To my mind, NTPC presents an asymmetric payoff matrix centered around the budget. Lets go through this step-wise:
- NTPC is an uneventful thermal power company primarily relying on coal to generate power which it sells to state electricity boards. Its owned and is under the control of the Government of India for all practical purposes.
- Problems faced by NTPC (and other power producers as well)
- State Electricity Boards (SEBs) in India, NTPC's primary customers, are essentially bankrupt and do not make payments on time.
- The Government is very confused about its policy on coal which creates complications for producers
- There are two possibilities with the budget
- The government chooses to present a populist budget which does not augur well for the economy, power produces, and, in this instance, for NTPC.
The people of India might cheer it on but when they feel the pangs of slowing growth 12 to 15 months down the line towards the end of 2013, they will not reward the government in the 2014 general elections. The people of India want a performance oriented, not a promise oriented, government - this is clear from elections over the last 3 - 4 years.
- The government chooses to reform. Even if they do nothing on the issue of power sector reforms, any inkling of reform will be enough to boost sentiments to the point where market participants become bullish on the power sector. In this case, power producers should benefit.
- Why NTPC?
- The above analysis assumes rationality on the part of the Congress. Their actions over the last one year have been anything but rational / sensible.
- NTPC presents an asymmetric payoff structure due its limited downside potential. Downside in NTPC is limited - my reasons are dominantly technical supported by the fundamentals of the company. I do not think this asymmetric payoff structure applies to private power companies due to their unproved execution skills and weaker balance sheets.
The trade can be structured by going long NTPC March contract. Another way to structure it is by going short 160PE and long 180CE. Personally, I would go for a combination of the two depending on risk appetite.