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Why you should sell stocks of firms supplying equipment to thermal power plants

Why you should sell stocks of firms supplying equipment to thermal power plants
It’s time to sell capital goods companies supplying equipment to thermal power producers as they have been under pressure due to sectoral issues.

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It’s time to sell capital goods companies supplying equipment to thermal power producers as they have been under pressure due to sectoral issues.
ET Bureau
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India has committed itself to promoting renewable energy and is pursuing an ambitious target of setting up 175 GW of renewable energy capacity by 2022. The last financial year, 2015-2016, was truly remarkable in terms of renewable energy development in India, with the highest ever solar and wind power capacity additions in a single year—3.02 GW of solar power and 3.42 GW of wind power.

And with this push, renewable energy’s contribution to power generation has also moved up from 4.97% in 2012-13 to 5.7% in 2015-16. Of the total 175GW renewable energy target for 2022, 100 GW has been set for solar power and the remaining for wind. As of now, the solar and wind power capacities are placed at 8GW and 29GW respectively.

How should investors play out the structural changes taking place in the power industry? Experts say, even as major action is expected on the solar energy front, Indian listed companies in this space may not benefit much. “Solar panels constitute around 60% of the project cost and most of them are imported directly from China now,” says Subhadip Mitra, Analyst, J M Financial. Also, despite the continued push from the government, wind power generation is facing several challenges.

While a solar plant can be set up almost anywhere, availability of suitable land, where there is high wind, is a problem for installing wind turbines. Also, the cost of generating solar power has been coming down and is already less than that of wind power. Since wind power is more sporadic compared to solar, the cost of absorbing it is also higher for the state electricity boards (SEBs). This means that the SEBs will prefer solar over wind power, which is bad news for wind power equipment manufacturers such as Suzlon and Inox Wind. “We are not bullish on equipment manufacturers such as Suzlon and Inox Wind because, at 5GW, the annual target for wind power capacity addition is half the total industry capacity of 10GW,” says Mitra.

The winning bets
Companies in the traditional power segment have been under pressure due to sectoral issues— several thermal power projects are stuck due water, coal and funding issues. And, even among the projects that are up and running—around 200GW—capacity utilisation is just about 70%. Other than NTPC, most other thermal power producers are struggling with a high debt burden as well.

Buy coal and thermal PSU stocks
The push for renewables comes at a cost for capital goods firms.
ET Lazy Load Image

High production costs jeopardise wind equipment makers’ future. (Suzlon Energy and Inox Wind)

Fall in thermal capacity addition will hurt capital goods suppliers. (BEML and Bharat Heavy Electricals)

Cash-rich NTPC and Coal India will become dividend yield play in the absence of capacity addition.


This is why private players are not adding new thermal capacities. However, despite the challenges facing the industry, experts are still bullish on NTPC because its projects are underpinned by a fixed return on capital: NTPC has already tied up with SEBs for power purchase. “Since around 20GW of capacity under construction is expected to go live in the coming years, NTPC’s profitability should increase from 2017-18 onwards,” says Mitra.

There is no need to worry even if solar becomes a big hit and NTPC does not add further capacity. “If NTPC shelves future capacity addition, it will become a dividend yield stock because of good cash flow from its existing projects,” says Phani Shekhar, Fund Manager, PMS, Karvy Capital. Though the demand for coal from thermal power producers may fall, a substantial reduction in overall demand for coal is unlikely. Existing thermal projects and, around 15-20GW of projects to be commissioned soon, will require coal. “Coal can also be diverted to other industries such as steel. So coal consumption won’t come down even in extreme conditions (no new thermal capacity addition),” says Shekhar. Besides there are other reasons why experts continue to be bullish on Coal India.

First, it boasts of one of the lowest production cost. Second, it is a non-leveraged cashrich company. Third, its cash levels will swell further if it stops capacity addition and the same can be given out as dividend. Investors should note that the government has been extracting special dividends from Coal India to meet its revenue targets. “If Coal India’s stock price falls, investors should use it as a good entry opportunity,” says Shekhar.

Who’s losing out?
Capital goods companies catering to the thermal power segment will a big hit as orders from thermal power producers are drying. “The situation is pretty tepid for players such as BHEL because the thermal power industry’s annual demand is only 10-12GW against the BHEL’s capacity of around 20GW,” says Mitra. The impact on BHEL’s competitors such as ABB, Siemens, and others will be less because they are mostly into power transmission, a segment where a lot of action is expected in the coming years. Equipment manufacturers, such as BEML, catering to the coal mining sector will also take a hit due to the fall in incremental demand. “We don’t expect a fall in coal production, but the increase in coal production may come down. So, most of the equipment sales will be for replacements— a fraction of the current overall demand,” says Shekhar.

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