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ET Intelligence Group: Investor interest in the shares of Power Grid, India's largest power transmission company , has increased manifold in the past one month as it offers the characteristic of a defensive play -that is earnings are unaffected despite economic cyclicity -along with high earnings visibility and growth. As a result, the stock outperformed its benchmark index by 14% in the past one month.
The company's earnings are based on the fixed return on equity (RoE) of 15.5% on its regulated equity -the proportion of equity exposure in its gross block (that is, value of plant, property and equipment without depreciation). When a new plant is commissioned and added to the gross block (called capitalisation), it boosts the company's earnings growth. So, if the capitalisation of the company in a year is higher than its capital expenditure, it is positive for the earnings growth.
In FY16, capitalisation ratio of the company has exceeded its capex for the first time and this trend is likely to continue till FY20. The cumulative capitalisation between FY17 and FY19 is expected to be Rs 84,000 crore as compared with Rs 72,600 crore of capital expenditure in the same period.This is likely to result in its regulated equity to grow 19% and 16% for the current and next fiscal, respectively , and translate into earnings growth in the similar order.
Power Grid has an outstanding investment approval of Rs 1.2 lakh crore, which provides earnings visibility for a few years on the extent of the asset base of Rs 1.6 lakh crore.
Even in Q2FY17, Power Grid reported 29% earnings growth due to a sharp increase in asset capitalisation. It capitalised assets aggregating Rs 6,700 crore in Q2 and incurred Rs 5,300 crore on capex. Power Grid has front-loaded asset capitalisation with 76% of FY17 target achieved for transmission lines (regarding circuit km) and 83% of the target achieved for substations (MVA) in the first half.
Also, a fall in interest rates is positive for Power Grid since it increases the spread of their RoE over fixedincome securities. According to analyst estimates, a drop of 50 bps in risk-free rate could increase the valuation of Power Grid and NTPC by 8-10% based on the discounted cash flows method.
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