Superior return ratios make Torrent a good bet

Torrent Power, a leading power player in Gujarat, would benefit from steady consumption growth in its licensing areas apart from turnaround in operations at its newer franchisee areas.

Business: Torrent Power, promoted by Torrent Group, is an integrated utility having interests in power generation, transmission and distribution.

The company has an aggregate power generation capacity of 1,647.5 mw comprising 1,147.5 mw gas-based mega combined cycle power plant located in Surat, 400 mw coal-based thermal power station at Sabarmati and 100 mw gas-based combined cycle power plant at Vatva in Ahmedabad.

The company has allocated around 1,300 mw capacity for licence areas while the remaining capacity is sold on merchant basis. Torrent transmits and distributes power to more than 3 million customers annually in Ahmedabad, Gandhinagar, Surat, Bhiwandi and Agra.

Torrent was one of the first companies to enter into the distribution franchise business by signing an agreement with Maharashtra State Electricity Distribution Company for Bhiwandi circle in 2006. Since then it has been awarded distribution franchise for Agra and Kanpur in Uttar Pradesh and Dahej in Gujarat. Though operations at Agra have commenced, currently it is making losses.

The company is expanding its installed power generation capacity by further 1,600 mw which includes setting up 1,200 mw gas-based power project at Dahej currently under implementation apart from adding one more unit of 382.5 mw at its Sugen plant.

The company, which has received environmental clearances and has given EPC contracts to Siemens for these projects, expects completion in fiscal 2014. The company also plans to add 3,000 mw to its Sugen plant capacity and 2,000 mw in its subsidiary Torrent Pipavav Generation Limited, but has not made much progress in either of these two projects.

Investment rationale: The company has a stable and robust cash generating business model as more than 80% of its capacities are tied on long-term basis to licence areas while merchant capacity provides a further boost to revenues.

The company, being sole distributor of electricity to consumers in highly industrialised and growing cities of Ahmedabad, Gandhinagar and Surat, would benefit from steady consumption growth of 4 to 6% in these areas and approval of proposed hikes in tariffs.

The company has filed a petition before Gujarat Electricity Regulatory Commission to approve the proposed tariff revision corresponding to revenue gap arrived at considering the average revenue requirement for fiscal 2012.

The company would be a beneficiary in transmission and distribution (T&D) space where government is encouraging more private sector participation given the poor financial condition and inefficient operations of SEBs.

The T&D losses in India are currently around 25-28% which leads to significant revenue loss.

On operating front, the company’s T&D losses (in Gujarat licence areas) which are under 8%, are one of the lowest in the industry.
Torrent, which is the only successful player in private distribution franchise business, has been able to drastically reduce aggregate technical and commercial (AT&C) losses in Bhiwandi from around 60% in 2007 to under 20% now. The company would benefit from reducing AT&C losses at Agra in the coming years thereby leading to a turnaround.

The average plant load factor (PLF), which had fallen in last few quarters, are expected to improve as gas allocation to power sector is given priority by the government. The company has a strong balance sheet with net debt-equity ratio under 0.60 (for FY11) and had reported negative working capital along with positive free cash flow generation last fiscal.

This reveals that the company is in a comfortable position to fund its expansion plans. The company has also been consistently generating superior return ratios as its ROE in FY11 stood at 22%, one of the highest among its peers.

Concerns: Any unfavourable changes in the regulatory norms related to tariffs or operations could impact the earnings. Also, declining merchant rates on back of increasing private competition pose threat to profitability. Issues related to ramp up in KG basin gas may also impact the company as it has still not been able to tie up its fuel (natural gas) requirement for 1,200 mw Dahej project.

Valuations: Given that there are no new incremental capacities coming up in the near term, the revenues are expected to grow at CAGR of 9% over FY11-FY13E, while the net profit is expected to grow at 7% annually in the same period. At current market price of Rs255.95, the stock is trading at 10.43 times its expected FY12 earnings per share and 2.13 times its expected book value for fiscal 2012.

Considering its strong balance sheet, superior return ratios and operating parameters, one can consider entering the stock on dips from medium to long-term perspective.

Disclaimer: The writer does not hold any shares in the company