Issues surrounding improving domestic fuel supply, price pooling for imported coal and signing of FSAs remain a big overhang with no immediate resolution likely in the new orders position in the power sector, says Espirito Santo Securities in its Fundamental Insight report

A slew of reforms, for example, debt restructuring of SEBs (state electricity boards) and anticipation of revision in Power Purchase Agreements (PPA), have brought back expectation of a revival in the power sector. Espirito Santo Securities, in its Fundamental Insights report, thinks that these reforms would be able to address only the current set of problems (tariff hikes to reduce current SEB losses and revision in PPA for imported coal based UMPPs—ultra mega power projects). Though this gives a positive signal to investors, 80% fuel supply under the best case scenario leaves little incentive for the IPPs (independent power producers) to commit fresh investments. Reforms implemented for improvement in domestic coal production (faster environmental and forest clearance) and price pooling across the projects for imported coal, would also improve the situation only after a couple of years. The industry oversupply situation would also mean that every incremental order would be bid for aggressively; leading to downward trends for EBITDA margins and return ratios for the power equipment suppliers. Espirito Santo continues to maintain ‘Sell’ recommendation on the shares of BHEL, BGR Energy and Thermax.

Owing to the issues surrounding the sector, capital goods companies have witnessed a sharp reduction in their order intake. BHEL registered order intake of Rs82.8 billion in H1FY13, a contraction of 45% y-o-y (year-on-year). Order intake for Thermax remained flat (3% y-o-y contraction), while for BGR it grew only on account of NTPC bulk tender (Rs37 billion). Espirito Santo points out that there is significant stress in the system impacting order inflows and revenue visibility. As per Coal India (CIL), green clearances have held up 244 mines leaving CIL with no room to raise output. The company is awaiting expansion orders at several mines with about 80 million tonnes of coal reserves and in some of the mines it has exhausted the limits up to which the clearances are in place. The shortage in fuel is adding pressure and the sector has witnessed a rise in stalled and shelved projects.

According to Espirito Santo, the private sector has been at the forefront of thermal power capacity addition, contributing 60%-70% of new orders over CY09-11. However, owing to issues over domestic fuel supply, pricing of imported coal and high interest rates, contribution from the private sector has significantly come down. In CY12 YTD, new orders from the private sector (9GW) contributed 30% to the total order pipeline. Most of the projects in the pipeline are awaiting environmental clearance, land acquisition or are at the planning stage and it seems unlikely that the current pipeline will contribute to order inflow for FY13 in any meaningful way.

The government’s reform focus was the feature of the last quarter, causing a powerful rally in Indian equities. It has resulted in the expectation that the new project announcements in the power segment will pick up, thus providing some respite to a sector hit by a drought in new order inflows. However, on the ground realities continue to reflect a very negative scenario, where order inflow from the power segment continues to decline every quarter and with the reform process not oriented towards an improving fuel supply scenario, Espirito Santo thinks that the bottom is not yet in sight. New orders from the power segment have contracted sharply, with orders in H1FY13 contracting by 57% y-o-y. New orders for the quarter at Rs79 billion have also touched their lowest levels since 2005 and have contracted by 91% y-o-y.