Over FY18-22, investments in the transmission segment are estimated to jump 1.5x to Rs 3 trillion compared to FY12-17.
We initiate coverage on Adani Transmission (ATL) with ‘BUY’ and NPV- based TP of Rs 154. Our conviction is underpinned by (i) whopping Rs 3 trn domestic transmission opportunity over FY18-22; (ii) aggressively growing ATL capturing 20% of TBCB projects; (iii) debt restructuring & additional leveraging boosting IRR of existing/M&A projects by 300- 400bps; and (iv) scale & synergy benefits as O&M costs are spread across projects. Hence, we estimate the company to clock 19% and 36% Ebitda and PAT CAGR, respectively, over FY17-19. We expect ATL to generate robust FCF, though we do anticipate high growth and M&A appetite. Cost overruns in new projects, aggressive bidding in TBCB projects, unfavourable regulatory changes and delay in true-up orders are risks. Rs 3 trillion domestic transmission opportunity over FY18-22e.
Over FY18-22, investments in the transmission segment are estimated to jump 1.5x compared to FY12-17 to a whopping 3 trillion rupees. Of these, Rs 0.9 trillion projects are expected to be awarded on tariff based competitive bidding (TBCB) basis. We estimate ATL to garner 20% share of these projects by virtue of its lead position in the domestic market.
Robust credit profile: Leveraging USP to enhance value
ATL has successfully restructured debt by issuing Masala bonds and USD/INR denominated offshore bonds worth Rs 45 bn at a blended cost of 9%. This has led to 100bps interest cost savings, ultimately boosting project IRRs by 150bps. Additionally, the company enhances debt proportion to 85% from 65-70% leveraging its strong credit profile, thereby releasing equity and boosting IRRs by another 250bps.
Aggressive growth to drive economies of scale
ATL’s strategic bidding approach and capacity expansion (2x to 11,500cKm) are likely to improve project IRR by 40-50bps as O&M cost is spread across projects.
Outlook & valuations: Potent growth platform; initiate with ‘BUY’
With existing assets generating Rs 10 bn FCF p.a., ATL is positioned to satiate its growth and M&A appetite. Moreover, potential to fund its aggressive growth plan at lower cost lends an edge. In our NPV-based TP of Rs 154, we assign 25% to growth value. Our valuations could be in Rs 154-185 range if we assign a higher market share provided the company maintains same economies in expansion. Initiate coverage with ‘BUY/SO’.
Domestic transmission opportunity pegged at Rs 3 trillion
Though investments in the transmission sector have surged, they have significantly lagged those in the generation sector. However, with the government sharpening focus on alleviating congestion via several grid enhancement projects, transmission capacities are anticipated to clock robust growth. Over FY18-22, investments in the transmission segment are expected to jump 1.5x compared to FY12-17 to a whopping Rs 2.9-3.0 trillion. We estimate Rs 0.9 trillion of projects to be awarded on tariff based competitive bidding (TBCB) basis, an opportunity for the private sector, though PGCIL also bids under this mode. We have not built any TBCB projects under intra-state projects.
Private sector participation via TBCB: Gathering steam
Historically, the power transmission business was a monopoly as almost all projects were awarded either to PGCIL or state utilities on a regulated basis. This changed when the government opened the transmission sector from January 2011 via a tariff-based competitive bidding (TBCB) model led by Tariff Policy 2006. This opened the transmission sector for private players.
Over FY11-15, the pace of awarding projects was slow—mere Rs 180-190 bn projects awarded. However, this has significantly gathered steam with Rs 260 bn projects awarded during FY16-FY17. The government is expected to sustain focus on accelerating the award of transmission projects with a visible pipeline of Rs 70 bn plus. Though awarding has slowed a bit in H1FY18 mainly due to implementation of reverse bidding mechanism as participants are watchful in initial bidding of projects, we expect the awarding to gather pace gradually.
Aggressive competition waning; market maturing
Post FY11, competitive bidding for all inter-state transmission lines was made mandatory. This triggered intense competition with players rushing to gain a foothold in the sector. Competitive intensity in the sector was extremely high across projects awarded in FY12-14, reflected in the participation of several players across related spaces but with limited experience in end-to-end project execution. Post FY14, the competitive intensity has been waning, reflected in the presence of only major credible players in the private sector with relevant experience. In fact, the average number of players participating in bids fell from 7 between FY11 and FY14 to 4 in FY17. This was an outcome of a few developers facing difficulties in commissioning projects on time, which led to escalation in project cost, in turn, leading to revenue loss. Hence, players have started bidding for projects rationally, keeping equity returns in mind.
Market share under TBCB
As on June 2017, 40 inter-state transmission projects worth around Rs 440 bn have been awarded via the TBCB route, of which almost 31 have been won by private players and balance 9 by PGCIL.
