Powergrid (NSE: POWERGRID) - my company deep-dive and valuation. Feedback appreciated!

[michaela57]

Powergrid owns and operates 45% of India’s electricity transmission network. It meets all the criteria for a good long term investment:

• Moat: the dominant player in transmission. Has 20~30 year contracts with assured ROEs. Is the government’s preferred vendor for large scale or complex transmission projects
• Long growth runway: increasing Indian power consumption and massive investments in new renewable power generation capacity
• Management execution: consistently exceeded regulatory benchmarks with 99%+ transmission system availability and demonstrated ability to execute large scale projects over the last decade
• Attractive valuation: limited downside possibility at current prices, with attractive returns on the upside. Risks to the growth trajectory: regulatory regime and tariff changes, competition by private players and fraud / corruption.

The valuation and detailed analysis follows - please go through and let me know your thoughts!

Link: https://opensourceinvestor.substack.com/p/powergrid-the-backbone-of-indias

Contents:

• Indian electricity demand
• Energy value chain
• Powergrid’s business model
• Management
• Financials
• Competitive advantages / moat
• Runway / future growth potential
• Risks
• Valuation
• Sources

https://preview.redd.it/s0183d9kt5w...bp&s=5cd8e9155154d184d8707ed1a9cd136f490de547

 

[jamessecondson]

@michaela57 Debt is insane

 

[michaela57]

@jamessecondson Their debt is pretty high, but easily covered by cash flows that are fixed in 30+ year contracts and guaranteed by RBI. Also , they operate critical infrastructure- very low probability that a significant portion of their transmission network stops operating . If that happens, most of India would not have electricity

 

[nicksc]

@michaela57 Govt PSU, that’s a big caveat if you ask me.

 

[michaela57]

@nicksc Agreed, this is also why it trades at such low prices currently. However, based on the below points, I think they are actually comparable to private cos:

(1) Powergrid's performance is crucial to the country's functioning . Also new projects are critical for the renewable energy transition of the country. Hence, their activities are highly regulated and scrutinized. Large scale fraud and corruption unlikely. There might be low-level corruption in some smaller contracts (example: 1, 2), but that should not hurt the long-term growth prospects

(2) Government and CERCunlikely to drastically change regulations to hurt Powergrid's returns, as they are still pushing for increased investment into the power transmission space to support 24X7 electricity for all and 50% renewable generation capacity by 2030. Hence, they would not want to scare off investment into this space by frequently changing regulations that hurt investor returns.

(3) Management execution has been great for the last 10 years. They have been supported multiple times in the past by the World Bank and Asian Development Bank, who have given their endorsement to the management efficiency. They also run quite a lean team of 8.7k executives and bureaucracy level seems to be much lower than other PSUs. They also attract some of the top GATE rank students because of this.

 

[claire96]

@michaela57 It is a PSU. I'll forever be skeptical of a the govt transferring control of some part of the grid to a private company.
What happens to the cashflows then?
What happens to debt?
What happens to operational efficiency?

 

[michaela57]

@claire96 Thanks for the feedback.

You are right - the government is planning to increasingly privatize state assets through the 'National Monetisation Pipeline. Of the overall plan, INR 452Bn is from transmission assets, which I assume will all come from Powergrid. That represents around 15% of Powergrid's enterprise value.

The first example of this was the recent PG InvIT offering, where approx. INR 100Bn of enterprise value in the form of Powergrid's assets were floated on the market. For existing Powergrid investors, this helped reduced some debt from the balance sheet and didn't change the ROE much, as both Powergrid and the InvIT assets had an aggregate ROE of ~19%.

Powergrid had planned a 2nd InvIT, but has dropped the plan now, as it said that the cost of funds is high through that route and would instead focus on a " securitization model" - where banks or private investors will pay an up-front amount for the future cash flows from particular assets.

So, as long as you can trust the management to value the assets correctly and privatize them at the correct prices, it should benefit Powergrid investors, as that money can be used to fund new projects at attractive ROEs. The company also uses a independent valuator for the assets - you can read their InvIT valuation here.pdf).

 

[goddog]

@michaela57 I'm just gonna add that government privatisation can take years and even at the very last stage can fall apart, for example, NMDC Steel.
Due to the public strikes and dissent, Amit Shah announced that NMDC Steel which has only one plant operational as of today, won't be sold off and will be a public asset even though the very purpose of NMDC steel demerging from NMDC was to privatize it. Governments are hard to predict, add that to the mix of corporations and you've got something even more hard to predict than a standard corporate operation.

