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2 September 2005

UpdateSECTOR: UT ILITIES

©Motilal Oswal Securities Ltd., 81-82, Bajaj Bhawan, Nariman Point, Mumbai 400 021 Tel: +91 22 56575200 Fax: 2281 6161

Delhi Privatization: Success or Failure

Satyam Agarwal ([email protected]); Tel: +91 22 5657 5353 / Anjali Shah Vora ([email protected]) Tel: +91 22 5657 5305

BSE Sensex: 7,900 S&P CNX: 2,416

Delhi state government rolls back power tariff

hike

Following large-scale protests from consumers and political

leaders, the Delhi government has decided to roll back the

proposed average power tariff hike of 10% for domestic

consumers for FY06.

Financial health of distribution companies will notbe impacted

Media articles state that the proposal entails a revenue gap

of Rs1.84b. Of this, the Delhi government is expected to

provide Rs950m, while the balance Rs900m will be shared

by the three Delhi distribution companies – North Delhi

Power (NDPL), BSES Rajdhana Power (BRPL) and BSES

Yamuna Power (BYPL). The final details of the

arrangement are still being worked out.

We believe that the shortfall of Rs900m for the threedistribution companies will be met through the incremental

revenues generated through over-achievement of AT&C

loss targets. We note that a 1% reduction in loss level over

the targeted level will generate additional revenue of Rs900m

per annum.

Under the current mechanism, such revenues are being

shared equally by distribution companies (as efficiency

incentives) and consumers. Thus, a 2% reduction in AT&C

losses over targeted levels will entail that the gap of Rs900m

can be offset by the share due to consumers.

We believe that the current fiasco could also hasten the

process of making power theft a cognizable offence in

Delhi. The distribution companies have been demanding

this for quite some time. Some states in India, namely

Andhra Pradesh, Karnataka, Rajasthan, Uttar Pradesh and

West Bengal have already enacted an anti-theft law and

set up such special police stations and special courts. This,

in our opinion, will provide regulatory teeth to the distribution

companies and enable them to accelerate the process of reduction in AT&C losses.

Performance of distribution companies has been

encouraging

We believe that the performance of Delhi distribution

companies has been encouraging. By end FY07, we expect

the distribution companies to reduce AT&C losses to 20-

25%, which is a sharp improvement from FY02 levels of

50-55%.

Our calculations indicate that even at the current level of

AT&C losses, a 10% tariff hike will completely eliminate

the need for government subsidy in the Delhi power sector.

Also, the FY06 revenue gap of Rs3.2b would have been

significantly lower if the gains through accelerated

reduction in AT&C losses of Rs2b during FY05 were

accounted for. These gains are now being utilized to finance

the regulatory asset of Rs5.5b created for FY05, to meet

past under recoveries.

TARGETED AT& C LOSS LEVELS (%)

FY03 FY04 FY05 FY06 FY07

BRPL 47.6 46.0 42.3 36.3 30.7

BYPL 56.5 54.7 50.7 45.1 40.0

NDPL 47.5 45.4 40.9 35.4 31.1

Source: Delhi Electricity Regulatory Commission

AC TU AL PERFO RM AN CE (% )

FY03 FY04 FY05

BRPL 47.4 45.1 40.6

BYPL 56.5 54.3 50.1

NDPL 47.8 44.9 35.1


State government better off, despite incremental

budgetary support

As per media articles, the Delhi government will provide

budgetary support of Rs900m to the distribution companies,

post the decision to roll back the proposed tariff hike.

This would entail that for FY06, the total budgetary supportfrom the government will stand at Rs2.3b (Rs1.4b in the

All distribution companies

have outperformed the

targets



Update

22 September 2005

form of transition support and Rs900m as revenue gap for

FY06), which is much lower than the transition support of

Rs13.6b, Rs12.6b and Rs6.9b provided for FY03, FY04

and FY05, respectively. Thus, we believe that the current

fiasco and consumer criticism does not put a question mark

on the privatization model being adopted by the Delhi state

government.

STATE GOVERN M ENT’S TRA N SITORY SU PPORT (RS M )

FY03 13,640

FY04 12,600

FY05 6,900FY06 1,380

FY07 0

Total 34,520


Has the tariff hikes by discoms been excessive?

As per the privatization model in FY03, distribution

companies were expected to become self-sufficient by

FY07 as a result of:

? Reduction in AT&C losses by 17%, and? Increase in power tariffs by 43.9%

Based on these assumptions, the state government had

accounted for a decline in transition support to Rs1.4b in

FY06 from Rs13.6b in FY03. We note that as against the

proposed cumulative increase of 39.8% till FY06, the actual

tariff hike has been 15.5% (not factoring in the recent 6.6%

hike which has been rolled back for domestic consumers).

TARIFF INCREASE (%)


Proposed * 10.0 10.0 10.0 5.0 3.0

Actual 0.0 5.0 10.0 - -

CUMU LATIVE TARIFF INCREASE (%)


Proposed * 10.0 21.0 33.1 39.8 43.9

Actual 0.0 5.0 15.5 15.5 -

* Proposed at the time of privatization


We foresee an accelerated pace of power sector

reforms in India

We believe that the progress on power sector reforms in

India till date is quite encouraging. ( Please refer to our

detailed 156 pages report: Utilities – Light at the end

of the tunnel, dated 27 May 2005). Very recently, the

Uttar Pradesh Electricity Regulatory Commission started

the groundwork for granting permission to set up parallel

networks in Meerut, Gaziabad and NOIDA. Also, the

Maharashtra Electricity Regulatory Commission has asked

the distribution companies to submit proposals for setting

up similar networks in urban circles.

