Power grid - a superior alternative to Invits

The Indian power sector is made up of power generators, distributors (also called discoms), power transmitters and exchanges. In this entire value chain, discoms have been suffering losses by giving extraordinary discount to end customers due to political compulsion (example). Because of suffering discoms, the long term purchase agreements with power generators is not met, resulting in large receivables for power generators leading to their deteriorating fundamentals (eg: Tata power threatening to shutdown their Mundra power plant). Power exchange such as IEX has lowered electricity prices because of more efficient match of demand and supply resulting in more discoms purchasing from exchanges (in short term market). This has come at the cost of discoms voiding long term power purchase agreements with generators. In this whole value chain, only two players are still making good profits (Power grid and IEX).

Power grid connects the power generation companies to power distribution companies by building towers which forms a part of the grid network. This sector was opened to private entities in 2011, but power grid still maintains its monopoly status commanding 85% market share of inter-state transmission network and 45% market share of overall domestic transmission network.

Business fundamentals: Power grid invests in building grid network, maintains it and charges a fee for its services. It is governed by CERC and gets regulated ROEs of 15.5% (for the period of 2019-2024). This ROE is decided by CERC and gets revised every 5 years (in the previous 5-year period, ROE was also at 15.5%). For building a new asset, power grid uses 70% debt and 30% equity. Their mandate is to maintain this ratio.

Past financials: Tangible book value has grown from ~16’000 cr. in FY10 to ~64’000 cr. in FY20 (15% book value growth). D/E was ~2.16 in FY10 and has grown to ~2.35 in FY20. Debt grows when a new project is getting constructed (CAPEX phase) and is paid down when it gets commissioned. Sales, profits and CFO have grown at 18%, 18.4% and 16.7% over the last decade. Company has spent close to 1.05 lakh cr. in the last 5 years, and cumulatively has spent more than 2 lakh cr. since 2004.

Operational efficiency: Power grid is an efficient transmission company, making a gross margin of ~90% and a net profit margin of ~30%. For context, Power grid Bangladesh makes a gross margin of ~40% and a net profit margin of ~15%. PAT margins of Power grid have varied between 28-32% over the last 2 decades.

Growth drivers:

  • The company planned to do invest 1.6 lakh crore from FY17-FY22 adding ~43% of new transmission lines within their network. Out of this, they have done CAPEX of ~85’000 cr. in the past 3 years. This was partly funded by debt (~30’000 cr.) and rest from internal accruals. Over the last decade, power grid has generated CFO of ~1.75 lakh cr.
  • Railway electrification project: Railways are trying to achieve 100% electrification by FY22 at a cost of ~35’000 cr.
  • Cross border transmission with neigboring countries (Bhutan, Nepal and Bangladesh)
  • Telecom services: Powertel is rapidly expanding its optical fibre network, their plan is to connect 2.5 lakh gram panchayats.

Risks:

  • TBCB route of bidding: In this route, companies have to bid for projects and tariff is not cost-plus but based on the best bidder. This is a huge risk as a large part of incremental projects are coming from this route. If players become too aggressive, it can destroy profitability.
  • Government interference: Power grid had to give a rebate of ~1000 cr. to discoms during the Q1FY21. This will always be something to be watchful about.
  • Receivables have increased recently from 4’900 cr. in March 2020 to 7’500 cr. in July 2020 due to deteriorating fundamentals of discoms. Collections have improved recently but this is a key monitorable.

Key monitorables:

  • CAPEX vs commissioning: When the project commissioning is higher, it leads to greater free cashflow generation, which can be distributed to shareholders. In FY20, CAPEX came down from 25’000 cr. to 15’000 cr. As a result, free cashflow increased to ~19’500 cr. leading to higher dividend distribution. Going forward, management has guided for lower CAPEX (10’500 cr. in FY21) and will generate higher free cashflows. Dividend has increased at ~20% over the last decade.
  • Government recently announced launch a $1bn Invit from Powergrid (link). If this is successful, future projects can be directly funded by this structure instead of additional debt.

Valuations:

  • Its trading at 5.8% dividend yield (which is sustainable because the dividend payout ratio is only 50%), ~8x P/E and 1.4x P/B. For a business growing at 10-12% with a ROE of 15%, valuations are not demanding.

Disclosure: Invested (portfolio size here)

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There is a very nice report from Motilal showing how lucrative the tariff based competitive bidding projects are (link). For me, this is a key risk item as bidding can sometimes get heated and reduce the project viability. Motilal report suggests that the current TBCB based projects generate ~14% ROE with 80:20 debt/equity. This is inferior to regulated projects where Powergrid makes ~15.5% ROE. with 70:30 debt/equity. Other takeaways from the report are below:

  • Tariff based competitive bidding (TBCB) projects are generating ~14% equity IRR (assuming d/e ~ 80:20), with project specific IRRs varying from 2-27%
  • Currently TCBC projects account for 5% of gross block and 3% of PAT
  • Company plans to monetize TBCB assets through InvIT structure
  • Now intrastate projects are also coming up via TBCB route. Powergrid won 7 of the last 13 projects where it had bid for in FY20
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Do you have access to this report? Is it possible for you to send this to me?

