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POWER FINANCE CORPORATION
Spreads sustained; growth momentum intact
�� Strong core operating performance
Power Finance Corporation (PFC) reported strong core operating performance,
with loan book growing 27% Y-o-Y and NIMs sustaining at high level of 4.1% in
Q3FY11. This led to 24% Y-o-Y (3.3% Q-o-Q) growth in net interest income, to
INR 9.26 bn. PFC reported PAT of INR 6.59 bn, including extra-ordinaries:
• MTM loss of INR 280 mn on forex borrowings (net of tax ~INR 180 mn)
• INR 150 mn of nodal agency fees and expenses reimbursement on APDRP
• Prepayment premium of INR 70 mn and prior period tax of INR 20 mn
Adjusted for this, PAT grew 22% Y-o-Y to INR 6.6 bn during the quarter.
�� Robust disbursements; uptick in transmission
PFC’s disbursement growth maintained a strong trend with 20% Y-o-Y increase,
to INR 78 bn (45% in 9mFY11), resulting in loan book growth of 27% Y-o-Y. The
transmission segment picked up and formed 12% of disbursements, while
traction continued in generation. Unutilised sanctions during the quarter stood at
INR 1.7 tn (~45% towards projects where documents have been executed and
disbursements have commenced; more than 20% in favour of private projects);
this suggests better traction in disbursements of unutilised sanctions than in
previous years. We continue to maintain a healthy outlook on disbursement
(~30% in FY11) and build in loan CAGR of 24% over FY10-12E.
�� Spreads at ~2.7% for third consecutive quarter
While we were anticipating decline in spreads due to rise in wholesale funding
cost over the past six months, PFC managed to sustain it near 2.7% for the third
consecutive quarter. The full impact of ECB of USD 240 mn raised in September
helped to some extent. While we expect cost pressures to build up on margins
over the next 6-12 months, further borrowing via ECB (of USD 260 mn expected
in Q4FY11), infrastructure bonds (INR 53 bn) and fund raising via FPO (expected
in Q1FY12) will offset funding cost pressure. Owing to appropriately matched
ALM, effective pricing power and benefit of IFC status, we expect PFC’s spreads
to sustain over 2.5% in FY10-12E.
�� Outlook and valuations: Positive; maintain ‘BUY’
Led by strong outlook on business and steady margins, we expect 23% CAGR in
earnings over FY10-12E. We are revising up our EPS estimate (ex forex MTM
losses) by 4% to INR 23.3 for FY11 and INR 28.1 for FY12 and expect average
RoE of ~19% over FY10-12E. FPO will be a near-term trigger (20% of current
equity base), which will be book value accretive (INR 15 per share). The stock is
trading at 1.8x FY12E book and 9.7x earnings. We maintain ‘BUY/ Sector
Outperformer recommendation/rating on the stock.
�� Robust disbursements; uptick in transmission
PFC’s disbursement growth maintained a strong trend with 20% Y-o-Y increase to INR 78
bn, resulting in loan book growth of 27% Y-o-Y to INR 921 bn in Q3FY11. The generation
segment continued its traction, constituting 71% of the total disbursement (growing
16% Y-o-Y); transmission (in particular) saw an uptick, forming 12% of the total
disbursements in Q3FY11, up from 3% in Q3FY10 and 4% in FY10. Private sector
witnessed marginal reduction in its share in the pie of sanctions (25% of 9mFY11
sanctions vis-à-vis 28% in 9mFY10). However, skew towards private sector sanctions in
FY10 and H1FY11 kept disbursements strong to the segment (14% of 9mFY11
disbursements vis-à-vis 4% for 9mFY10). Overall, sanctions during the quarter at INR
178 bn, were in line with the run rate of INR 160 mn per quarter in FY10 after having
clocked INR 297 bn worth of sanctions in Q2FY11.
Unutilised sanctions during the quarter were INR 1.7 tn. Of these, ~45% was towards
projects where documents have been executed and disbursements have commenced and
~13% where documents have been executed but disbursements are pending. Further,
more than 20% of these utilised sanctions are in favour of private projects and ~65%
towards state utilities. This composition suggests better traction in disbursements of
unutilised sanctions than in previous years. Considering the traction in 9mFY11 and
seasonality to favour robust disbursements in Q4FY11, we are building in ~30% growth
in FY11 and expect loan book to post CAGR of 24% over FY10-12E.
�� Spreads at ~2.7% for third consecutive quarter
While we were anticipating decline in spreads due to rise in wholesale funding cost over
the past six months, PFC managed to sustain its spreads near 2.7% for the third
consecutive quarter (marginal increase Q-o-Q). While the cost of funds came off 10bps
Q-o-Q as the base was set higher in Q2FY11 due to upfronting of expenses incurred in
raising ECB in September, it was similar to borrowing cost reported in Q1FY11. Yields on
advances also sustained near 11.1% and margins were stable at ~4.1%. The full impact
of overseas borrowings of USD 240 mn raised in September at ~200bps over JPY LIBOR
helped maintain the spreads to some extent in this quarter.
