Light speed rush

Why transmission and distribution players are seeing increasing investor interest

For the residents of the distant village of Permapara, a tiny hamlet in the Darbha block of Chhattisgarh, dark days lie ahead. With the northern state recording a deficit rainfall last year, households that don’t have two pennies to rub together will have to find a way to purchase oil to light their homes as electric supply continues to evade them.

“There are a number of hamlets in this block that are still waiting for a power connection,” says Aditya Kumar, volunteer at Pradan, a non-profit that looks into development issues in rural India. He further adds how post sunset, women find it hard to do their household chores and children are unable to study due to lack of electricity. No wonder then that Darbha has one of the lowest literacy rates (24.4%) in Bastar district.

However, the hamlets of Darbha are not the only ones battling darkness. According to World Bank data, 21.3% of Indians have no access to electricity. This translates into a fair demand to increase power generation capacity in the country and data available shows a slight improvement on that front. As per the Ministry of Power’s website, overall power generation in India has increased from 967.150 billion units in FY14 to 1048.673 billion units in FY15. 

While addressing the power shortage of 18.7 billion units is turning out to be long drawn-out, with several policy twists, there is a more easily addressable problem that’s been craving for attention. That is power transmission. 

Sample this: as per official data for Chhattisgarh, the state boasts of an installed generation capacity of 16,000MW whereas demand stands at 3,500MW. Global EPC player, Kalpataru Power Transmission elaborates further in its FY15 annual report, “Resource-rich states such as Chhattisgarh, which have high installed generation capacity are also unable to evacuate the excess power. Even within a state boundary, shortage in transmission networks leads to under utilisation of power generated.” In a recent report, analysts at HSBC observe that the generation industry currently operates at sub-50% utilisation. This means with no more addition to generation capacity, power supply can be doubled simply by enhancing the transmission infrastructure. 

Racing ahead
That throws open a big opportunity for power transmission players. Vimal Kejriwal, MD and CEO, KEC International, says, “Over 16,000 villages are yet to be connected to the grid, thus, necessitating the development for adequate evacuation infrastructure. This bodes well for us in terms of opportunities.” 

Vimal Kejriwal, CEO, KEC InternationalAmar Ambani, Head of research, IIFLAnalysts at Anand Rathi estimate that developing a transmission infrastructure capable of distributing the existing generated capacity across the country would require $75 billion worth of investments over the next five to seven years.

Certainly, the shortage in transmission capacity might aid in making an investment case for the sector, but what makes this perennial long-term opportunity relevant now? Amar Ambani, head of research at IIFL, says, “The slew of orders registered by transmission companies and the sluggish order book of power plant equipment players such as BHEL, underlines the government’s shifting focus from generation towards transmission and distribution.”

Already, companies in the space are seeing some traction. In October, Delhi-based Alstom T&D which belongs to the French Alstom Group bagged a Rs.140-crore order from Odisha Power Transmission Corporation. Later in December, Kalpataru Power Transmission signed contracts worth Rs.1,207 crore with the Tamil Nadu Transmission Corporation and Transmission Corporation of Telangana. 

Eyeing the attractive growth potential, new players are venturing into this segment. For instance, in October, engineering conglomerate Punj Lloyd made its debut in the transmission and distribution sector by winning two orders for rural electrification from the Power Grid Corporation of India (PGCIL).

Going green
The good news does not end there though. In addition to focusing on improving transmission capacity, the government’s green signal to renewable energy could trigger the next spate of orders. The government aims to generate 100 GW of solar power capacity by 2022 and 10 GW of wind power every year. It has already assigned the development work of nine high-capacity green energy transmission corridors. Says Manish Mohnot, managing director, Kalpataru Power Transmission, “Recently, the government earmarked a capex of Rs.35,000 crore – 40,000 crore for green energy corridors. This includes Rs.19,000 crore for inter-state transmission lines, that is a good opportunity for us.” 

Manish Mohnot, MD, Kalpataru Power Harsha Upadhyaya, CIO, equity, Kotak AMCPGCIL is implementing the Renewable Energy Corridor Phase 1 at Rs.13,000 crore. Both Kalpataru and KEC International are expected to profit from this initiative as both the companies were among the top-10 contract awardees of PGCIL in the last three fiscals. Besides, these companies are also banking on better technology to improve transmission capacity. Kejriwal says, “To enhance the electric current carrying capacity of a transmission line without any modification to the existing transmission towers, conductors are being replaced with new generation high temperature low sag (HTLS) transmission conductors.”

