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RoE progression presents potential for re-rating

* NHPC offers moderate earnings growth in the medium term (FY22-FY24E: 7% CAGR, FY22-FY26E: 10% CAGR) on the back of a 50% increase in standalone capacity over the next four years.

* In the past few years, the company has increased its dividend payout, and the yield stands at ~6% currently. With a strong balance sheet (D/E of 0.7x and Rs22.5bn of cash on books), NHPC can increase its capex, especially on Solar assets. The company has emerged as the winner of a 1,000MW Solar project under CPSU Scheme II.

* We assume coverage on NHPC with a Buy rating and a TP (Sept’22E) of Rs34, based on SoTP. We expect its RoE to touch 12/13% by FY26E from 9.3% in FY22E and 8% in FY15. Our TP implies ~0.9x Sept’23E BVPS. We believe that improving RoE profile is one of the most important factors for re-rating in Utilities.

Moderate earnings growth with improvement in RoE to continue in the medium term: NHPC is expected to expand its standalone capacity by 50% over the next 4/5 years - 5.5GW to 8.4GW with the addition of Parbati II (800MW expected by FY23E) and Subansiri Lower (2,000MW expected by FY25E). Further, it has projects under construction - 500MW (through subsidiary) and 1.6GW (under JV) - that will get commissioned in the medium term. Based on these factors, we estimate ~10% earnings CAGR for the company in FY22-FY26E. More recently, it has emerged as one of the winners (1,000MW) under CPSU Scheme II. Further, NHPC has over 7GW of projects under the clearance stage. Higher incentives (secondary energy and PLF) and manpower recovery have allowed the company to earn higher plantlevel RoE. With the conversion of CWIP into fixed assets in the medium term, we expect RoE to touch 12/13% by FY26E from 9.3% in FY22E (RoE stood at 6%/8% in FY10/FY15).

Strong balance sheet with ~6% dividend yield: NHPC has a D/E ratio of ~0.7x, and we expect it to be under 1x in the medium term despite a 50% increase in capacity. In the last few years, the company has judiciously allocated capital – cash on books in FY16 stood at ~Rs74bn vs. ~Rs22bn as of FY21 although capex and dividend have increased. A large part of the cash and internal accruals have been used to increase capex and the dividend. The dividend has increased from Rs0.7/share to Rs1.6/share in the last five years.

Assuming coverage with Buy and a TP of Rs34: While there has not been much capacity addition in the past few years, we expect 800MW/2,000MW addition in the next 2/4 years. In the medium term, we see an improvement in earnings growth and ROE on the basis of these capacity additions. We believe that the improvement in RoE trajectory will lead to an expansion in the valuation multiple as well. We initiate coverage on NHPC with a Buy rating and a SoTP-based TP (Sept’22E) of Rs34, implying 0.9x Sept’23E Book. The 6% dividend yield is a long-term benefit. Key risks include large GOI stake divestment and delayed project execution.

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