Macquarie Research, Power Finance -Solid margins, attractive valuations

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Power Finance
Solid margins, attractive valuations
Event
 Power Finance reported 3Q11 net profit of Rs6.5bn, up 16% YoY but 5%
below our expectations. NII was ahead of our estimates due to solid margin
performance. We maintain an OP rating on the stock even as we cut our TP
to Rs362 from Rs458 to take into account slower loan growth and higher
credit costs.

Impact
 NIM surprise on lower cost of funds. An environment of very tight liquidity
management has actually been able to reduce its cost of funds by 10bp QoQ
to 8.35%, which has helped to keep its NIMs flat. Overall spreads increased
marginally QoQ, to 2.73%.
 Management attributed this to yen borrowings of US$240m done in
September 2010. It expects to borrow another US$260m in 4Q11, which
along with Rs53bn of infra bonds at ~8% and a loan rate hike done recently,
should partially offset the expected increase in cost of ordinary bonds. We
have built in ~25bp QoQ decline in NIMs in 4Q11.
 Sanction book should support ~25%YoY loan growth over the medium
term. Loan growth of 27%YoY was slightly below our estimate. While loans to
generation have been robust at 29%YoY, T&D loans still lagged behind at
20% YoY. Given the high base effect of 4Q10 and the slowdown in the sector,
we expect loan growth to slow further. However, the large outstanding
sanction book of Rs1.7tn, out of which Rs0.8tn of sanctions have already
commenced, give us comfort that the company will be able to achieve 25%
YoY loan growth over FY11–13E.
 Asset quality impeccable, but state utility losses a concern. With all its
assets covered under escrow arrangement and gross NPL nil, management
remains sanguine about asset quality. It believes benefits of APDRP will start
beyond FY12E. However we believe state distribution utility losses remain a
concern. We have accordingly incorporated higher credit costs (0.5% of
assets vs 0.1% earlier) in our sustainable ROE calculations, reducing the
ROE and target multiple.
Earnings and target price revision
 We have cut our earnings by 4–11% on lower loan growth (25% vs 30%
earlier) and higher equity dilution (15% vs 10% earlier. Our TP multiple has
been reduced from 2.6x to 2.1x.on lower sustainable ROE. Our TP falls to
Rs362 from Rs458 on a lower multiple and BVPS.
Price catalyst
 12-month price target: Rs362.00 based on a Gordon Growth methodology.
 Catalyst: Follow on public offering in 1Q12E.
Action and recommendation
 We believe current the valuations of 1.6x FY12E BVPS looks attractive for a
robust franchise and more than discounts the macro concerns. Maintain OP