He also points out the growing popularity of gas-insulated transmission lines (GIL). “These lines have high transmission capacity and are best suited in cases where construction of overhead transmission lines is not feasible. GIL can be laid above the ground, installed in tunnels or buried underground.” KEC is present in both the gas-insulated sub-station and the GIL business and it also manufactures HTLS conductors.

Going all in
Fund managers feel that apart from early signs of a revival in the investment cycle in the transmission space, attractive valuations are drawing investors’ interest in this set of companies. “Growth outlook for the power transmission sector remains positive. We expect steady investments in transmission infrastructure in the medium-term leading to steady earnings growth for asset owners. We see reasonable upside in the sector as valuations remain attractive,” says Harsha Upadhyaya, CIO, equity, Kotak AMC. 

Leading EPC players such as Kalpataru Power, KEC International, PGCIL, Techno Electric & Engineering and Skipper are trading at an average P/E multiple of 13x to FY17-earning estimates. Kartik Soral, fund manager, Edelweiss AMC, adds, “We are seeing a healthy pick-up in orders since the beginning of FY15. In the current fiscal, a meaningful pick-up is seen in rural electrification orders. The power transmission and distribution market is at an inflection point. While order visibility from PGCIL remains strong, increased orders from state electricity boards, utilities, and green energy projects could be additional catalysts.” 

This buzz is also reflected in the financials of leading power transmission companies. Gujarat-headquartered Kalpataru Power Transmission has secured orders worth Rs.3,460 crore in H1FY16, which is 191% higher than the orders secured during the same period last fiscal. The company’s ebitda margin in H1FY16 has improved by 130 bps to 10.8%. Analysts expect operating margins to remain in the range of 10%-11% during FY16-FY18 and operating profit to grow at 17% CAGR over FY15-FY18.

KEC International, a subsidiary of the RPG group, has also been receiving orders at a steady pace. The EPC major has seen a 57% rise in order inflows at Rs.4,591 crore in H1FY16 and its ebitda margin has improved by 190 bps to 7.6% for the same period. Analysts at Religare predict an earnings growth of over 30% CAGR during FY16-FY18.

Kolkata-based Skipper, which entered the transmission market in FY09 has managed to gain a 10%-15% market share. With an order pipeline that currently stands at Rs.2,200 crore, analysts expect it to grow further by 17% CAGR over FY15-FY18. The power transmission tower manufacturer avails the benefit of low raw material (steel billets) and labour costs, by virtue of being based in West Bengal. It is one of the few companies that builds monopoles — steel tubes that can be easily erected in areas with space constraints — which provides tremendous scope for growth, as per the management.

EPC major Techno Electric that has enhanced focus on its transmission and distribution business, reported net sales of Rs.794 crore in FY15 with a net profit of Rs.106 crore. Analysts expect the company’s earnings to grow at 15.7% CAGR over FY15-FY17. Due to its experience in project ownership and sub-station execution, the turnkey player aims to execute one BOOT/BOOM project annually for a portfolio of three-four projects by 2017. This would give it the dual advantage of EPC and O&M (operations and maintenance) revenue thus, translating into a steady annual income.

Even marquee investors like S Naren and Prashant Jain are betting big on power transmission companies as is evident from their portfolios. For HDFC’s Prashant Jain, 14.8% of the equity assets managed by him are parked in shares of Calcutta Electric Supply Corporation, PGCIL, KEC International, Kalpataru Transmission and Techno Electric & Engineering. Naren, the chief investment officer at ICICI Prudential AMC, who is known for his contrarian bets, seems to have his sights set on state-owned PGCIL. The stock features in four of the five schemes that are co-managed by Naren. His co-managed schemes’ exposure to PGCIL stands at 25.24% of combined net assets.

Due to the monopoly enjoyed by PGCIL in the country’s inter-state and inter-regional power transmission network, the company earns an assured return on its completed projects. The revenue certainty makes it a comparatively safer bet in an otherwise turbulent power sector. Another factor that gives the state-run transmission utility an edge over other players in the private space is that given the complexity of large transmission projects and the need for timely completion, projects are assigned to PGCIL outside of the bidding mechanism.

Analysts say that at 9x FY17 estimated earnings, PGCIL’s valuation look attractive with earnings expected to grow at 17.4% CAGR between FY16-18. For quarter-ending September 2015, the company’s net sales grew 18% y-o-y to Rs.4,904 crore, while net-profit was up 20.5% to Rs.1,488 crore. While growth prospects and valuation look attractive, investors need to temper return expectation given the overall weakness in the market.