Will Power stocks continue to outperform?

By Ravi Samalad |  22-02-22 | 

Power is an important component of infrastructure and economic growth. Power is produced from conventional sources such as coal, lignite, natural gas, oil, hydro, nuclear power and non-conventional sources such as wind, solar, and agricultural and domestic waste.

Economic growth, growing urbanization and rising energy consumption are contributing to the increasing demand for energy in India. According to the Ministry of New and Renewable Energy, India stands in the fourth global position for overall installed renewable energy capacity.

The all-India annual per capita consumption of electricity has increased from 631.4 kilowatt hours (kWh) in 2006 to 1208 kWh in 2020. India had a total installed capacity of 3,93,389.463 megawatt (MW) and a majority of it is produced from coal as of December 2021. (Source: Central Electricity Authority)

(RES: Renewable Energy Sources)

The BSE Power Price Return Index has been the top performer (58.41%) over a one-year period as of February 18, 2022, outperforming the broader market by a wide margin. Currently, the Index is 5% lower (3,821.41 as of February 18, 2022) than its 52-week high (4,013.13). The Index consists of 12 players: ABB India, Adani Green Energy, Adani Power, Adani Transmission, Bharat Heavy Electricals Ltd. (BHEL), JSW Energy, National Hydroelectric Power Corporation (NHPC), National Thermal Power Corporation Limited (NTPC), Power Grid, Siemens, Tata Power, and Torrent Power. 

Mutual fund holdings

We asked fund managers their outlook on this sector. Here's what they have to say.

Valuations are reasonable. - Abhinav H Sharma, Senior Research Analyst & Fund Manager, Tata Asset Management.

The power sector is going through a momentous transition as the world moves towards renewable energy generation to reduce carbon emissions. Aided by technological advances, electricity generated from renewable sources like solar and wind has become cost-competitive vs. highly polluting fossil fuels like coal and is also becoming more reliable. The transition thus enjoys government, public, corporate, and investor support, and hence its inevitable in our view. India has also set an ambitious target of 500 gigawatt (GW) of installed renewable energy capacity by 2030 as compared to 105 GW now.  The addition of nearly 400GW over the next eight years would mean an investment of $ 200 billion-plus in the generation sector alone. Commensurate investments in power transmission and distribution will also be needed. Thus, there is a very large growth opportunity for all the companies in the power sector value chain over the next eight years and beyond.

While last one-year returns are impressive, BSE Power Index is still 20% below its January 2008 peak and has returned a meagre 6% CAGR over the last 10 years. Valuations of most companies in the sector are quite reasonable and near or below historical averages. A combination of attractive valuations and high growth prospects makes us very positive on the sector and expect the sector to outperform over medium to long term.

Some of the headwinds that the sector can face over the medium term are high competition eroding shareholder returns, technological changes, contractual disputes and high receivables due to the poor health of state distribution companies.

Power distribution is under stress. - SBI Mutual Fund, Bhavin Vithlani, Fund Manager, SBI Mutual Fund. 

Stocks in India’s power sector have seen a strong run-up over the last 12 months outperforming the broader indices and catching up on the underperformance over the last five years. The power sector is vital to India’s economic growth and pickup in manufacturing activities would benefit it as it is one of the highest tariff slab consumers.

The sector is undergoing a major transformation from coal to renewables and is reflected in the government’s target of 500 GW of renewable by 2030 from approx. 100 GW currently. This transformation provides an opportunity for generation and transmission companies to accelerate growth, but easy liquidity coupled with low-interest rates has intensified competition. This energy transformation is also a challenge for companies with a large dependence on conventional thermal.

India’s Power Distribution sector continues to be under financial stress, exacerbated by the pandemic. The Union Budget of 2021 and 2022 allows States additional borrowing of 0.5% of Gross State Domestic Product (GSDP) tied to power reforms such as Direct Benefit Transfer (DBT), privatization, etc. This would accelerate privatization in the distribution sector wherein approximately 95% is controlled by state-owned entities thereby benefiting companies specializing in power distribution.       

Renewable energy space is overvalued.  – Nilesh Shetty, Fund Manager, Quantum Mutual Fund.

You have to differentiate between the renewable and old economy space, which is thermal power linked. Valuations in the thermal power space are depressed. Once the demand for thermal power picked up post unlock phase, there was rerating in the valuations. The renewables space is different. There is a lot of global capital is flowing in green energy. So the cost of capital is low for these players.

There has been a rerating in the renewable energy space. So the gap between the old economy and renewable could be a factor of 4 or 5. The Power Index constitutes of players from renewable, thermal power, and companies linked to capital goods space. The major run-up has happened on the renewable energy side.

I will be cautious in this space because the valuations leave very little scope for comfort. During 2006-07, thermal power companies were richly valued, and it did not turn out well for investors. Most of these companies have very limited capacity as of now and have priced for potential. the assumption is five years down the line they will have a certain capacity, output and profitability. We have to wait and watch what happens. On the ground, the existing business is negligible. We are not holding any companies in the renewable space in our portfolios. We are invested in a stock that has a renewable plan, but the bulk of the business comes from thermal. The share prices of companies linked to the old economy have gone up but not that much. They still have a capacity for rerating, but we are not sure if the stock prices will double in one year.

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Ravi Samalad
Feb 22 2022 06:10 PM
 Hi Rahul,

a) It is MW
b) It is coal which is the largest producer. Thanks for bringing it to our attention.
Rahul Kumar
Feb 22 2022 05:25 PM
 Thanks for the article. Couple of clarifications needed :
a) Total installed capacity : 3,93,389.463 (The units is MW ?).
b) According to the chart of RES : Is Hydropower really the top producer or os it Thermal power (coal ?)
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