Power Grid, NTPC seen as safe havens as yields slip

ET Intelligence Group: The yield on 10-year G-secs has fallen 60 bps year-to-date, driven by a combination of global and domestic factors. A fall in interest rates is positive for regulated-return utilities such as Power Grid and NTPC since it increases the spread of their return on equity (RoE) over fixed-income securities.

Due to relatively stable and regulated RoE of 15.5%, utility stocks offer a safe haven to investors during bouts of market volatility. The stocks of Power Grid and NTPC have a beta of less than 0.8 reflecting lesser variability in return compared with the benchmark index.

Investors evaluate RoEs of utility companies with respect to bond yields and if the spread between the two widens, the relative attractiveness of regulated utility stocks over the fixed income increases.

According to analysts’ estimates, a drop of 50 basis points in risk-free rate could increase the valuation of Power Grid and NTPC by 8-10% based on the discounted cash flows method (DCF). This is because lower bond yield reduces the risk-free rate for the computation of the stock valuation by the DCF method.

CLSA, in a recent note, raised target price for Power Grid to Rs 215 from Rs 200 and that of NTPC to Rs 165 from Rs 155 after it reduced their risk-free rate assumption to 7.25% from 7.5% earlier. Power Grid and NTPC have gained 28% and 16%, respectively, on the bourses since the start of 2016.