Power sector’s meteoric rise faces valuation concerns; HSBC Securities predicts post-summer adjustment

Power stocks have demonstrated remarkable performance on Dalal Street in recent sessions, with many achieving new milestones and contributing to a significant expansion in their market capitalisations.

The BSE Power index, a key indicator of power stock performance, has surged by 100% over the past year, with 10 out of 13 constituents delivering multibagger returns.

The surge in power stocks was primarily driven by a power shortage exacerbated by a weak monsoon, which heightened agricultural demand and air-conditioning usage despite insufficient hydroelectric support. This increased demand resulted in higher power prices, triggered discussions on expanding sector capacity, and bolstered stock valuations.

The one-way rally in stocks began in July 2023, triggered by a shortage of power from July to October 2023, attributed to the weakest monsoon in 122 years.

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In response to escalating power consumption, the government has announced plans to add 80 GW of thermal capacity by 2032 and increase annual renewable power auctions to over 50 GW, up from approximately 18 GW seen in FY24, which further supported the power stocks to trade at higher levels.

However, global brokerage firm HSBC Securities expects stock valuations to cool down after the summer due to capacity additions, effective management, La Nina, and the high base effect.

The brokerage notes that electricity demand growth in FY22 and FY23 benefited from the lower base of COVID-19, while FY24 demand growth was driven by an acute shortage of rainfall from July to September 2023.

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If monsoons are normal as forecast by the IMD and La Nina does prevail, HSBC anticipates much lower deficits and an optical decline in power demand during July to October 2024.

Since September 2023, 4.1 GW of thermal capacity and 14.9 GW of renewable energy (RE) capacity have been added to meet demand. HSBC believes FY25 will see another significant capacity addition of approximately 10 GW of thermal and 25 GW of RE. This will likely cool the valuation premium attributed to capacity shortages, it said.

Further, despite strong demand in FY22-24, the 5- and 6-year CAGR electricity demand growth has been 5.1% from FY19-24 and FY18-24, reflecting a much lower impact of industrial activity on power demand.

Positive but calibrated

While the brokerage remains positive on the long-term potential of India’s power sector, it advises a more calibrated view. According to the brokerage, the power capacity in India will be commissioned, but based on the ability of state distribution companies (discoms) to pay. Increased electrification is expected to boost power demand, but the adoption of more efficient power equipment will help manage this increase.

A greater focus on renewable energy (RE) will drive an increase in captive RE plants, reducing the demand pressure on discoms but also negatively impacting their finances. The brokerage notes that RE installations combined with batteries will pick up the pace on favourable economics, driven by lower module and battery prices.

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Additionally, it notes that the expiry of the Inter-State Transmission System (ISTS) waiver, the adoption of battery storage, and the promotion of decentralisation schemes will democratise transmission and reduce the burden on ISTS.

Finally, the brokerage believes India will proceed with electricity reforms, but given the involvement of states and a lower central government majority, reforms will be only gradual.

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Cut ratings

The brokerage has downgraded the ratings on multiple stocks, citing that investors have overestimated the growth trajectory of these companies.

The brokerage downgraded Powergrid Corporation's rating to 'Reduce' from 'Hold' and set a target price of ₹270, indicating an 18% downside from its current levels. Similarly, it downgraded NTPC's rating to 'Hold' from 'Buy,' with a target price of ₹355, signalling a 2.1% downside.

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Additionally, the brokerage maintained its 'Reduce' rating on Tata Power and BHEL, with target prices of ₹300 and ₹72, respectively. This suggests a 31.6% downside for Tata Power and a significant 75.6% downside for BHEL.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.