Sector Update | 6 November 2015
Financials
Please refer to our on Utilities
dated on 29 October, 2015
Lightening the power sector
“UDAY” - Right combination of carrot and sticks
Union Cabinet has approved a scheme
“UDAY”
(Ujwal DISCOM Assurance Yojna) for
turnaround of financially distressed DISCOMs. If accepted by states (optional as of
now) this will help resolve problem of aggravating SEB debt. Effective implementation
of the “UDAY” scheme is based on the 4 pillars of a) Reduction in cost of power, b)
Improving operational efficiency to reduce AT&C losses, c) Reducing interest cost of
discoms and, d) Enforcing financial discipline through alignment with states. Key
takeaways:
Debt of SEBs has increased to INR4.8t as on September 2015. The scheme’s
proposal of state governments taking over 75% of debt of SEBs by March 2016
and guaranteeing the remaining will significantly reduce cost of borrowing,
improving SEBs financial health. Not allowing bank funding for future losses is a
key measure which, in our view, could force SEBs to reform their operations.
Total debt of Discom has doubled
over FY11-15 (INR t)
FRP bonds
Banks
PFC/REC
State government loans / Others
0.5
0.4
1.4
0.4
1.1
0.4
0.8
0.3
0.6
0.5
1.9
1.8
1.8
1.5
1.4
0.6
0.4
2011
2012
2013
2014
2015
Scheme will lead to ~20bp CET1 release and reduce ~15% of net stress loans for
state owned banks. Expected fall in NIMs will largely be compensated by
reversals of provisions in the first year thus; earnings are unlikely to be impacted
meaningfully. RECL/POWF are likely to be impacted the most as we expect ROEs
to come down to ~16% from ~20%
Within the power sector, we see key beneficiaries to be NTPC (higher PLF), Power
Grid (focus on lower power purchase cost by moving energy through grid than
rail) and JSPL (in the longer-term pit-head power plants).
Within the capital goods space key beneficiaries are Inox Wind and Crompton
Greaves. BHEL, L&T and Thermax would benefit with a revival in orders for power
generation equipment over the medium term. Negative for diesel generator set
suppliers like Cummins India, Kirloskar Oil Engines (as demand declines as power
supply improves).
Success of UDAY lies in willingness on the part of States to reform. With right
combination of carrots and sticks we believe there is a high probability that
States are likely to find themselves pushed into corner to accept UDAY.
Sanjay Jain
(SanjayJain@MotilalOswal.com);
+91 22 3982 5412
Alpesh Mehta
(Alpesh.Mehta@MotilalOswal.com);
+91 22 3982 5415
Nalin Bhatt
(NalinBhatt@MotilalOswal.com);
+91 22 3982 5429
Ankur Sharma
(ankur.vsharma@motilaloswal.com);
+91 22 3982 5449
Proposal to transfer 75% of DISCOM liabilities to states
st
th
DISCOMs total debt of as on 31 March 2015 and 30 Sept 2015 was INR4.3t
and INR4.8t. Under the optional scheme “UDAY”, States shall take over 75% of
DISCOM debt as on 1HFY16 over two years - 50% in FY16 and 25% in FY17.
Remaining 25% of DISCOM debt can be funded by state guaranteed DISCOM
bonds/loans at the prevailing market rates which shall be equal to or less than
bank base rate plus 0.1%. This can bring down the cost of debt from as high as
14-15% to 8-9%.
State government Bonds will have non SLR status and will be priced at 10year G-
Sec+50bp+premium for non SLR status. Thus, it works out to be 8.25-8.5%
Incremental future losses post FY17 will be taken over by states
(5%/10%/25%/50% in FY18/19/20/21 respectively)
States will issue non-SLR (including SDL) bonds, which will not be counted in the
states’ fiscal deficit for FY16 and FY17.
Investors are advised to refer through disclosures made at the end of the Research Report.
Motilal Oswal research is available on
www.motilaloswal.com/Institutional-Equities,
Bloomberg, Thomson Reuters, Factset and S&P Capital.

Financials | Update
Focus on reducing AT&C losses and bridge the gap between ARR and ACS by FY19
DISCOMs will be required to reduce the average AT&C loss from around 22% to
15% and eliminate the gap between Average Revenue Realized (ARR) & Average
Cost of Supply (ACS) by FY19.
Improving operational efficiencies through compulsory smart metering (for 500+
kwh user), up-gradation of transformers, meters etc., energy efficiency
measures like efficient LED bulbs, agricultural pumps, fans & air-conditioners
etc.