We believe that given the state of the power sector in the

country and the provisions in the Electricity Act, SEBs have

no option but to shape up.

Maharashtra experience indicates tremendous

urgency towards reforms

The recent experience of Maharashtra indicates that the

country could soon face a serious power crisis if adequate

pr ivate sector in vestments are not channeled in to

generation. We believe lack of adequate investments in

generation and increasing electricity consumption

precipitated the Maharashtra crisis.

On a nationwide level, FY05 peak deficit stood at 11.7%.

Electricity consumption growth of ~5.5% p.a. over the last

few years has been largely met through improvement in

capacity utilization (industry PLF increased from 64% in

FY99 to 75% in FY05). Given that electricity consumptionin India continues to grow at ~6% p.a., average capacity

utilization cannot be increased beyond 80-82% and in view

of the fact that it takes three years to commission a new

pr oject, we sense a tremendous ur gency towards

accelerating the pace of reforms in the sector.



Update

32 September 2005

Attracting private sector investments in

generation remains the key challenge

We observe that CPSUs like NTPC and Neyveli Lignite,

are going ahead with the capex addition programme in

generation, driven by improved cash flows and payment

security mechanism. Private players have outlined a series

of projects, but they continue to remain on the drawing board

as the companies are waiting for mining allocations and

access to distribution. We believe that attracting private

sector investments remains one of the biggest challenges

for the government.

INCREASE IN GENERATION CAPACITY ON FIRMED UP CAPEX (FY05 -12)

optionality, which could be in multiples of the current size.

While CPSUs like NTPC and Neyveli Lignite have

embarked on a capex programme to double the existing

capacity by FY12, private players have also announced

large projects. For eg., Reliance Energy’s current

generation capacity stands at 942 MW, while announced

projects total 20,000 MW+ (Dadri 3,740 MW, Maharashtra

4,000 MW, Orissa 12,000 MW, etc). Tata Power has also

announced projects for 15,000 MW (coal based 11,000 MW,

Western region 1,000 MW, Eastern region 1,000 MW,

Maithon 1,000 MW and Delhi 1,000 MW).

Growth optionality is not equity dilutive

Most companies in the sector have large liquid investments

and cash in their portfolio. Therefore, a significant part of

the growth would not be equity dilutive. As at March ’05,

companies like NTPC, Tata Power and Neyveli Lignite

had around 50% of their capital employed in cash and

investments. For Reliance Energy, the percentage is 70%.

CASH AND INVESTMENTS (% OF CAPITAL EMPLOYED)


NTPC 43 46 48 46 43

Neyveli Lignite 11 43 50 55 56

Tata Power 36 41 49 50 55

Reliance Energy 32 56 70 74 76

CESC 2 2 6 10 10

Jaiprakash Hydro 1 1 10 16 22

PTC India 60 86 48 43 37

Source: Company/Motilal Oswal Securities Ltd

Source: Motilal Oswal Securities Ltd

Incumbents enjoy growth optionality

We believe that the Indian power sector is interestingly

poised, offering significant growth potential. Incumbents,

especially the private players and CPSUs, enjoy growth

6% 0% 0%0%15%

90%94%

443%

0%

100%

200%

300%

400%

500%

N

T P C

N e

y v e l i

L i g n i t e

T

a t a

P o

w e r

R e l i a n c e

E n e r g y

C

E S C

J a i p r a

k a s h

H y d

r o

J i n

d a l

S t e e

l a n d

T o

r r e n t

A

E C

CPSU’ s have firmed up capacity

addn plans; Private cos are

waiting for CBT / M erchant

Plant guidelines to be firmed up

and access to distribution

before committing generation

capex

Similarly to

JSPL, due to

the low base,

growth option

for private

players could be

in multiples of

current size

VALUATION COM PARATIVE

TARGET

RECO . CM P PRICE U PSIDE P/E (X ) ROE (% ) P/B V (X ) B V (RS/SH )

(RS) (RS) (% ) FY06 FY07 FY06 FY07 FY06 FY07 FY06 FY07

NTPC Buy 103 107 4.2 16.2 14.2 12.1 12.8 1.9 1.7 54 59

Neyveli Lignite Buy 85 88 3.1 14.3 13.2 12.6 12.5 1.7 1.6 49 54

Tata Power Buy 462 487 5.4 16.2 14.3 10.5 11.0 1.8 1.6 261 284

Reliance Energy Buy 574 734 27.9 18.7 17.8 9.7 8.8 1.7 1.6 329 354

CESC Neutral 239 219 -8.5 13.6 13.1 13.9 12.7 1.5 1.3 159 179

Jaiprakash Hydro Neutral 32 32 0.0 21.4 21.0 12.2 11.7 2.5 2.4 13 13

Jindal Steel and Power Buy 1,225 1,360 11.0 5.7 5.1 33.9 27.6 1.9 1.4 640 868

PTC India Buy 48 67 38.8 27.2 19.8 11.6 14.6 3.0 2.8 16 17

NTPC (Adj)* Buy 103 107 4.2 13.1 12.3 12.8 13.4 1.9 1.7 55 60

Neyveli Lignite (Adj)* Buy 85 88 3.1 11.0 10.8 14.7 13.6 1.6 1.5 53 58

* Adjusted for higher depreciation in books as compared to Tariff Order and Rebate on OTSS bonds



Update

42 September 2005

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