.