In order to reduce the gap between ARR and ACS focus is on reduction of cost of
power by a) lower fuel cost b) Reduction in interest cost of DISCOMs (state
government guarantee and transfer of debt to reduce financial burden
substantially)
Carrots: to get states on board
States accepting UDAY and performing operational milestones will be given
additional funding under DDUGJY, IPDS, PSDF etc to strengthen the grid and
distribution network.
Govt of India (GoI) will support states with additional low cost coal from COAL
and power from NTPC etc.
Increased supply of cheaper domestic coal, coal linkage rationalization, liberal
coal swaps from inefficient to efficient plants, coal price rationalization based on
GCV, supply of washed and crushed coal, and faster completion of transmission
lines.
NTPC alone is expected to save INR0.35 /kwh through higher supply of domestic
coal and rationalization/swapping of coal which will be passed on to DISCOMs /
consumers.
Sticks: Closing the funding tap
While the press release is silent about the additional loss funding to DISCOMs by
banks; Power minister in his media briefing indicated about advising banks to
not fund DISCOM losses and be prudent in lending. Majority of the SEB losses
are funded through state owned banks and entities.
Non-performance will result in forfeiting of benefits under DDUGJY (INR756b)
and IPDS (INR326b)
Exhibit 1: Total debt of Discom has doubled over FY11-15 (INR t)
FRP bonds
Banks
PFC/REC
State government loans / Others
0.5
0.4
0.3
0.5
1.4
2011
0.4
0.6
1.5
2012
0.4
0.8
1.8
2013
1.1
1.8
0.4
2014
1.4
1.9
0.6
2015
Source: MOSL, CRISIL
6 November 2015
2

Financials | Update
Impact on Financials Sector
Positive for Public Sector Banks; Negative for POWF/REC
PSBs: CET1 release of ~20bp | NSL decline of ~15% | Provision reversal to partly
compensate for NIMs
Restructured SEB loans currently carry a risk weight of 125% and when converted
into state bonds will be zero risk weighted. This will release ~3% of the CET1 capital
(~20bp) for PSBs. Reduction in the coupon rate will have impact on NIMs (~6bp of
avg. assets) however, reversal of standard restructured loans related provision
(~3bp) will compensate for the same. Earnings benefit is available for 1
st
year
however; if banks decide keep these bonds on the balance sheet then it will be
earnings dilutive (5-6% of earnings assuming no MTM gains on the bonds). Further,
restructured SEB loans will reduce NSL by ~15% (~2% of loans). Overall we believe
this is positive for the state owned banks as it will reduce the overhang from the
balance sheet and release much needed capital.
Exhibit 2: Capital release in PSU banks
Capital
Capital
% of
% of
% of SEB % of
% of
Current
Exp. Tier
INR b
INR b
INR b
% of NSL Current Revised
Release
loans
loans
exp.
loans
OSRL
Tier I (%)
I (%)
(bps)
CBK
639
20%
263
8.16%
65
25%
2%
28%
20%
10.0%
8.5%
8.6%
20
8.8%
INBK
238
19%
96
7.64%
41
43%
3%
41%
31%
10.6%
8.1%
10.4%
55
10.9%
OBC
345
23%
72
4.80%
55
77%
4%
39%
29%
12.8% 10.1%
8.6%
35
8.9%
UNBK
388
15%
100
3.91%
60
60%
2%
42%
27%
8.5%
6.8%
7.2%
21
7.4%
BOI
483
13%
155
3.90%
38
26%
1%
20%
11%
9.2%
8.4%
7.2%
9
7.3%
ANDB
199
16%
47
3.70%
38
81%
3%
26%
21%
14.5% 12.3%
7.3%
27
7.6%
PNB
638
17%
107
2.80%
57
54%
2%
14%
10%
14.5% 13.4%
8.6%
15
8.8%
BOB
357
9%
65
1.60%
29
44%
1%
11%
8%
8.3%
7.8%
8.9%
8
8.9%
SBIN
1,719
13%
118
0.90%
39
33%
0%
7%
5%
6.4%
6.2%
9.6%
4
9.6%
Note: We assume all restructured SEB exposure would be converted under 'UDAY'
Note: For revised NSL, we assume 75% reduction of SEB restructured loans within NSL
Source: MOSL, Company
Power
SEB Exposure
SEB Restructured
NSL (%)
Exhibit 3: SEB exposure of PSU banks
INR b
SBIN
PNB
CBK
BOB
BOI
UNBK
INBK
ANDB
OBC
IOB
CBOI
VJYBK
CRPBK
ALBK
SNDB
DBNK
PSBs
Infra
1,719
638
639
357
483
388
238
199
345
287
410
234
254
254
255
159
7,407
% of loans
13.1%
16.7%
19.8%
8.7%
12.6%
15.2%
19.0%
15.8%
23.0%
16.4%
21.2%
27.6%
18.1%
16.8%
12.6%
20.4%
15.8%
Power
1,077
373
449
192
334
220
156
140
214
173
270
158
140
139
170
100
4,455
% of loans
8.2%
9.8%
13.9%
4.7%
8.7%
8.6%
12.5%
11.1%
14.3%
9.9%
14.0%
18.6%
10.0%
9.2%
8.4%
12.8%
9.5%
SEB Exp.
