At a time when the stock market is volatile and the macro environment remains uncertain, it's advisable to invest in defensive stock trading at low valuation. Power Grid's low-risk business model and strong earnings visibility offer a defensive investment opportunity. Investors can consider buying the stock at its current market price.
About the Company
Power Grid is a Navratna company with 50% market share in the transmission business and has a monopoly in inter-state transmission. Nearly 95% of its revenue is generated from the transmission business, with the balance coming from the consulting services provided to power companies in India and abroad and from leasing its optic fibre bandwidth to telecom operators.
It is controlled by the Central Electricity Regulatory Committee (CERC) and operates under a regulated business model with a fixed return on equity. The company is assured a return of 15.5% plus some incentives on equity investments, from its clients.
Financials
Power Grid's net sales have grown at a compounded annual growth rate (CAGR) of 21% over the last three years to Rs 8,389 crore in FY11 and the profit after tax has grown at a CAGR of 30% to Rs 2,697 crore. The company's major cost is capital expenditure on setting up transmission lines, while there is hardly any operational cost.
As a result it has an operating margin as high as 90%. The company's earnings growth will depend on how much capital expenditure it can afford and how fast it can capitalise its capital expenditure. In simpler terms, how fast it can commission its transmission lines so that the return on capex is faster.
For the XIth fiveyear plan, the company's capex target is Rs 55,000 crore, of which it has already incurred 70% in the first four years and roughly 60% of it has already been commissioned.
And for the XIIth five-year plan, the company, which has a strong execution record, has already set an additional capex target of Rs 95,000 crore. Power Grid's dividend pay out ratio is 32% and it has a very strong balance sheet
Valuation
Given the company's huge capex plans and strong execution record, the company's 30% growth in earnings is likely to continue for another few years. At the current market price of Rs 95, Power Grid's stock is trading at price to earning multiple of 9.7 which appears to be attractive.
Investment Rationale
India's GDP growth rate has outpaced the growth in installed power capacity in last 10 years, increasing the demand-supply gap. Given the monopoly that Power Grid enjoys in the central transmission system, it will benefit from this increasing demand. The company has an extremely low-risk business model.
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