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Power Trading Corporation: What to do?

Apr 7, 2004

Power Trading Corporation (PTC) finally got listed on the bourses today at more than double the offer price (Rs 14 to Rs 16). Since the power sector is expected to grow at faster rate in India (due to the reform measures initiated by the government), investors have shown large interest for the scrip, as a result, the offer got oversubscribed around 47 times overall. While other reasons for the enthusiasm can be returns that stock markets have given over last one year, the low price of stock as compared to other IPOs, retail participation was at its peak (retail category oversubscribed 66 times). Lets take look into the fundamentals of the company and find the fair price of the stock. PTC was incorporated on April 16, 1999 with the objective of carrying on the business of purchase of electricity from state power utilities, licensees, generating companies, independent power producers, captive power plants. And in the process, selling the same to the state power utilities, licensees, bulk consumers, whether in private and public sector in India and abroad. Thus the business of the company is to buy power from power plants in surplus areas and sell it to entities in power deficient states.

The company's marketing department maps the power deficit and power surplus pockets of the country on a continuous basis. The price is negotiated, which is acceptable to both the parties (buyer and the seller). Thereafter, PTC facilitates the physical transfer of power from the seller to the buyer by arranging transmission lines by contacting various zones. PTC charges a traction margin for the services provided that can be determined either as a fixed amount per kWh (kilowatts per hour) of power traded or as a percentage of cost of power traded. It helps both consumers as well as producers in the sense that producers can operate at full capacity by entering into power purchase agreement with PTC which in turn also reduces the cost of power produced due to economies of scale for consumers.

After having a look at the business profile, lets analyse the strengths and concerns of the business model.

The strengths include:

  • Power sector potential. (power sector expected to grow at CAGR of 10% to 12% over next 10 years)

  • The first mover advantage into power trading business.

  • Nodal agency for cross border trade of power.

Concerns are:

  • Low barriers to entry. (Competition from National Thermal Power Corporation, Tata Power and Reliance Energy and others as these companies are also planning to enter into trading of power.)

  • Loss due to open positions of the power. (As company needs to enter into long term purchase agreements. In such a scenario if it fails to find a buyer at right time and right price, the company can land into problems).

  • Change in the billing cycle. (Higher working capital requirements if payment of buyers extend beyond current status of one month)

  • Operational risk (T&D losses will have to be borne by PTC in case of any change in the point of delivery).

  • Regulatory intervention. (Can regulate margins going forward)

Having seen the positives and negatives of the company, we believe that the risk profile of the company is on higher side. Instead of buying a low margin and highly leveraged (in a single business) company like PTC, one will be in a better position to captialise on the future growth of power sector if a combination of power generation, power distribution and power trading business is bought with a long term investment horizon.

At the current price levels of Rs 38, the stock trades at P/E multiple of 17.3x annualised 9mFY04 earnings. Since there are no peers for the company in India as of now, globally, such companies trade with in P/E band of 6x to 10x. Considering the uncertainty over the company's earnings and concerns mentioned above, we would like to place the company on the lower side of valuation matrix, (6x to 8x band). Those who are betting on volume growth to drive the revenues of the company must remember that company will need to raise more capital for topline growth, as it has to maintain a reserve equivalent to 5 months sale. So the growth in EPS due to volumes will be offset by equity dilution to great extent. Even assuming a 50% CAGR growth in EPS over the next two years, the stock seems to be over valued at current juncture.

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