118
107
263
65
155
100
96
47
72
72
183
74
39
51
116
73
1,558
% of loans
0.9%
2.8%
8.2%
1.6%
4.0%
3.9%
7.6%
3.7%
4.8%
4.1%
9.5%
8.7%
2.8%
3.4%
5.7%
9.3%
3.3%
SEB Rest.
39
57
65
29
38
60
41
38
55
17
143
25
24
32
43
37
705
% of SEB exp. % of loans
33.3%
0.3%
53.6%
1.5%
24.6%
2.0%
43.8%
0.7%
24.8%
1.0%
59.8%
2.3%
43.0%
3.3%
81.1%
3.0%
76.7%
3.7%
23.6%
1.0%
77.9%
7.4%
33.3%
2.9%
60.7%
1.7%
61.8%
2.1%
36.8%
2.1%
51.6%
4.8%
45.2%
1.5%
Source: MOSL, Company
6 November 2015
3

Financials | Update
POWF/RECL to be negatively impacted; sustainable ROEs to come down
With the expected improvement in DISCOM health, yield on loans are expected to
decline sharply. Further, as per CRISIL discom debt of these entities contributes
~30% of combined debt (INR1.4tr). Of the combined debt we assume 50% is for
project related/Capex purposes and of the rest given as a transitional
finance/funding for cash losses. Our back of the envelope calculation suggest that
overall spreads are likely to decline by ~70bps (assuming conversion to bonds and
rest of the loans spreads to decline to ~2%). Currently RECL/POWF are making a
spread of ~3.7% which in our view can come down to ~2.6% and NIMs can come
down to ~4% from ~5.2% on a sustainable basis (assuming 20% private loans with a
spread of ~3%). ROAs are likely to decline to ~2.3% and with a leverage of 7x ROEs
can be ~16% (down from ~20% currently)
Exhibit 4: Expect INR22b of PAT losses for combined RECL and POWF (~15% of FY17 PAT)
Total Loans (REC/PFC)
INR4.3t
T&D
INR1.4t
Genco
INR2.9t
Capex related project
finance ~INR700b
Transitional / operational loss funding
~INR700b
Expect spread of 2% (v/s 3.7%
blended reported now)
To be converted into bonds
(75%) leading to spread loss of
3.7% (blended)
Expect spread of 2% (v/s 3.7%
blended reported now)
Source: Company, MOSL
Exhibit 5: POWF and RECL- Return ratios likely to decline
1.2
3.1
0.4
20.6
2.2
15.7
Current RoA
Impact on
margin
Impact of
taxation
Est. RoA
Current
RoE*
Revised
RoE*
Source: MOSL
*Assuming similar leverage of 7x; and 20% share of private loans
6 November 2015
4

Financials | Update
Impact on Power Sector
NTPC and PGCIL key beneficiaries
We believe that key reasons behind poor financials of DISCOMS is both high
ACS, low ARR (function of tariff, AT&C loss etc.) and debt due to accumulated
financial losses. We have discussed the key issues in our recent report “Second
FRP in three years; Will it work this time?”
Click here to access detailed report
UDAY has laid down clear path for de-stressing balance sheet of DISCOMs. But,
this will not be enough to bridge the gap (ARR-ACS) for DISCOMs in Rajasthan,
Tamil Nadu, UP and MP among the larger states as evident from following
exhibit.
Success of UDAY lies in willingness on the part of States to reform. UDAY has
right combination of carrots and sticks.
