Reposting this old note here for ease of reference :
October 01, 2020 :
CMP : 46.90
Market Cap : 1388 cr
FY20 Standalone PAT / EPS - 320 cr / 10.81
PE : 4.3x
Dividend Yield (FY20) : 11.7%
Investment Hypothesis :
- Divestment of Non- Core Businesses :
PTC has invested approximately Rs 1400 cr in its two subsidiaries, PFS and PEL.
PFS stake is up for sale, 10 bids were received before 31st July 2020. IDFC Securities managing the sale process.
PTC’s investment in PFS is Rs 750 cr. Let’s assume it recovers only Rs 600 cr.
Similarly, investment in PEL is Rs 650 cr, assume recovery of only Rs 500 cr. Note that PEL’s divestment was derailed by IL&FS failure. Due to uncertainty created by AP government over renewable energy contracts, regulatory clarity is required and could delay PEL’s divestment.
Given the current environment, lets assume both these divestments happen over 2 years from now. Therefore over next 2 years, about Rs 1100 cr should be received from sale of subsidiaries.
- Sale of investment in Athena Energy :
The plant is commissioned and running smoothly for over 12 months now. All contracts are operational and PTC does not require to retain its stake any more. Thus let’s assume the stake sale is conducted over next 2 years and PTC receives book value of Rs 191 cr. Sikkim State Government has already put up its 30% stake for sale and Greenko has expressed interest.
The sale of 2 subsidiaries and stake in Athena Power could generate Rs 1291 cr conservatively. Management expects to get a premium on book value in all 3 cases.
- If PAT remains flat at FY 20 levels for 2 years, cumulatively Rs 640 cr, of incremental cash would be generated, bringing total cash visibility to approximately 1931 cr, which is 40% more than current market cap.
It would help to address some shareholder concerns at this juncture :
A bulk of debt on the consolidated balance sheet pertains to its subsidiaries which are leveraged and should reduce as these are sold.
Receivables : A lot of concern in the stock pertains to receivables. However 2 points to note here : 1) Historical track record attests to the fact that there are cases of delay in payments but never defaults. Entire sums are recovered with full interest. 2) These receivables represent credit exposure to state government bodies and therefore can be considered as quasi government debt. There are delays but no capital losses; which makes it a situation of nil loss, given default. More perspective on this later.
Volume Growth : There is a perception that current growth is aided by the long term contracts executed during the 2009 - 2012 period. No doubt some of those contracts provide volumes but a bulk of those contracts are not yet functional since the underlying assets are not yet commissioned. Additionally, PTC continues to enter into similar arrangements continuously. For eg : In FY20, it aggregated 1900 mw of power demand from multiple discoms and sourced power from various generators for medium term ( 3 - 5 years). In FY21, it aims to contract 2500 mw of power on similar lines. Historically volumes have grown 12 to 14% p.a. and i expect that to continue. Volume growth could pick up if merchant prices rise and make defunct capacities functional. Merchant prices need to rise to about Rs 4.5 to 5 / unit for this to come into play.
Secondly, PTC’s market share in a growing market has remained fairly stable and has reported gains in FY20. This suggests that PTC is growing in line with market or improving share.
Capital Allocation : The management has categorically stated in the AR as well as in the past few concalls that it intends to focus on its core business and exit its non core investments. The proceeds are likely to be used for investments in trading software and bulk of the proceeds will be returned to shareholders. Furthermore, they have committed to remaining in asset light businesses, thereby limiting the need for capital.
The stated dividend policy envisions paying out at least 50% of PAT. The stock currently trades at a dividend yield of 11.8%
- A Fresh Perspective on Receivables : PTC’s core business does not require reinvestment. Therefore the cash it generates would remain on its Balance Sheet if credit were not extended to clients. In such a scenario, this cash would generate 4 to 6% p.a. through investment in liquid mutual funds.
A : Treasury Management : PTC opts to provide credit to its customers and charge 12 to15% p.a. on this credit. Historically, they have even charged 18% as surcharge. Extending credit to Government bodies and reducing risk of capital loss is smart treasury management in my opinion.
