Should you bet on the power sector now?

Last Updated: Thu, Oct 25, 2012 04:32 hrs

Power stocks have been rising after the government unleashed its reforms programme late-August. The BSE Power Index has returned seven per cent over three months. The sector went into a limbo on coal shortage, poor financial health of state electricity boards (SEBs) and tariffs that had become unviable for some power producers. However, with the government coming up with a plan to clean up the finances of SEBs and distribution companies, the market believes this could result in a "full pass through of power procurement cost".

The market is expecting some of the other issues to be sorted in the coming months. For instance, if coal price pooling is implemented and unremunerative fixed price offtake arrangements revised, then the sector could see a re-rating. While these measures might take some time, other triggers have already played out.

For instance, analysts say merchant power prices are appreciating, as discoms are buying more power to meet peak demand. Also, the rupee's appreciation will help those importing coal. According to JP Morgan, benchmark imported coal prices are down 10 per cent over the last three months in rupee terms, which will benefit JSW Energy and Adani Power. Players like Tata Power could also benefit if the government allows fixed price offtake arrangements to be revised upwards.

On such expectations, numerous brokerages have upgraded the sector. However, plenty of risks still cloud a secular uptick, given that many of these stocks have already run up. Analysts say the government's solutions to address the numerous problems faced by the industry are quick fixes, not lasting solutions.

According to HDFC Securities, "Top echelons of government are desperately fishing for solutions to the coal shortage. So far, two steps have been proposed. First, Coal India signs fuel supply agreements for 80 per cent of annual contracted quantity for domestic coal-based plants having long term PPAs. Pooling of coal costs is the second." HDFC Securities believes price pooling will face resistance. As far as merchant power is concerned, analysts don't expect cheap coal to be available to power generators who will be able to sell power at high prices in the market as cheap coal from Coal India is not likely to come. Analysts expect merchant power to remain at Rs 4 per unit levels. Clearly, the road to recovery is lined with hurdles.

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