@harsh.beria93

I did some research on PowerGrid and had the following questions for which I couldn’t find the answer in AR. If you have the insights, please do let me know

  1. Who is the customer for PowerGrid? Who pays the transmission charges? Is it the Power Producers or Discoms?

  2. What is inventory for PowerGrid? I see an amount of Rs1400 Crores in AR for FY 2019-20 as Inventory Assets. Can’t understand what inventory will be there due to transmission or consultancy.

  3. I see Adani Transmission as a major competitor to PowerGrid. However, in all financial aspects (EPS, Debt-Equity, RoA, RoE, RoCE), Adani is lagging PowerGrid. But still, Adani Transmission commands a PE and PB of 37 and 6 while PowerGrid has 7 and 3 respectively. So,

    1.Why is the private player not as competitive as the CPSE?
    2. Why is the private player commanding such premium with worse financials?

  4. Are there any other sizeable competitors to PowerGrid? I believe no other public player (NTPC or NHPC) is involved in transmission.

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Its discoms. Here is an excerpt from the latest Crisil rating report


https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/Power_Grid_Corporation_of_India_Limited_June_05_2020_RR.html

About inventory, maybe an accountant will be more qualified to answer it. What is more important is the cash conversion days over time.

About competition, its a very capex heavy business. However, competition is one major risk for powergrid, especially if private players start bidding very aggressively for the projects bringing down ROE (covered in the post before; the motilal report covers this well).

There are no real competitors for powergrid in India as on date; with powergrid having a 85% market share in inter-state networks and 45% market share in total domestic network.

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To understand the inventory for an organization like powergrid, please have a look at their project cycle. Normally, Transmission projects are completed in a time frame of 3 years (18 months sometimes for RTM projects). So, sometimes they purchase the raw materials, in advance… so, for example they need six transformers for a project to be completed in 2 years… they will place the order for all six transformers, even if only 3are needed in the current fiscal year… hope this helps…
Disclosure: no investment

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Transmission has to be looked from 2 angles

  1. Transmission within the state (intra state). This is solely state’s responsibility. (No pvt player wants to touch it for obvious reasons).

  2. Transmission between states (inter state). This is where PGCIL comes in. Till recently, inter-state was PGCIL’s monopoly. This was opened only recently to competitive bidding. (That is why financials are weaker for all pvt players). Currently, two main competitors are there for inter-state projects - a) Sterlite Power Grid and b) Adani.

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@Rits

To understand the inventory for an organization like powergrid, please have a look at their project cycle. Normally, Transmission projects are completed in a time frame of 3 years (18 months sometimes for RTM projects). So, sometimes they purchase the raw materials, in advance… so, for example they need six transformers for a project to be completed in 2 years… they will place the order for all six transformers, even if only 3are needed in the current fiscal year… hope this helps…
Disclosure: no investment

wont these items be placed under work-in-progress section as they are used to create fixed assets for the company and not manufacturing goods (for sale)

it might be dumb question , just curious to understand BS …

Regards,
Rama

Power grid announced another interim dividend of Rs. 5. This is the third dividend in 2020 taking cumulative dividends for CY20 to Rs. 15. This is in contrast with CY19/CY18/CY17 where dividends distributed were Rs. 8.33/5.25/4.35. The large increase in dividend reflects increase in free cashflow generation due to higher capitalization of assets compared to CAPEX requirements. Debt/equity has also come down to ~2.01 due to higher free cash generation, the debt/equity has now come down to FY11 levels.

Disclosure: Invested (position size here)

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I have 2 slightly stupid questions:

  1. Does anyone have a financial model or some rough calculation showing the financials of one particular project over its lifetime? (15/20/30 years – whatever the lifetime may be). I was hoping to get a sense of how things work.
    a. If not, I’ve found a microgrid financial model. (It’s not ideal and majority of it is not even applicable, but this is the closest I could find). Suffices to say I don’t really understand some of the technical details. Would someone like to collaborate on modifying it?
  2. Based on the above, how does 15.5% ROE work on a project? As you move across time, equity component of the project keeps increasing. How is this part calculated and how does it affect tariffs?
  1. the roe is only on initial equity… or proportionate share of any upgrade capex.
  2. the pricing works on bottom up basis to compensate for roe + incentive + tax+ interest + depreciation + opex. So overtime topline keeps falling as debt and depreciation drop. However net profit remains same assuming status quo on availability of the line.
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Eq Inv. 3000
Debt 7000
ROE 15.50%
Interest 8%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
REV 1491.7 1454.3 1417.0 1379.7 1342.3 1305.0 1267.7 1230.3 1193.0 1155.7 1118.3 1081.0 1043.7 1006.3 969.0
DEP 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7 466.7
INT 560.0 522.7 485.3 448.0 410.7 373.3 336.0 298.7 261.3 224.0 186.7 149.3 112.0 74.7 37.3
PROFIT 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0 465.0

Thanks for that. So this is what it would look like right? (Getting rid of taxes, O&M, expenses, etc. to simplify the calc. and they’ll just be added on top)

Depreciation is generally for the debt portion only, so you must stop after net block is 30% of original. I might be a little off, but not materially. So you can assume 6% each over 12 years and then stop. So on 13th year… depreciation, ebitda and sales will drop… but no impact on net profit component (only on 30% equity and other income is seperate if cash is retained.).

