Call it an error in judgment, but domestic mutual funds (MFs) have missed the boat by investing in India’s leading PSU power companies. Over the past 24 months, MFs have stuck with their higher portfolio allocation to NTPC as the rally in another PSU Power Grid Corporation has taken the markets by surprise.

Power Grid and NTPC had almost similar market caps, but the former has outperformed NTPC by 33% in the past 24 months. The MFs hold 18.4% of the capital of NTPC and only 8.2% of Power Grid. MFs have 1.5% of their portfolio invested in NTPC and only 0.7% in Power Grid. To date, Power Grid is valued at over 1.49 lakh crore and NTPC at almost ₹ 1.25 lakh crore.

MFs and banking financial institutions preferred NTPC to Power Grid. This despite the fact that NTPC faces significant disruption risks associated with the transition to clean energy and the power grid is likely to benefit from the same transition to clean energy. Investors can perhaps be swayed by the cheaper valuations of NTPC versus Power Grid and the hope of their valuations converging. (But) they might want to take note of the very different long-term perspectives of the two, ”Kotak Institutional Equities said in its report.

Kotak’s take on NTPC’s transition to clean energy

India’s accelerated transition to clean energy will result in a significant negative change in the return and risk profile of NTPC given the low generation of Free Cash Flow (FCF). NTPC will need to invest cash flow from existing coal-fired power plants in new solar capacity to remain relevant and protect its terminal value. It will have a limited growth in production capacity, because new solar capacities gradually replace the existing thermal powers over a certain time; solar tariffs are already cheaper than thermal tariffs, and higher risks to solar asset cash flows given open market tariffs compared to existing guaranteed regulated returns of thermal assets.

“We note that solar power plants generate high single-digit IRR at current tariffs, which are significantly lower than the guaranteed RoE of 15.5% (of regulated equity) for NTPC’s thermal assets,” the report said.

Power Grid perspectives

Kotak says India’s accelerated transition to clean energy will provide new growth opportunities for PWGR after a slowdown in the pace of adding new capacity in recent years. Its core power transmission business is likely to thrive, as India invests heavily in new transmission capacity to modernize its national grid and connect to new sources of solar power, much of which will be built in the north and western India given favorable solar radiation, far from coal. factories based located in central and eastern India.

“Power Grid is indifferent to the production mix and faces lower financial risks as it operates in a heavily regulated industry with 96% of its asset base regulated as of September 2021. Power Grid deserves a higher valuation premium compared to NTPC, ”the report said.

Power Grid shares had traded at higher valuations compared to NTPC for the past 18 months, unlike when their valuations were very similar.

“In our view, Power Grid’s relative premium over NTPC is justified, as NTPC’s performance profile has deteriorated significantly relative to Power Grid over the past few years and faces significant risks of disruption. long-term. However, the relative positioning of investors in the two equities implies the conviction of national investors that the valuation multiples of NTPC and Power Grid would converge (reversion to the mean). In our opinion, this is unlikely given the very different fundamentals of the two companies, ”said Kotak.


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