Power Stocks: Value Buys or Value Traps?

Indian power stocks have been in the limelight with power majors like NTPC, Adani Power and Tata Power rising by 14%, 13% and 6.5% in the past one month (July 2023).

Company	Change (%)
	1 Month	YTD	1 Year
Adani Energy Solutions Ltd.	3.40%	-69.30%	-77.40%
Adani Green Energy Ltd.	9.50%	-46.40%	-52.70%
Adani Power Ltd.	11.20%	-8.20%	-20.80%
Bharat Heavy Electricals Ltd.	16.00%	27.20%	91.40%
CG Power and Industrial Solutions Ltd.	7.10%	50.00%	78.10%
JSW Energy Ltd.	-2.40%	-0.10%	4.90%
NTPC Ltd.	13.40%	32.30%	42.20%
Tata Power Company Ltd.	6.70%	13.30%	3.30%

Source: Equitymaster

This surge comes from the simple fact that power stocks have been trading at bargain prices. Therefore, amid the current market scenario, where the broad stock market is trading close to record highs, long-term investors are increasingly finding power stocks appealing.

In addition to being attractively priced, power stocks have a long history of rewarding their shareholders with dividends.

The BSE Power index enjoys a dividend yield of 2.27%. NTPC has been a dividend paymaster, clocking in a 5-year average dividend yield of 4.6%. Tata Power has also been generous to its investors, with a 5-year average dividend yield of 1.7%.

Power Stocks: Disappointing History

Given the current bullish market sentiment, a surge in stock prices of market leaders with a long history of hefty dividends should not come as a surprise. But power stocks have a long history of disappointing investors with a track record of underwhelming results.

The BSE Power Index fell 60% during 2008-2020, due to various reasons.

These include overzealous bidding for projects, subdued power demand growth, regulatory interference, excessive borrowing, lack of fuel security, and transmission and distribution losses among others.

As a result, stocks in the sector traded at dismally low valuations. Tata Power traded a 5-year average P/BV of 1.3, NTPC at 1.1x, and Adani Power at 3.1x.

However, these stocks have seen recent upgrades and are now trading at a multiple higher than their 5-year averages. Tata Power is trad at 2.6x, NTPC at 1.4x, and Adani Power at 3.6x.

This remarkable performance has caught investors off-guard, forcing them to question this disparity. It has led them to wonder if power stocks could be at risk of becoming value traps.

A "value trap" occurs when investors are lured by a stock's low price and seemingly attractive metrics but fail to grasp the underlying poor fundamentals or slow earnings growth, leading to eroded value over time.

A value buy or a value trap? This time it's different

While we can't know for sure, this time, there is more to the story than meets the eye.

Apart from attractive valuations and hefty dividend payments, a fat chunk of the surge in power stocks comes from enhanced capex spending by the companies.

For fiscal 2024 alone, Adani Green Energy is hiking its capex by 133% to Rs 140 bn. While this target is still under review, the company has ramped up its operational capacity by 43% to 8,316 MW during the June 2023 quarter.

Adani Energy Solutions is targeting a capital expenditure of Rs70 bn, a more than 16% rise from the previous year. The company plans to increase its capital expenditure by about 10%, every year.

Tata Power plans to invest about Rs 120 bn this year, double the capex in FY23. It aims to focus on renewable energy, distribution, transmission, and solar equipment manufacturing.

NPTC plans to disburse a total of Rs 189 bn in FY24 and over Rs 1.9 tn over the next three years allocated towards conventional and renewable capacity addition.

This time around most companies boast a relatively well-capitalised balance sheet and are better poised to support all kinds of capital outlay.

Market expects demand boost, operating leverage

The market also anticipates a healthy improvement with a better demand scenario as the operating leverage kicks in.

NTPC's relatively strong June 2023 quarterly performance only reaffirms this belief. The state-run power generator reported a substantial 20% increase in operating margins during the quarter ending June 2023 compared to the corresponding period of the previous year.

A lot of the hike in the results came from the fact, that NTPC's domestic coal-based power plants played a big role, earlier this year, as imported coal became unviable.

The closure of approximately 8.6 GW (4.5% of India's coal capacity) of power plants in Mundra, primarily due to the unviable costs of imported coal, resulted in a mini-energy crisis in certain parts of the country.

This incident underscored the significance of the public sector's role in coal production (Coal India) and power generation (NTPC), as these entities helped shield the country from potential power price shocks.

So, while India remains on track for its pathway of the energy transition, domestic coal power players remain the bedrock of India's grid power.

The buzz around transition to cleaner energy sources

The power sector is undergoing a generational shift, with clean energy capacity projected to surpass conventional sources in India. Clean energy capacity has already increased from 76.4 GW in March 2014 to 170 GW in December 2022, with plans to reach 500 GW by 2030.

Apart from the expanding renewable energy capacity, the growing EV investing megatrend will have a significant impact on power companies as well. Just like lithium-ion batteries are the heart of electric vehicles, charging points are also crucial components in the EV ecosystem.

The EV charging infrastructure business is expected to reach a value of US$ 29.7 bn by 2027, a CAGR of around 40% between 2020-27.

To boost EV adoption in India, the government plans to install 70,000 EV chargers across the country, with 22,000 using existing petrol pumps. And power companies are actively pursuing this robust opportunity for growth.

NTPC has joined hands with Indian Oil Corporation to set up charging stations across the country.

Tata Power, on the other hand, is leading the electric vehicle charging station pack, having installed over 3,000 public and private chargers as on June 2023.

Aiming to create a large dedicated electric vehicle battery charging infrastructure, the company plans to become the leader with over 100,000 chargers installed by 2026.

Government's proactive policy reforms to bolster growth

The government is also gearing up, helping the industry with earnest policy reforms every step of the way.

To meet India's 500 GW renewable energy target and tackle the annual issue of coal demand-supply mismatch, the Ministry of Power has identified 81 thermal units which will replace coal with renewable energy generation by 2026.

The government is accelerating renewable energy growth. It has mandated utilities to procure a minimum purchase of renewable power, made massive investments in transmission infrastructure, and helped reduce project development and land acquisition risk for solar parks.

It's consistently introducing production-linked incentive programs, renewable manufacturing zones, and a slew of other initiatives to achieve self-reliance (Atmanirbhar) in the renewable energy sector.

However, the key to success lies in ensuring policy certainty and timely implementation of these programs.

India ranks as the world's third-largest electricity producer, following China. Despite a significant increase in power generation capacity (416 GW as of March 2023), meeting the growing demand remains a challenge due to limited reliable supply.

The power demand is likely to remain strong, considering India's per capita consumption is lower than a third of the global average. The growing population, in tandem with increasing electrification, rapid urbanization and infrastructure development will provide further impetus.

Conclusion

The recent surge in best power stocks has both intrigued and concerned investors. While the sector's past track record of disappointing performance and value traps has been a cause for caution, the current scenario seems different.

Power stocks are trading at attractive valuations, with a history of generous dividend payments, making them appealing to long-term investors. And there is no doubt the sector is undergoing a massive transformation.

But before jumping in, investors must stay up to date with the ever changing market dynamics, government policies, and the financial health companies, to make well-informed investment decisions.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...