Industry Risk Score

UNION BANK OF INDIA January 2010

Power Generation - Central Utilities

Introduction Contents
Industry Risk Score (IRS) reflects the impact of industry Executive summary 1
variables on the cash flows and debt repayment ability of
the companies in the industry over a 3-4 year period. The
risk score for an industry is arrived at by aggregating the Background 2
scores assigned to the relevant parameters for the industry.

Industry parameters include variables such as demand- Industry risk parameters 3

supply outlook, cost structures, competition and financial
performance. Parameters are selected based on the extent to
which they affect the debt servicing ability of the companies Demand-supply 3
operating in the industry. Scores on these parameters reflect
the extent of positive/negative impact on cash flows, and
the degree of variability in cash flows of the companies. Government policies 3

The industry risk scores have been graded on a ten-point

scale, with 1 indicating high risk and 10 indicating low risk. Input-related risk 4

Extent of competition 4
Risk score Risk factors
1 Extremely negative
2 Extremely negative Financial risk 5
3 Negative
4 Marginally negative
Annexure 6
5 Neutral
6 Marginally positive
7 Positive
8 Positive
9 Highly positive
10 Highly positive
Industry Risk Scores

Industry Risk Scores (available on 135 industries) capture the influence of industry variables and the extent of
positive/negative impact on the cash flows and debt repayment ability of companies in an industry over a 3-4 year horizon. The
risk score for an industry is arrived at by aggregating the scores assigned to the relevant parameters like demand supply
outlook, cost structures, competition and financial performance.

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Executive summary

Industry
CGUs benefit from low demand risk, relatively easy access to fuel, assured offtake of power and favourable
government policies. The industry does not face any demand risk, given the importance of electricity to the
economy and prevailing power shortage in most parts of the country. In addition, the allocation of power
generated by CGUs to different states results in an assured offtake.

The Electricity Act, 2003, has helped central utilities reduce their dependence on the financially-weak SEBs,
and forward-integrate by acquiring distribution licences. The implementation of the Ahluwalia Committee
recommendations on SEB dues has improved the cash flows of central utilities. The CERC regulation, which
increased the return on equity from 14 per cent to 15.5 per cent, will further affect cash flows of CGUs
positively.

CRISIL Research expects demand for power to increase at a compounded annual growth rate (CAGR) of 7.6
per cent over the next five years (2009-10 to 2013-14). The tight supply position in coal and gas poses a threat
to thermal plants, as coal-based units would have to increase their reliance on imports. However, the persisting
deficit scenario would act as a growth driver for CGUs.

Parameter Weightage Score

Power Generation- Central utilities - Industry risk score 8.1
Industry characteristics 85 8.6
Demand-supply gap 35 10.0
Government policy 35 8.0
Input-related risk 15 7.0
Extent of competition 15 8.0
Industry financials 15 5.6
Operating margin of industry 35 10.0
RoCE of industry 65 3.3
Source: CRISIL Research

CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES 1 JANUARY 2010

Background

The power sector consists of three types of players - the central sector, state sector and private sector.

The central sector is the second-largest player in terms of installed generation capacity and one of the most
efficient in terms of power generation. The central sector generating units (CGUs) account for about 32 per
cent of the installed capacity. CGUs are forced to sell the power generated by them to State Electricity Boards
(SEBs) as the SEBs monopolise power distribution.

Large-scale operations and older and depreciated CGU plants lead to lower cost of power generation and
reduced tariff.

In 2008-09, the total size of the power industry (excluding power equipment) was estimated at about Rs 2,075
billion. The transmission and distribution (T&D) losses of around 28 per cent, due to theft and unauthorised
usage of power, has led to accumulated losses of over Rs 610 billion for the industry.

As of December 2009, India`s installed power generation capacity was 156,092 megawatts (MW) (excluding
over 19,509 MW captive capacities connected to the grid). During the first half of 2009-10, the average energy
shortage was 9.9 per cent, while the peak shortage was 12.6 per cent. Energy shortage varies from 2-3 per cent
to 25 per cent in various states.

