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Strong generation continues

* Strong generation in Q1FY23 so far - Power generation grew by ~17% YoY in the first two months of Q1FY23, with a 3-year CAGR of ~5%. Thermal/RE generation increased by 15%/32% YoY, with a 3-year CAGR of 4.4%/15.5%. Generation growth was aided by strong demand. The peak/energy deficit hit 4%/2%, which ideally has been less than 1% for some time now.

* The Ministry of Power recently detailed a mechanism for allowing flexibility in generation and scheduling of thermal power stations. As per the ministry, there is scope for replacement of thermal power with RE power in the country. This will increase generation through RE sources, reduce emissions and enable compliance with renewable purchase obligations (RPO).

* While the existing regulations of CERC define a technical minimum of 55% for the operation of thermal power plants, the ministry has highlighted that a reduction in this technical minimum to 40% is feasible in 2-3 years.

* Thermal energy from thermal power plants (with high variable costs) is proposed to be replaced by RE sources to optimize the cost of power delivered to customers.

* The ministry has carried out an exercise to assess the amount of energy from thermal units that can be replaced. Based on this exercise, it has been found that 58,000MU (by FY26) of thermal power can be substituted by RE sources, which would correspond to 30GW of thermal capacity running at lower PLF.

* Of the 30GW, NTPC/NLC/DVC would have ~15GW/~1.5GW/388MW of capacity. The fixed returns on the thermal units will remain intact, while they can invest on the RE sources. The generating stations, which don’t get scheduled (for RE capacity put), are free to sell such power on the power exchange. Given that the exchange prices are significantly higher than solar tariffs, this should not be a hindrance in our view.

* NTPC: We have a Buy rating with a Mar’23 TP of Rs180 as the company remains a play on large fossil assets (with robust cash flow), along with strong growth in the RE space. NTPC’s standalone generation grew by 16.5% YoY, with a 3-year CAGR of 7.8%. Thermal PLF stood at ~81% in Apr-May’22, up from ~72% YoY. Its subsidiaries NEEPCO+THDC combined saw ~48% YoY growth in generation, with a 3-year CAGR of 6%. The stock price of NTPC has increased by more than 40% in the last one year, but it still trades at ~1x PB on FY24E with an RoE of ~12% and an earnings CAGR of 6-7%. NTPC intends to float an IPO or invite a strategic investor for its RE portfolio in FY23.

* CESC - Buy with a Mar’23 TP of Rs108: The key issues in CESC’s license areas are low demand and no increase in tariffs. On the demand front, power generation for CESC license areas and Haldia Energy grew by ~9% YoY, with a 3-year CAGR of 25%. We believe this will lead to better standalone earnings. Further, Dhariwal’s medium-term PPA has started and should add ~Rs800mn to the profitability in FY23. We also believe that better demand in Kota will lead to lower losses and will help CESC improve its consolidate earnings. The stock trades at 0.85x FY24E book and 6.6x FY24 earnings.

* NHPC – Buy with a Jun’23 TP of Rs40: After a gap of 4-5 years, NHPC is expected to commission 2,800 MW of hydro capacity (50% of its present capacity of 5.5GW) over the next 2 odd years. Parbati II (800MW) and Subansiri (2,000MW) are at an advanced stage of construction. Together they will add Rs90bn to the regulated equity (up from Rs130bn to Rs220) over the next 2-3 years. This will lead to improvement in RoE from 9.5% to ~11% by FY25. We expect an EPS CAGR of ~11% over FY22-FY25E.We have raised our TP from 37 to 40 as we roll over our target multiple to June’23.The stock trades at 9.3x/7.6x PE on FY24E/FY25E.

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