NTPC: NTPC to acquire NEEPCO and THDC; Transaction value yet to be finalized

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Government to sell stake in NEEPCO and THDC

–      As part of the Indian government’s strategic divestment program, the cabinet has approved the stake sale in NEEPCO (GoI stake: 100%) and THDC (GoI: 74%; UP govt.: 26%) to NTPC (GoI: 54.5%).
–      Details on the transaction value though are still awaited. According to our interaction with NTPC, the purchase value for these assets will be decided after an internal assessment. This process could take another 2-3 months.
THDC and NEEPCO: A hydro dominated portfolio
–      THDC (~1.5GW) and NEEPCO (~1.45GW) are broadly a hydro dominated portfolio, with a combined hydro capacity of 2.3GW (refer exhibits 1/2). Acquisition of the same would increase NTPC’s commercial capacity by ~5%.
–      THDC – a stable portfolio of hydro: THDC operates 1.4GW of hydro plants and ~0.1GW of renewable capacity. According to tariff orders, regulated equity for its hydro portfolio stands at ~INR32b. Adj. profits were at INR8.5b for FY19, implying a core RoE of ~19-20% (base RoE: 16.5%). Overall, RoE is at ~9-10% given CWIP and WC investments.
–      NEEPCO – u/r likely denting profitability: NEEPCO’s 1.45GW of operational portfolio includes a mix of hydro (0.9GW) and thermal (0.5GW) capacities.  According to our analysis of tariff orders, the regulated equity base would stand at ~INR33b. However, annual PAT for NEEPCO stands at just ~INR2b (implied PAT at 15.5% RoE should have been ~INR5b). We believe that this could be led by: (1) F/C under-recoveries for its thermal plants (given actual PAF is lower than normative availability factors) and (2) lower capital costs approval.
Value accretion dependent on transaction value and upcoming projects
–      Value accretion would be dependent on the actual acquisition value and the progress on under-construction projects at THDC and NEEPCO. THDC and NEEPCO together have 2.1GW of hydro assets under construction along with other projects that are awaiting/have recently received approvals. A total of INR117b of works are under CWIP (for THDC + NEEPCO). Given the long gestation period and delays (related to clearances, resettlement & rehabilitation issues) in the commissioning of hydro projects, there remains a risk to execution timelines. NEEPCO’s Kameng (600MW) project though is expected to commission this year, which would be a positive.
–      In terms of the acquisition, media articles have indicated a purchase price of INR80-100b. We note that a purchase price of INR80b will lead to ~INR3-4b of PAT accretion, implying ~2% upside to our FY21 estimate. RoEs though may take a slight dip (~8bp; exhibit 6).
–      We remain positive on NTPC from a medium-term perspective, given the pickup in capitalization and the decline in fuel u/r – which should drive 14% earnings CAGR over FY19-21. Maintain Buy with a DCF-based target price of INR163/sh. Over the near term though, the risks related to government divestment and the uncertainty on value accretion over the potential acquisition could be an overhang on the stock.