JANUARY 2010 2 CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES

Industry risk parameters

Demand-supply
India has been facing a shortage of electricity over the past few decades, primarily because of inadequate
capacity additions, high T&D losses, poor inter-regional transmission links, low plant load factor (PLF) of
thermal plants and fuel supply bottlenecks. During the first half of 2009-10, it faced an average energy deficit
of 9.9 per cent and a peak shortage of 12.6 per cent.

Over the last two 5-year plans, demand for electricity has grown at a CAGR of around 5.3 per cent and 6.2 per
cent, respectively. Industrial consumers` increasing preference for captive power generation has constrained
demand growth for power utilities to some extent. The growth in supply has been higher, mainly driven by
capacity additions. For 2009-10, capacity additions during the first nine months stood at 6,250 MW. The PLF of
thermal plants has grown from 57 per cent to over 78 per cent in the last 16-17 years. CRISIL Research expects
demand for power to increase at a CAGR of 7.6 per cent over the next five years, driven by higher industrial
demand, rural and semi-urban electrification, commercialisation (by setting up malls, metros etc) and
urbanisation.

In view of their cost-competitiveness, CGUs are well placed to cater to the expected demand growth, as they
rank higher than private generation entities (PGE) in the merit-order dispatch (MOD), resulting in higher
preference towards offtake of power.

Government policies
CGUs have enjoyed better financial health vis-à-vis other SEBs, on account of higher efficiency and support
provided by the government through equity infusion, low-interest rate loans, import duty exemptions (in the
case of mega power projects) and security of payments.

The implementation of the Ahluwalia Committee recommendation for one-time settlement of outstanding
receivables, as of September 3, 2001, through the issue of 15-year bonds guaranteed by state governments, has
also increased CGUs` cash flows.

The Electricity Act, 2003, helps CGUs reduce their dependence on SEBs by allowing them to supply power to
other states or to acquire trading or distribution licences. A CERC regulation states that state distribution
utilities could lose part of their entitled power allocation from CGUs if they are not able to clear dues. This has
acted as a big positive for CGUs. The Electricity Act also cancels the condition of obtaining prior clearance
from the Central Electricity Authority (CEA) for setting up thermal power plants, thus shortening the project
development cycle.

The Electricity Act has permitted open access for power generation by doing away with the requirement of
licence and aiding private players to add capacities. However, to date, private sector capacities are not even 60
per cent of the total central sector capacities. The Tariff Policy announced by the government in January 2006
specifies the competitive bidding route for private players. However, it exempts state-owned/controlled

CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES 3 JANUARY 2010

companies and CGUs for the next 5 years (up to 2011). As a result, CGUs are better placed than private
players.

The CERC norms for tariff regulations (2009-14) have increased the return on equity from 14.0 per cent to 15.5
per cent for existing plants, effective 2009-10 onwards. In case of projects commissioned on or after April 1,
2009, an additional return of 0.5 per cent shall be allowed if such projects are completed within the time
specified. This would be a positive for CGUs, as from 2009-10 onwards, these players would start earning a
higher return on equity at 15.5 per cent post-tax versus the previous 14 per cent.

Input-related risk
CGUs are dependent on coal, natural gas and hydel resources. Most power projects are based on coal, as it is
a cost-economical fuel and abundant in supply. However, the Ministry of Power has projected that the sector
could face a huge short supply of coal (of about 50 million tonnes) over the next 2-3 years, posing a risk for
thermal generation units. Coal stock availability has dropped significantly from the minimum norm of 15-30
days, resulting in 18 power plants (as on December 31, 2009) having coal stock at critical levels (less than 7
days).

The concentration of coal in central and eastern regions restricts CGUs from investing in coal-based plants of
other regions. Besides, the inferior quality of domestic coal results in higher generation and maintenance costs.
All these issues have led to a rise in imports of non-coking coal, from around 10.5 million tonnes in 2000-01 to
35 million tonnes in 2008-09.