We believe that there is very little headroom to increase tariffs for high paying
consumers without losing them. As the banks stop lending further to fund
losses, DISCOMs and States will be compelled to improve ARR by reducing AT&C
losses. States may find it difficult to avoid benefits under DDUGJY and IPDS.
There is very high probability that states are likely to find themselves pushed
into corner to accept UDAY.
Exhibit 6: SEBs interest, depreciation and revenue gap - INR/kWh
4.00
3.00
2.00
1.00
0.00
Bihar, Haryana,
Punjab are
operationally okay
with subsidy but gaps
due to debt
0.3
0.6
0.8
Interest
Dep.
Gap w.r.t. cost
Rajasthan has highest
interest cost
0.4
0.4
0.6
0.7
1.5
0.9
0.7
Source: MOSL, PFC
NTPC and PWGR are likely beneficiary
If States do accept UDAY, we are likely to see efficient Gencos like NTPC (better
PLF), Transco’s like PWGR (more investment in long distance transmission lines
bet” low cost fuel and demand centers) and low cost coal supplier like COAL
(Coal India) benefiting gradually.
Price rationalization based on GCV will ultimately benefit COAL as it will narrow
the gap between low grade and high grade coal. Also, COAL will have to
rationalize production between low cost and high cost mining because
inefficient subsidiaries/mines will report losses.
Among the private players, we expect pit head power plants e.g. Jindal power
are better placed and will be able to tie up their open capacities ahead of
others.
6 November 2015
5

Financials | Update
Impact on Capital Goods Sector
Successful implementation of “UDAY” to resuscitate T&D Equipment/EPC
supplier value chain; Power Generation equipment orders to wait
Distribution sector losses bane for the sector:
High and non -sustainable
distribution sector loses have been the primary reason behind subdued
demand for power from discoms. This in turn has negatively affected capex
plans of generation, transmission and distribution utilities and in turn impacted
demand for the entire value chain of companies in the equipment supply/EPC
in the Power generation and T&D sector. A successful implementation of the
‘UDAY”’ programme which intends to eliminate discoms losses by FY19 would
help revive demand for the entire value chain. However, given the over-
capacity in generation and poor financial health of private IPP’s, we expect an
improvement in orders for power generation equipment suppliers to happen
over the medium term.
Key BUY ideas:
In our coverage space, key beneficiaries are Inox Wind and
Crompton Greaves while BHEL, L&T and Thermax would benefit with a revival
in orders for power generation equipment over the medium term.
Negative for Diesel Generator set suppliers:
A meaningful reduction in AT&C
losses and an improvement in power supply would be a negative for Diesel
generator set suppliers as power deficits drop in the true sense – currently
deficits are low since SEB’s resort to power cuts as they lack funds to buy power
and also restrict supplies to areas where the cost recovery is low. Once AT&C
losses reduced, the improved reliability of power supply would result in a drop
in diesel generator demand which is a medium term negative for players like
Cummins India, Kirloskar Oil Engines.
Exhibit 7: Key beneficiaries in the listed space to benefit from the proposed “UDAY” scheme
Key Measures proposed
Improving operational efficiency to
reduce AT&C losses
- Compulsory Smart Metering
- Up gradation of Transformers and
substations
Energy efficiency measures to reduce :
- LEDs
- Agricultural pumps
- Fans
- Air-conditioners
Reduction of Cost of Power
- Better Transmission connectivity to
reduce cost of power
Renewable Purchase
Obligation (RPO) outstanding since
Apr, 2012 complied
Will ensure efficient and reliable grid connectivity
Will ensure implementation of RPO norms and higher
procurement of power from renewable Energy by
discoms
Inox Wind, Suzlon Energy, ABB India,
Source: MOSL, Company
6
KEC International, Kalpataru Power, L&T,
Skipper, Techno Electric
This will ensure better utilization of the power
generated and significant energy saving
Havells, Bajaj Electricals, Eveready, Surya Roshni
KSP Pumps, Crompton Greaves ,ABB
Crompton Greaves, Havells, Bajaj Electricals
Voltas, Blue star, Hitachi
This will ensure reduction of AT&C losses through
faster implementation of IPDS Scheme and Deendayal
Upadhyaya Gram Jyoti Yojana.
Schneider Electric, ABB, Siemens, Crompton
Greaves
Voltamp, Indo tech, TRIL, ABB, EMCO, Schneider
Electric, BHEL, KEC International
Impact
Beneficiary Companies
6 November 2015

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For Singapore
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6 November 2015
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