 

[videomission]

@michaela57 Hey nice analysis, can you tell in the end where you did the INVIT analysis why does the returns fall so drastically around 27-29 ? and why does it not recover , if it was some 1 time expense it would come back up, will be helpful if you can throw some light here.

Talking about PPTL, PWTL, PJTL - I mean they start with 30-40% ROE and then suddenly such a big drop - why ?

https://preview.redd.it/hu1qn0jmebw...bp&s=51b0fa2fcefbe497036ac9c661e309d87f5047ee

 

[michaela57]

@videomission Hello - thanks for reading! The drop in ROE in the 3 projects is due to drop in revenue after 2027 in the service agreements. I am not sure why the agreement is structured like that, but I think it has something to do with a CERC ruling to grant additional revenues in the first few years due to higher than expected costs incurred during these project.

Example: the revenues / cash flows of PJTL can be found in page 70 of this report.pdf). They also mention the additional revenue point in page 66 under revenue assumptions.

I've pasted the table below - you can see a drop in revenue of 30% from 2028 onwards:

https://preview.redd.it/ors4icplvbw...bp&s=f7f30b1458462066cc8f1a329742ded305236860

 

[videomission]

@michaela57 Hey I checked the Annexure, don't see how there is such a big fall, the adjustments you mention are like 3-7% per year in revenues and they would be there permanently throughout the lifetime of the asset - this just looks weird - why is there such a huge drop in revenue and no clear mention of it anywhere - this is just another huge red flag not explaining anywhere concretly ki why will revenues fall so much. Atleast you plotted the graph so it becomes clear where to look for. Do let us know if you find the exact reason anywhere. The Invit doesn't even have transcripts of their concalls - another f**ing red flag, I heard the audio of last one and management was asked to provide it they said they will and still nothing. And management is appointed by POWERGRID only.

 

[michaela57]

@videomission I just tried to check now, but looks the InvIT website is down - didn't find any further details in their latest annual report.

However, one point to note about the 3 projects with initial revenue spikes: their average ROE for the contract is very high (19%~22%), whereas standard projects are around 15.5%. So, this makes me think that the initial revenue spikes were additional / special revenue and the years after 2028~2029 are the "normal" revenue as per the original service agreement.

https://preview.redd.it/xnjkme9av4x...bp&s=7a7073e2a71216feb60d134e929b41a4cb8702ed

 

[pumpthebrakes]

@michaela57 so net of net with this kind ROE what would the ROI be for a 101 INR buy in the future .. as thats the going rate as of now

 

[nic11]

@michaela57 Govt is rarely gets in a business to make money for it's shareholders

 

[michaela57]

@nic11 You are correct. The primary reason for the company to exist is to provide electricity supply to the country - financial returns would only be a secondary consideration. However, given the growing energy needs of the country, the government needs to encourage massive investments into generation, transmission and distribution. They need domestic and foreign investors / banks to participate. Hence, they have provided an attractive ROE in the past (15.5%) and I expect this to continue for the next few decades until all energy supply and distribution needs are met (i.e. 24X7 steady power supply for all consumers)

 

[dp797]

@michaela57 Don't they have high debt? Which makes it little sceptical

 

[michaela57]

@dp797 High debt is an issue only if the company could find itself in a position where it can't make interest payments. In Powergrid's case, operating cash flow is 3x interest payments and contracts are 20~30 years long.

If, theoretically, revenue gets cut to 1/3rd, they might have problems servicing debt. However, that is close to impossible - that would mean that 1/3rd of India's grid shuts down and 1/3rd or the people don't receive electricity. They are also protected against State DISCOM payment defaults, because DISCOM payments are guaranteed by RBI.

It is a similiar case to Bershire Hathaway energy in the US - Buffett describes it here:

 

[dp797]

@michaela57 Thank you mate. I get that and government will always be there to support in some or the other way. Considering the rate at which India is growing it is not going to happen. Luckily the RBI stopped increasing interest rate or else it would have been mess for number of companies in India. The west is already facing the problem and is expected to continue owing to the sticky inflation.

 

[shespeakschrist]

@michaela57 Great prediction

 

[michaela57]

@shespeakschrist Thanks!!