Coal pricing has also been a major issue over the last fiscal with global prices escalating over $100 per tonne,
although the average for the first nine months of 2009-10 stood at around $72 per tonne.

In October 2009, Coal India Ltd (CIL) increased its prices by 10-12 per cent across all levels. The previous hike
was in 2007, at around 10 per cent. However, input prices do not pose a risk, as they can be passed on to
consumers while determining tariffs; hence, this will not affect operating profits of the players.

Although natural gas is economical for power generation, its usage is restricted due to limited availability as
compared to demand. The commencement of supply from new gas fields of Reliance Industries, Gujarat State
Power Company (GSPC) and Oil and Natural Gas Corporation (ONGC) at the Krishna-Godavari (KG) Basin is
expected to improve generation by gas-based power plants from 2009-10.

Extent of competition
The Electricity Act 2003, moves towards the creation of a market-based regime in the power sector, thereby
opening it for competition. Consequently, the power industry, which has been highly regulated and licensed,
is now moving towards an open environment.

Open access has permitted private players to venture into power generation without the need for licence.
Private players are posing a threat, as capacity additions of over 150 GW were announced by them, most of it
to be commissioned in the Twelfth Plan. But the electricity regulatory commissions at the central and state
levels insist on merit-order despatch, wherein the least-cost provider of power is asked to meet the base load

JANUARY 2010 4 CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES

demand and the higher cost producers have to meet the intermittent and peak demand. Due to old
depreciated plants and the use of coal as feedstock, CGUs are amongst the power producers with lowest cost.

In the medium term, competition among players will lead to improved efficiency, reliability of supply and
competitive tariffs. However, these changes will occur only over a period of time. Currently, their effect on the
players is negligible.

Financial risk

Power Generation - Central utilities: Financial parameters

Select financial parameters unit 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Aggregate turnover Rs million 272,942.2 301,797.9 308,441.3 343,687.9 404,342.5 462,244.1 504,433.3
Operating profit margin Per cent 40.53 38.31 39.08 35.83 35.38 35.94 29.57
Return on capital employed Per cent 10.23 11.01 9.89 10.41 10.26 11.09 10.36
Net profit margin Per cent 24.2 31.67 30.43 26.07 24.52 22.93 20.33
Return on equity Per cent 10.99 13.35 11.4 10.15 10.44 10.42 11.68
Interest coverage ratio Times 6.32 7.2 7.51 7.19 6.33 6.13 4.95
Debt-equity ratio Times 0.42 0.41 0.4 0.42 0.49 0.54 0.65
Current ratio Times 3.63 2.14 2.83 2.17 2.25 2.16 3.2
Assets turnover ratio Times 0.34 0.33 0.3 0.29 0.31 0.31 0.35
Raw materials days Days 67 66 56 60 56 53 51
WIP holding days Days 0 0 0 0 0 0 0
Finished goods days Days 0 0 0 0 0 0 0
Debtors days Days 262 29 36 17 20 31 40
Creditors days Days 50 61 51 55 47 47 56
No. of companies No 4 4 4 4 4 4 4
Source: CRISIL Research

Power Generation - Central utilities: Cost aggregates

Cost structure (% of net sales) Unit 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Raw material cost Per cent 45.27 41.22 48.22 51.85 52.61 50.54 57.18
Power and fuel cost Per cent 0.73 3.28 0.46 0.48 0.5 0.56 0.61
Other operating costs Per cent 9.06 8.96 6.9 7.32 7.86 7.83 7.1
Employee cost Per cent 6.41 6.14 7.28 7.42 7.23 9.34 10.13
Selling cost Per cent 1.85 4.08 2.48 2.36 2.38 1.91 1.52
No. of companies No 4 4 4 4 4 4 4
Source: CRISIL Research

CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES 5 JANUARY 2010

Annexure

Companies used for calculating sector aggregates

National Hydro-Electric Power Corpn Ltd
National Thermal Power Corpn Ltd
Neyveli Lignite Corpn Ltd
Nuclear Power Corpn of India Ltd
Constitutes 97 per cent of the sector

