RBS says Sell Power Finance Corp target Rs 272

PFC's management reiterated the potential lending opportunity in the power sector in India.
However, it fell short of discussing the impact on the sector from the mounting T&D losses at the
state utility level. The company plans to raise equity capital, which we factor now, and revise our
TP to Rs272. Sell maintained.


Fundamental issues that will turn around the sector, according to management
1) The ultra mega power projects (UMPPs), which will result in significant power-generation
capacity addition, particularly from 12th plan onwards; 2) the large independent transmission
projects on similar lines to UMPPs will enable significant strengthening of the transmission
infrastructure; 3) the restructured APDRP programme, which is under implementation, will show
the benefits in the form of significant AT&C loss reduction; and 4) renewable and nuclear power
will increasingly gain focus as alternative energy, and will supplement capacity addition in the
longer term.
Capital raising in FY11; equity float to support margins in a rising interest rate regime
The capital adequacy ratio was 17.4% (tier I: 16.3%; tier II: 1.1%) as of 30 June 2010. According
to management, loan book will grow at 25% in FY11 and consequently CAR may drop below
16%. Thus, PFC has to look at the option of augmenting capital by fresh equity issue so as to
ensure that the required CAR is met comfortably. We factor in 10% equity dilution in FY11 at
Rs340 per share (refer to Table 1). PFC has shown consistent improvement in margin in the last
three years (3.7% in FY08 to 4.0% in FY10). We believe that, going forward, as wholesale
borrowing cost rises margins may come under pressure. However, this will largely be offset by
the benefit of free-float from the equity capital to be raised in FY11-12. Thereby, we factor in
largely stable margins in our FY11-12 estimates.
Lack of distribution reforms remains a barrier, in our view; we maintain Sell
We believe that rising commercial losses in State T&D Utilities, due to a lack of distribution
reforms, remain a key barrier to the power sector growth story. We keep our FY11-13 net profit
estimates largely unchanged and increase our target price from Rs256 to Rs272 (calculated
using the EVA™ method). The increase in our target price is due to the increase in FY11F book
value, which is partly offset by the lower ROEs over FY11-13F (15.7%, vs earlier estimate of
about 18%). We maintain our Sell rating on PFC. At our target price, the stock would trade at 1.8x
FY11F book value.