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Increasingly new projects are basis of competitive bidding or tariffs and not regukated RoE (which can change every 5 years.

I hear that most such new projects work on basis of 11-13% project IRR. If we assume 70% debt then equity return is reasonable. The additional game.being played by renewables or private sector cos in tariff based bidding is trying to upfront the return of equity. Say if you have a debt moratorium for 2 years then the cashflow of first 2 years will go to equity holder which will boost his return meaningfully. More so part of the equity can be originally infused as preference debt to make it tax efficient vs dividend. This partially explains the bubble in renewables apart from ESG investing.

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Quick correction - Depreciation is till the salvage value and doesn’t stop at debt. So, effectively you are getting equity back and still earning returns on that portion.

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Came across this news - https://www.moneycontrol.com/news/business/ipo/power-grid-files-for-1-1-billion-invit-ipo-first-ever-by-a-psu-6402011.html

Can anyone help to understand - what is means for the business prospects and consequently stock price/dividend yield for power grid?

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I couldn’t find the filing on SEBI’s website (invit section)/the bankers website. Anyone seen it yet?

EDIT: made available on the site today:

https://www.sebi.gov.in/filings/invit-public-issues/jan-2021/powergrid-infrastructure-investment-trust_48912.html

If invit floated by power grid comes out be successful (in context of current market), will it lead to the special dividend for current shareholder, as it would lead to hiving of current cash generating assets from its balance sheet.

Haven’t been able to complete the document yet. Major highlights so far.

The Invit will have 5 TBCB projects. “Of the Sponsor TBCB Projects, we propose to acquire five projects initially with a total network of 11 power transmission lines of approximately 3,698.59 ckm and three substations having 6,630 MVA of aggregate transformation capacity, as of September 30, 2020, across five states in India (the “Initial Portfolio Assets”).”

These are:

  1. POWERGRID Vizag Transmission Limited (“PVTL”)
  2. POWERGRID Kala Amb Transmission Limited (“PKATL”)
  3. POWERGRID Parli Transmission Limited (“PPTL”)
  4. POWERGRID Warora Transmission Limited (“PWTL”)
  5. POWERGRID Jabalpur Transmission Limited (“PJTL”)

Essentially, money raised will be used to repay loans advanced by PGCIL to the tune of Rs. 5000 crores towards these projects. Plus the invit will hold 74% in these projects.

"Interest: The loan shall carry an interest rate of 14.5% (fourteen and a half per cent) per annum, which may be reset on each interest payment date occurring after the first interest payment date i.e. the last business day of each interest period.

Repayment: The relevant Initial Portfolio Asset shall repay the principal amount of the loan to the Trustee (in its capacity as the trustee to the Trust) or the Investment Manager through a single bullet payment upon expiry of the TSA. The relevant Initial Portfolio Asset shall pay the interest due on a quarterly basis on the last business day of each interest period, which dates may be reset on mutually agreeable terms.

All payments under the Facility Agreements shall be subordinate to any secured or unsecured loan obligations incurred by the relevant Initial Portfolio Asset from any bank, non-banking financial company or financial institution, which is neither an affiliate of the Trust or the Sponsor.

Premature repayment: The relevant Initial Portfolio Asset shall, with a prior notice to the Trustee, be entitled to prepay all or any portion of the outstanding principal amounts of such loan, without any prepayment penalty or premium.

Term: The loan agreement shall remain in force until all monies payable by the relevant Initial Portfolio Asset to the Trustee under the loan agreement are paid in full and all obligations of the Initial Portfolio Asset are discharged to the satisfaction of the Trustee."

In terms of future scope, they’re looking to acquire more such assets as they come online plus “Further, our Investment Manager may seek to generate non-transmission revenue from various avenues, including leasing of optical ground wire and transmission towers.”

Impressions so far: I’m not sure if I understood that 14% correctly (which would be AMAZING if it’s actually being advanced at 14%). The overall impact on PGCIL in terms of financials is limited (also considering these are TBCB and not regulated assets). These projects have revenues to the tune of 1300 crores each year and PAT of around 380 crores. But PGCIL get’s a huge chunk of money back will be significant (as % of market cap). (I’m guessing they’ll probably reinvest in other projects).

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Power Grid launches e-tendering portal ‘Pranit’