Power Generation - Central utilities: Sector Aggregate - Interim results

(Rs. Million) Jun-Sept % of Jun-Sept % of Apr-Sept % of Apr-Sept % of
2009-10 Net sales 2008-09 Net sales 2009-10 Net sales 2008-09 Net sales
Net sales 121,341.6 100.0 107,592.7 100.0 255,464.3 100.0 218,038.9 100.0
Total Operating exp 82,745.6 68.2 76,602.6 71.2 176,578.6 69.1 153,001.4 70.2
Raw materials, stores, spares 67,604.8 55.7 60,658.3 56.4 146,242.3 57.2 123,177.7 56.5
Change in stock -15.7 0.0 15.1 0.0 442.3 0.2 26.0 0.0
Salaries & Wages 8,289.5 6.8 8,283.8 7.7 16,749.3 6.6 16,332.3 7.5
Other expenses 6,867.0 5.7 7,645.4 7.1 13,144.7 5.1 13,465.4 6.2
OPBDIT 38,596.0 31.8 30,990.1 28.8 78,885.7 30.9 65,037.5 29.8
Depreciation 7,164.4 5.9 6,290.0 5.8 14,015.3 5.5 12,840.0 5.9
OPBIT 31,431.6 25.9 24,700.1 23.0 64,870.4 25.4 52,197.5 23.9
Interest 4,675.3 3.9 4,352.8 4.0 9,131.4 3.6 7,981.8 3.7
OPBT 26,756.3 22.1 20,347.3 18.9 55,739.0 21.8 44,215.7 20.3
Other income 4,342.1 3.6 4,652.5 4.3 8,368.4 3.3 9,149.5 4.2
Extra Income/Exp -0.8 0.0 7.8 0.0 -1.4 0.0 -2,742.8 -1.3
PBT 31,097.6 25.6 25,007.6 23.2 64,106.0 25.1 50,622.4 23.2
Total tax 7,142.2 5.9 2,018.6 1.9 15,338.0 6.0 7,509.8 3.4
Current tax 6,708.2 5.5 1,971.6 1.8 13,714.3 5.4 7,413.2 3.4
Deferred Tax 424.3 0.3 0.0 0.0 1,614.0 0.6 0.0 0.0
FBT 9.7 47.0 96.6
Net profit 23,955.4 19.7 22,989.0 21.4 48,768.0 19.1 43,112.6 19.8
Nos. of companies 2 2 2 2
Note: Financials of NHPC & NPCIL are not available
Companies included in interim sector aggregate
National Thermal Power Corpn Ltd
Neyveli Lignite Corpn Ltd
Source: CRISIL Research

JANUARY 2010 6 CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES

Power Generation- Central utilities: Business risk evaluation
Risk entity name Weightages
Business risk 100
Operating efficiency 70
Access to cost effective technology -
Capacity utilisation 40
Availability of raw materials 20
Energy cost -
Raw material usage 20
Management of price volatility -
Product design and development -
Adherence to environmental regulation -
R&D activities -
FCA/MDA-approved plants -
Efficiency of beneficiation process -
Availability of skilled labourers -
Hygienic processing facility -
Indigenisation level -
Integration of operations -
Multi-locational advantage 20
Selling cost -
Employee attrition rate -
Vulnerability to event risk -
Bargaining power with suppliers -
Proximity to customers -
Market position 30
Brand equity -
Customisation of product -
Project management skills 25
Size-related pricing advantages -
Diversified markets 20
Replacement markets -
After-sales service -
Proximity to market 25
Long-term contracts/assured off take 30
Distribution set-up -
Financial ability to withstand price competition -
Access to patents -
Consistency of quality -
Product range -
Deficit region -
Value addition -
Consolidation of markets -
Support service facilities -
Other promotional ventures -
Source: CRISIL Research

CRISIL RESEARCH POWER GENERATION - CENTRAL UTILITIES 7 JANUARY 2010

NOTES
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