B : Credit : Many companies extend credit to their customers as a sweetener to boost sales. PTC follows the same practice to help grow sales. In this case too, bad debt write off is the key monitorable. As long as dues are recovered, this does not posit a problem.
- Core Business :
Let’s assume, post the new electricity reforms, the power sector in India becomes healthy and customers pay discoms on time and in turn discoms pay generators on time. This would result in a situation where PTC would not have to extend credit to discoms and therefore stop earning “Surcharge” and would not have an opportunity to provide liquidity to IPPs and earn “Rebate”. Thus PTC’s balance sheet would have negligible receivables and payables. Capital employed would naturally shrink to just its own gross (net) block. In FY20, PTC’s gross block stood at Rs 34.37 cr.
Since it intends to invest in trading software, lets assume the cost will be capitalised. Hypothetically, let the cost be Rs 50 cr. This would bring its gross block to about Rs 85 cr.
Now if we were to strip the amount of surcharge and rebate from FY20 earnings, we would be left with a PAT of approximately Rs 150 cr. Thus the core business would be generating ROCE of 176% on enhanced gross block of Rs 85 cr. Such profitability would be at par with some of the leading FMCG players in India.
While i do not envision such a scenario in India, the illustration serves the purpose of highlighting strength of the core business.
Outlook on Power Sector :
Power sector has witnessed the classic capital cycle over the past 2 decades. There was a rush to put up capacities until 2010. The subsequent 10 years have seen capital flight from the sector due to a host of challenges faced by private players. As a result no new capacity additions have been announced by the private sector. Meanwhile demand has consistently grown and has started accelerating due to the Government’s push for electrification of all villages. Deen Dayal Upadhayay Gram Jyoti Yojana has effectively added 35% of the population as new consumers for electricity.
Tellingly, electricity demand grew 5% yoy in september 2020, although economic activity is still below pre-covid levels.
Lead times to set up capacity are very long, generally 7 to 8 years. Therefore new capacity additions announced today are unlikely to ease supply constraints in the foreseeable future.
Arguments in favour of renewable energy are moot due to the low PLF of these assets. Broadly, lets assume PLF for solar and wind at 20%. Then 5000 mw of installations would generate 1000 mw of power. This output fluctuates due to climatic conditions and reduces consistently due to declining efficiency of the equipment every year.
Notably, the last few auctions for solar and wind have attracted less participation and efficient players like Torrent Power are refraining from bidding as they do not see a risk - reward equilibrium. Many FII’s like Softbank and GIC have decided to withdraw from investing in renewable energy due to contract repudiations by AP government.
Both solar and wind capacity bidding and installation targets were missed by a wide margin in FY20.
In sum, supply shortages are looming and not enough capacity can come up within reasonable time.
The Cement industry requires liasoning with the government largely for procurement of mines but has freedom in setting up capacities and marketing output. Additionally, capex requirements are lower and therefore the demand supply situation is fluid and can rebalance frequently.
Unlike Cement, Power is regulated end to end, from mining of coal to the price paid by the consumer, everything requires regulatory permissions and interactions. This makes setting up power capacity very challenging and therefore i do not see supply rebalancing quickly. We are likely to see several years of demand growth outstripping supply.
Naturally, this should lead to rising utilisations and rising prices for power. Investment in efficiency improvement such as shifting from CFL to LED etc have been carried out by the Government. There is now little scope to garner efficiency gains. Perhaps therefore EESL the nodal body for driving electricity efficiency is now repurposing itself to create battery charging infrastructure for EVs.
Today most discoms are unwilling to enter into long term PPA’s. This has been the primary driver of distress in the sector for the past 7 - 8 years. However, if power prices start rising, discoms will be forced to float long term PPA’s and get assured supply at reasonable prices. Else they will face higher prices and uncertain supply from players who have faced the brunt of low prices and absence of PPA’s. In a situation where a lot of capacities need to be tied up coupled with growing aggregate demand from discom, PTC should be able to play an important role in matching and optimising demand and supply.