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Event update: Power Utilities - CERC tariff regulations beat all expectations

Event

The Central Electricity Regulatory Commission (CERC) has finalised regulations on tariffs for the power sector applicable between FY20 and FY24. Overall, the regulations are better than extant regulations (expiring on 31 March 2019) and even better than the draft proposal floated earlier (in Dec 2018).

Key provisions and highlights

• The CERC has fixed the base RoE at 15.5% for thermal generation and 16.5% for hydro generation. We see this as a major positive for the sector (same as draft regulations).
• Generation

o   Capacity charge recovery on seasonal and peak basis (applicable from FY21 onwards): The recovery of fixed charge (capacity charge) has been linked to availability on a seasonal basis – High demand season of 3 months and low demand season of 9 months. Besides, recovery of capacity charge during peak hours has a higher 20% weightage (instead of 17% for peak supply of 4 hours). Higher availability at off peak hours cannot be offset with peak hours, whereas the vice versa is allowed to incentivize peak generation (similar as draft regulations – draft regulations has recovery on quarterly basis).

o   Energy charge - Relief on GCV: CERC has provided the allowance of loss of 85kCal/GCV between unloading and firing point. Note that NTPC faced 5-6% under recovery on fuel due to change in tariff regulations (in 2014) for FY15–FY19E while measuring GCV from firing point to unloading point. The regulation is expected to remove entire under recovery on account of fuel cost (same as draft regulations).

o   Incentive: Incentive at peak hours has been increased to 65paise/kwh (+) while off peak is at 50ps/Kwh (ó) (same as draft; better than extant regulations)

o   Sharing: Sharing of gains on account of controllable factors, including interest cost refinancing, has been decreased to 50: 50 (instead of 60:40)  (same as draft regulations)

o   O&M expenses exclude security expenses: The base O&M expense for FY20 has been set 8-10% higher than FY19. Note that the new base expense excludes security expense (which will be recovered separately on actuals). Permitted O&M expenses have been escalated at a lower rate of 3.5% for thermal and 4.8% for hydro asset. (base O&M expenses higher than draft regulations; escalation lower than extant regulations)

o   Operational norms have been slightly relaxed, with lower efficiency norms and higher auxiliary norms (slightly better than draft and extant regulations)

• Transmission: Maximum availability incentives for DC system have been decreased by 80bps (asset will earn additional 1.2% return instead of 2% additional maximum return on equity (same as draft regulations).
• Working Capital: Norms for working capital have been tightened with receivables days reduced to 45 days (from 60 days).The decrease in interest on working capital  has been offset by late payment surcharge of 1.5% available from 45 days (instead of 60 days) and lower rebate of 1.5% on the bill (better than draft regulations).
• No reduction in equity for older assets: In the final regulation, equity from older assets has been capped at 30% of capital cost. Note that the draft regulation proposed more than 2/3^rd reduction in the extant equity base of equity of assets that have completed their useful life (way better than draft regulations).

Outlook and View

We believe the final regulation is positive for generation and transmission companies, with base RoE maintained at 15.5% and 16.5% (hydropower), addressing a major concern for the markets. Besides, relief on GCV, minor relaxation in O&M norms and higher allowance in O&M expenses has come as a positive for the generation companies. As a result, the RoE of generation companies is expected to increase by 2-3%. The adverse impact of working capital norms has been offset by reduction in number of days for making payment without penalty and lower rebate on timely payment. Considering the sharp fall in NTPC and PGCIL stock prices over the past six months (trading at 1.x and 1.4x FY21E P/BV, respectively), we maintain Outperformer rating on both NTPC and PGCIL.