28 April 2014

PTC India - Rating Revision - Non-recurring treasury income propels PAT :: Centrum

Rating: Sell; Target Price: Rs48; CMP: Rs70.9; Downside: 32.3%



Skewed Business Model + Rich Valuations =>Sell



We maintain SELL on PTC India with a PT of Rs48 (32% downside). Our
rating and PT are strongly anti-consensus. We find the current
valuations too expensive at 10.7x FY16E EPS and 0.8x BV considering
(1) RoE of 7.4%, core RoE of 9% vs CoE of 15.8% and trading at near
par with NTPC and Power Grid on PE(x) basis; (2) negative free cash
flow over FY15/16E; (3) weak earnings outlook -EBITDA/EBIT earnings
CAGR of 6%/7% vs 35% over FY11-13; (4) unlikely monetisation of
investments over next 2-3 years; and (5) skewed business model.
Historically, 85% of consensus have rated it a BUY at all stock prices
between Rs40 and Rs140. The recent run-up in stock is unexplained,
except for its high beta of 1.5.

$ Skewed business model: The business model is skewed owing to (1)
Working capital and group company investments driving book value which
are non-remunerative keeping RoE subdued; (2) higher treasury income
propelling RoE by 36%/25% to 7.7%/7.4% over FY15/16E. When compared to
cost of equity of 15.8%, core RoE of 9% and government bond yield of
8.8%, PTC is not a compelling investment idea; (3) Persistent balance
sheet exposure towards risk of receivables and contractual disputes;
and (4) Though we have not factored in the mismatch between its Power
Sale Agreement (PSA) and Power Purchase Agreement (PPA), eventuality
will drag down earnings and FCF and hence is negative.

$ Current rich valuations vis-a-vis NTPC and Power Grid unjustified:
Over FY11-YTD, PTC had traded at an average 50% discount to both NTPC
and Power Grid (Not Rated) on 1-year forward P/Bx. However in recent
times, the discount band has been narrowed. Also, considering PTC’s
core RoE of 9% vs core RoE of NTPC/Power Grid at 18%/16% for the
forecast period, PTC certainly does not merit a P/Bx of 0.8x vs
NTPC/Power Grid’s P/Bx of 1x/1.4x FY16E. On dissecting PTC book value
(BV), +33% of it is driven by investments in group companies which are
non-remunerative whereas in case of NTPC and Power Grid, BV is driven
by revenue generating fixed assets that earn minimum RoE of 15.5%.

$ CMP factors-in optimism on positive FCF & surge in volumes: Expect
disappointment going forward: The street is jubilant over the recovery
of dues of Rs4.5bn from UPPCL and although we built-in recovery of
overdues of Rs2.5bn from TNSEB, which is disputed, we believe that a
significant part of incremental cash flow would be utilised towards
working capital to meet 17% CAGR in volumes over FY13-16E. We believe
FCF will be the appropriate measure to be jubilant. Free cash flow
would peak in FY14E and turn negative in FY15E/FY16E. As evident from
historical trends, even if we were to assume GDP of 9% in medium term,
we do not expect a surge in volumes beyond 17% CAGR factored-in over
FY13-16E.

$ Valuation and key risks: We maintain SELL with a PT of Rs48 which
has been derived from (1) average of value on fair multiple assigned
to EPS and book value on FY16E basis; (2) investments in PFS with a
20% holding company discount; and (3) other investments at 0.34x BV.
Key upside risks are (1) higher trading volumes and margins; and (2)
higher share in profits from long-term PPAs. Key downside risks are
(1) skewed working capital cycle which may lead to steeper negative
FCF; we have built in optimism in working capital cycle; and (2) lack
of buyers for its long term PPAs that could lead to lower volumes and
earnings.



Thanks & Regards
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