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PTC India: Regulatory pressure - Views on News from Equitymaster
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PTC India: Regulatory pressure
Jun 11, 2007

Performance summary
India’s largest power trading company, PTC India, recently reported mixed results for the fiscal ended March 2007. For FY07, while revenues grew by 21% YoY, net profits declined by 13% YoY, chiefly on the back of contraction in operating margins. Lower margins per traded unit impacted the company’s operating margins during the fiscal, with the same declining by almost half to less than 1%.

Financial performance: A snapshot
(Rs m) FY06 FY07 Change
Sales 31,086 37,667 21.2%
Expenditure 30,593 37,361 22.1%
Operating profit (EBDITA) 492 305 -38.0%
Operating profit margin (%) 1.6% 0.8%  
Other income 114 186 63.3%
Depreciation 36 34 -4.9%
Profit before tax 570 457 -19.8%
Tax 165 105 -36.0%
Profit after tax/(loss) 406 352 -13.3%
Net profit margin (%) 1.3% 0.9%  
No. of shares   150.0  
Diluted earnings per share (Rs)   2.3  
P/E ratio (x)   26.0  

Company background
PTC was incorporated on April 16, 1999 with the objective of carrying out the business of purchase of electricity from state power utilities, licensees, generating companies, independent power producers and captive power plants. And in the process, selling the same to the state power utilities, licensees, bulk consumers, whether in private or 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.

What has driven performance in FY07?
Realisations drive growth: PTC India traded 6% lesser amount of electricity during FY07. Against trades of 10,119 m units (MUs) during FY06, FY07 trades stood at nearly 9,550 MUs. However, despite this, the company’s topline recorded a growth of 21% YoY, being led by a near 30% YoY growth in realisation per traded unit. This jumped from Rs 3 per unit in FY06 to Rs 3.87 per unit traded in FY07. Revenues from coal intermediation, which forms less than 1% of the company’s net sales, declined by 25% YoY during the fiscal.

Lower trading margins impact margins: PTC’s average trading margins declined from nearly 6 paise in FY06 to less than 5 paise in FY07, on account of the regulatory fixation of margins per traded unit. As a matter of fact, through its order in January 2006, the CERC (Central Electricity Regulatory Commission) had fixed the trading margin at 4 paise/kWh for electricity traders who have been given licenses for engaging in interstate trading of electricity. The Commission reasoned that nearly 90% of trading during FY05 was done at a trading margin of 5 paise/kWh or less, but the same increased to a weighted average of 10 paise/kWh in the first half of FY06. Also, it noted that up to FY05, trading margin of 5 paise/kWh or less was a pre-dominant trend. However, trading margins shot up in the first half of FY06 and around 68% of volume traded carried a margin of 6 paise/KWh. Notably, the instance of highest trading margin in a single transaction in FY05 was 43 paise/kWh, which touched 128 paise/kWh in the first half of FY06.

We believe that the move to fix margins could be construed as a sign of excessive regulation in a sector that is yet to take off. At 4 paise/kWh, the margin works out to only 1% of the average cost of traded power at around Rs 4/kWh. This is much lower than around 3% margins on cost of power traded that is supposed to cover all risks (as per Crisil), and does not factor in the risks associated with third party transactions. PTC’s management has indicated that, since trading margin has to be based on cost-plus risk (as risk in dealing with one client differs from risk in dealing with the other), a higher risk trade must entail higher margins. Since the matter is still pending in the Supreme Court, we have factored in trading margin at the capped rate of 4 paise/kWh for PTC’s trades in the next 2 years. Considering the sheer estimated growth in volumes in the future, any relief on this front will tremendously boost profitability of the company.

It flows to the bottomline: The compression in operating margins has negatively impacted PTC’s bottomline, which has declined by 13% YoY during FY07. But for the strong 63% YoY growth in other income and decline in tax and depreciation expenses, the pressure on bottomline would have been higher.

What to expect?
At the current price of Rs 61, the stock is trading at a multiple of 26 times its FY07 earnings. PTC has underperformed our topline and bottomline estimates during the fiscal, and we shall be taking a re-look at our future estimates for the company. We, however, maintain our positive view on the company as we see tremendous potential in the power trading business in India. Also, the fact that the company is trying to gradually increase the share of long-term volumes in its total business, is a positive.

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