It's a googly

Torrent Power is one of the conventional, focused utility companies in the Indian power sector. While investors may find many hybrid variants of the original utility model in the form of Adani Power, JSW Energy, Tata Power, GMR Infra and so on, Torrent Power is involved in end-to-end power supply in Ahmedabad and Surat. The going has been tough for the company in the past year with uncertainties related to resource availability for its major expansions and rough weather in the Agra circle, which it took over in 2010. This is reflected in the gradual share price decline and the fall in its profitability from 2011 to 2013.

However, we believe in the DNA of the company, its understanding of the business and its track record in turnarounds and successful execution. We expect Torrent Power to clock  25% earnings CAGR over FY13-15. This, in turn, will have a rub-off effect on its return on equity and lead to a subsequent multiple re-rating. We would like to bet on the success of its gas gambit. Torrent Power also enjoys a strong valuation floor because its existing businesses churn out a lot of cash. We see an opportunity for doubling of the share price within three years, given the market potential and the company’s current positioning.

Growth story

Part of the $5-billion Torrent Group, the power business came to life with the acquisition of the erstwhile Ahmedabad Electricity Co. (AEC) and Surat Electricity Co. (SEC) in 1997. This made it the sole distributor of electricity in Ahmedabad, Gandhinagar and Surat. It turned around the operations and reduced aggregate technical and commercial (AT&C) losses by focusing on better quality of service, improved power factor, system strengthening and collections. Torrent also took over the Bhiwandi circle as an input-based distribution franchisee from Maharashtra state electricity distribution company in 2007 in one of the first of its kind models and rapidly turned it around by implementing the same formula. It has also commissioned a 1,147.5 MW gas-based plant, Sugen, in Surat and currently has 1,697.5 MW under operation. The company has also won the bids for input-based distribution franchisees in Kanpur and Agra and started operations in Agra on April 1, 2010. 

Torrent is in the midst of expanding its generation capacity by another 1,582.5 MW, through the 382.5 MW Unosugen and 1,200 MW Dgen gas-based power plants. It has already incurred a capex of ₹407 crore out of a total estimated capex of ₹633 crore and is expected to commission these capacities between 2014 and 2016. The off-take strategy comprises supply of 80% to license area operations and selling the remaining capacity in the open market. It stands to benefit heavily if gas is made available at a reasonable price.

Anybody’s guess

The challenge before the company is sourcing the gas requirement of 6 mmscmd for operating these plants at a reasonable price. Domestic gas production has been affected severely with the fall in KGD6 output, which has led to a gradual decline in the plant load factors (PLFs) of gas-based plants. Therefore, we have seen exorbitant spot prices of $10-12/mmbtu for regasified liquefied natural gas (RLNG) in India. 

RLNG prices are driven by developments in the global gas markets. Globally, there are multiple gas prices depending on the region and its differential demand-supply determinants — Henry Hub is trading at $3/mmbtu, European gas at $8-9/mmbtu and Asian gas importers are paying $12/mmbtu. While the Henry Hub index has crashed due to the shale gas boom in the US, heavy demand centres such as Asia are facing high LNG prices and gas availability is affected by lack of liquefaction terminals in the gas surplus areas. We expect the improvement in global availability of gas to lead to improvement in transport infrastructure from the US to Europe and substitution of Asian RLNG by American RLNG. This would free up gas for the Asian markets and could lead to lower RLNG prices in the region. Any improvement in domestic gas output will mean higher PLFs and lower cost of generation of power.

Price of power

We expect Torrent to sell power in the license area as per CERC guidelines. The remaining power will be sold in the open market and several factors are critical for it to ensure it is able to fetch a return on its merchant capacities — higher ranking on merit order dispatch, peaking nature of gas plants, availability of necessary gas transport infrastructure and readiness of small and medium scale industries to enter into direct power supply arrangements, given the possibility of open access.

A key issue will be competition from alternative sources such as imported coal-based plants, which have lower cost structures. This would result in lack of competitiveness in the open market and the company could also face pressure to source cheaper power for its license area operation. But Torrent will be the most efficient gas-based generator given its state of the art plants.

Existing hangover

One key concern for Torrent Power is regarding the non-operation of gas-based plants due to non-availability of gas. Investors are worried that the company is incurring heavy capital expenditure and whether this will generate sufficient returns to service the debt and then earn a return on equity.

We expect that the company will continue to source existing 3 mmscmd of gas from PMT and RIL basins and will be able to salvage some value from its expansions even in the scenario of extreme gas shortage and high RLNG prices. Besides, Torrent Power is incurring capex to improve the system and also attempting to undertake billing and collection activities. However, it has fallen flat on its face till now and is facing severe local protests and difficulties in controlling theft and AT&C losses. We agree that the company is facing tough times at Agra and we expect it to incur losses till FY15. Torrent was awarded the Agra franchisee by Uttar Pradesh Power Corporation on April 1, 2010 and has thus far managed to reduce AT&C losses to 54.33% in FY12 against 61.19% in FY11. But we expect that Torrent will be able to control losses beyond a certain point and will move to loss-minimisation mode in case consumers remain extremely hostile. 

The company has experienced a gradual share price decline and is prone to further declines given the uncertainty related to the availability of gas. It is difficult to judge the bottom and the investment might turn out to be a shot in the dark. But heavy promoter buying around ₹155-160/share and intrinsic value of ₹130-140/share of the business after writing off the merchant capacity suggests that this could turn out to be an opportunity to bottom fish.