National Thermal Power Corporation (NTPC) is a Public Sector Navratna Company, with Government of India having majority stake. NTPC is a power utility company that has business interests in thermal power generation industry. It is engaged into engineering, construction, and operation of power plants.

Trend Analysis

The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is based on last 8 years 2000 to 2008. Trend charts are shown in image below.

• Revenue: Increasing trend with average growth of 11.5%.
• Earnings per share: Increasing trend with average growth of 10.3%.
• Net cash flow from operations: The net cash flow from operations has an overall increasing trend. In general, the net cash flow is equal to or greater than reported net profit. This shows that corporation is able generating sufficient cash to have sustainable net profit.
• Profit/Loss from operations: Looking at standalone profit only, the corporation is showing consistently increasing profits from its operations.
• Reported net profit: Increasing trend
• Gross margins: Sustainable gross margin, averaging 22.2% (with narrow standard deviation of 3.55%). This is very good.
• Operating margins: Sustainable operating margin, averaging 30.1% (2.03% std. dev.). This is very good.

Quality of Dividends

In this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. In is also an indirect way to gauging management’s policy vis-à-vis sharing the profits with common shareholders.

• Dividend per share: Chart 3 shows the dividends consistently increasing trend of dividends.
• Payout factor: This is ratio of dividends per share dividend by EPS. NTPC has been consistently maintaining dividends less than 50%. This is good because, the corporation can use profits for further capital investments. This shows that corporation is sharing the proportional profits with common shareholders.
• Dividend growth rate: The rate of dividend growth is highly variable. The rate of growth has been 53% (2004), 73% (2005), 17% (2006), 14% (2007), and 9% (2008). Ideally, I would like to see a consistent growth rate. However, since this growth is always positive and above level of inflation, I would consider this acceptable.
• Ratio of cash from operations to reported net profit: In general, this ratio is more than one. This is very good.
• Ratio of profits from operations to reported net profit: In general, this ratio is more than one. This is very good.
• Ratio of Cash from operations to total debt: This ratio is consistently less than one. What this means is – in any given year, the corporation’s total debt is always higher than the amount of cash generated. Any reduction in yearly cash flow will affect how the corporation services its debt. However, since this debt level is consistently at a similar level, it demonstrates that it is being managed effectively, and perhaps sustainable.
  

Dividend Cash Flow vs. Risk Free Savings Cash Flow:

Why should I take risk if I can get a same or more cash flow by putting my capital into any risk free savings, fixed deposits, or any such risk free accounts? Therefore, I try to understand how dividends will affect my cash flow in 10 years of time period. The baseline assumptions are (1) the stock’s dividend yield is 1.9% at current price of Rs. 183; and (2) savings interest rate is 7%.

• Best case scenario: considering average dividend growth rate of 33% for last five years, the dividend cash flow will be 1.92 times the cash flow from savings interest.
• Worst case scenario: considering low end of the dividend growth of 8% for last five years, the dividend cash follow will be only 0.30 times the cash flow from savings interest.
• In order to have equal cash flow (i.e. dividends = savings interest) in 10 years time period, the current yield should be 3.1% with worst case dividend growth of 8%. At this yield the buy price is Rs. 112.

Beta-based expected return:

I measured Beta of NTPC stock’s risk (or price movement) relative to the S&P CNX NIFTY (or index movement). Here, I am trying to understand how a stock price behaves relative to the market and how to factor in the capital appreciation into my expected returns.

• The stocks four year Beta value is 0.67 (0.77). This means NTPC’s stock is relatively less volatile w.r.t. S&P CNX NIFTY index.
• The expected return is 12.7% (13.5%). Expected return = [risk free return, 7.0%] + Beta, 0.77 x [expected market return, 15.5% – risk free return, 7.0%]. I will provide more details on this calculation in future post. So stay tuned!
• Now factoring in 12.7% (13.5%) of expected return into the worst case dividend growth of 8% and current yield of 1.9%, the total cash flow is 3.19 (3.7) times the savings interest rate.

Fair Value Calculation

Based on the analysis so far, I believe NTPC will be a good long term investment. The next step is to estimate the fair value and understand risk return characteristics to make an investment.

• NPV price based on 15 year DCF: Rs. 110.5
• Average high yield price calculated based on past 8 years: Rs. 133.9
• Pricing relative to 8 year average PE ratio: Rs. 137.3
• Pricing based on PE ratio of 12: Rs. 97.5
• Graham number: Rs. 108.0

The range of fair value is calculated as Rs. 100.10 to Rs. 134.8. This is determined by taking average of above five parameters and using one standard deviation for high and low values.

Qualitative Analysis

NTPC is a well managed corporation in a very challenging power generation industry. In this industry new projects take 3-5 years in development which require sustainable execution and planning for break even and profitability. It also has a long term roadmap to more than double its generation capacity. I expect this to bring in increased revenue, increased cash, and potentially increased capital appreciation.

NTPC has had good financial performance in past and excellent present state of its business. In addition, it has sustainable financial operations, sustainable profitability, and sustainable cash flow.

Summary…

The analysis shows that NTPC is an excellent investment for long term (10+ years) dividend based cash flow and capital appreciation.

• Initiating a position at current pricing of Rs 183.75 provides a total expected return of 3.19 (3.7) times the saving interest cash flow.
  
• Waiting for initiating a position at Rs. 134, the total expected return would be 4.82 (5.22) times the savings interest cash flow.

Looking at the long term prospects of the company, I individual investors can initiate a starter position at this pricing. If pricing falls into the fair value range, the investor can add to this starter position. I will continue to add to my position as my allocation levels allows.

Full disclosure: Long on NTPC.

Please Note: April 16, 2009, One of the readers, Silambu Chelvan identified an error in my calculation. While the explain is correct, there was an error in my excel formula. I have now corrected this error in my calculation. The beta-based expected return is 12.7% (and not 13.5%). To make it more legible, I have included old values and indicated it as crossed line. After correcting this error, my conclusion about NTPC still remains same.

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