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PFC/REC (POWF/ RECL)
Banks/Financial Institutions
Margin pressure on power finance companies. We believe that rising bulk
borrowings rates will put pressure on margins of PFC and REC in the medium term.
Capacity addition in the generation segment will likely drive better traction for PFC
while loan growth will likely be somewhat lower for REC. Power finance companies
(PFC and REC) have underperformed on the back of likely margin pressure and slower
loan growth, we retain negative stance on both the stocks.
Rising bulk borrowing rates put pressure on margins
The current liquidity squeeze in the system has put significant pressure on bulk borrowing rates,
primarily in the shorter end on the yield curve - interest rates below one year are up by about 4%
from April 2010 levels. NIMs for PFC and REC have been in sweet spot over the past few quarters
supported by excess liquidity and lower borrowings cost - the decline in lending rates by these
companies was lower than the reduction in borrowings cost. We are reducing REC’s margins by
about 10-20 bps to factor lower margins over the next few quarters.
` In FY2011E, about Rs100 bn of REC’s loan assets are due for re-pricing as compared to Rs50-60
bn of borrowings - favorable re-pricing of assets as compared to liabilities supported REC’s
spreads, the benefit is unlikely to extend in FY2012E.
` Higher share of private sector business (in the XII 5- year Plan) will likely increase competition
for these companies and put pressure on margins. In case of PFC, about 23% of approvals are
driven by private players as compared to 7% share in the current loan book.
Generation companies growing at a faster clip
We believe that PFC will likely deliver about 27% loan growth over the next two years,
significantly higher than 22% loan book CAGR between 2007 and 2010, on the back of strong
growth in the generation segment. REC has reported loan growth of about 25% YTD and loan
growth will likely remain moderate as compared to 27% loan growth CAGR between 2007 and
2010. We are now modeling about 23% loan growth for REC in FY2011E and FY2012E as
compared to 26% CAGR factored earlier.
NPLs remain a risk
PFC and REC currently have negligible NPLs. Strong collections from state utilities despite the
latter’s poor financials remain a residual risk for these companies. Financial losses reported
by state utilities have increased over the years though the asset quality performance of
power finance companies remains strong likely due to their nodal agency role and central
Government ownership. Government’s impetus on power sector provides comfort in this
regard. Nevertheless, we would like to highlight that unlike other NBFCs (like IDFC) and
banks, PFC and REC have not made any provisioning buffers for any likely slippages.
Retain negative stance on PFC and REC
PFC and REC have underperformed the markets significantly over the last one month. We
believe that stock performance will likely remain under pressure as NIM compression is more
visible. We are revising down our estimates on REC to factor somewhat lower loan growth
and margins. Retain REDUCE rating with price target of Rs300 (Rs350 earlier). PFC is
relatively better placed due to higher growth traction though margins remain at a risk. The
stock is trading closer to our target price, we revise rating to REDUCE from SELL, retain
target price of Rs325.
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