Management expects INR 47 bn of loans and INR 200 bn of borrowings to come for
repricing in Q4FY11. We expect cost pressures to build up on spreads over the next 6-12
months due to rising wholesale costs. Structurally, spreads over the past six quarters
have moved above 2.4% and management indicated that it expects to sustain them
above 2.5-2.6%. The company is looking to raise USD 260 mn through ECB route in the
near term, whereas it is eligible to raise INR 53 bn through infrastructure bonds in FY12.
Fund raising from FPO (expected in Q1FY12) will also provide support to margins.
PFC has taken active steps to improve the asset liability maturity profile by resorting to
longer term borrowings of 3-10 years, lowering reliance on short-term funding and also
adjusting the floating proportion of liabilities in line with repricing expected on assets.
Fixed rate loans constitute just 10% of the total advances, whereas 76% fall under the
3-year reset basket. We expect PFC’s spreads to sustain at over 2.5% in FY10-12E owing
to appropriately matched ALM, effective pricing power, IFC status opening ECB and
infrastructure bonds funding and benefit of RBI comments on linking risk weights on
banks’ exposure to infrastructure financing companies with its credit rating.
�� Fee income to contribute meaningfully over next 12-18 months
As per the terms finalised by the steering committee of Ministry of Power on the terms of
payment of fee and reimbursement of expenses under disbursements under the R-APDRP
scheme, 30% will be paid at the time of sanction and disbursement and the rest on
completion. Management expects to garner fee income of INR 3 bn over 3-5 years from
the INR 500 bn APDRP scheme, of which, only INR 815 mn has been accrued till date.
Moreover, management expects to award four UMPPs (Chattisgarh, Orissa, Andhra
Pradesh and Tamil Nadu) over the next 18-24 months and garner fee of INR 250 mn per
UMPP. Chattisgarh and Orissa UMPPs will be ready for bidding, while Tamil Nadu and
Andhra Pradesh UMPP is pending for RFQ (Request for Qualification) issuance due to
Section 4 notification requirement.
�� Nil net NPA; SEBs’ financial health key monitorable
PFC did not report any slippage during the quarter and gross NPA was maintained at
near zero-level of INR 130 mn (0.01%). Also, NPAs were completely provided for in
Q3FY11; hence, the company reported nil net NPA during the quarter. With some of the
SEBs reporting deterioration in financials, asset quality in the T&D segment (in
particular) will be a key monitorable.
�� Notional MTM forex loss of INR 280 mn
The company booked MTM exchange loss of INR 280 mn in Q3FY11 on foreign exchange
borrowings. Outstanding forex borrowings now stand at ~USD 850 mn (as it borrowed
USD 240 mn in Q2FY11). It has outstanding unhedged borrowings equivalent to ~89%,
a significant chunk of which is due for redemption only after 2015.
�� Other highlights
• As infrastructure finance companies are required to maintain 15% CAR, PFC will look
to tap capital markets for funds. FPO is expected in Q1FY12, wherein the company is
looking to dilute 15% and an additional 5% in the form of offer for sale by
government.
• The board has approved formation of subsidiary for renewable energy, which will
smooth the process of approval as five independent directors have been appointed
in the subsidiary.
• PFC will be appointing consultants for advisory on its planned banking venture in the
next few days.
• The company is also exploring possibilities of doing business in Bhutan and Nepal.
�� Company Description
PFC is a specialised institution in power sector financing, providing fund and non fundbased
support for development of power projects in India. The company’s project
financing activities are primarily focused on the thermal and hydro-energy generation
areas. In addition, it finances renovation and modernisation of power projects, projects
related to transmission and distribution of power, and shunt capacitor projects. It has
also initiated financing of projects based on renewable energy sources such as bio mass
and wind power generation. PFC’s clientele comprises state power utilities, central power
utilities, private power utilities, joint sector power utilities, and power equipment
manufacturers. Of total loan assets of INR 921 bn, as on December 31, 2010, 65% of
advances were extended to state power utilities, 19% to central power utilities, 7% to
private power utilities, and 8% to joint sector power utilities.
�� Investment Theme
PFC’s outlook is strong, given investments of USD 155 bn lined up in the power sector
over FY07-12E, its leadership in power financing, superior domain knowledge, and lean
cost structure.
Growth triggers for the stock could be factors such as: (1) favourable asset liability
profile in rising interest rate environment; (2) the company’s heightened focus on
augmenting fee-based income; and (3) option value attached to its private equity
investments in terms of performance fees.
We expect PFC’s RoEs to increase to ~18-19% by FY12E, driven by increase in leverage
to 7x by FY11E and eligible tax exemption (for engagement in infrastructure financing),
supported by the company’s lean cost structure, and lower provisioning (better asset
quality).
�� Key Risks
The power financing space is becoming increasingly competitive with commercial banks
and financial institutions providing innumerable power finance products and services.
PFC’s ability to borrow from banks may be restricted with RBI guidelines limiting the
exposure of a bank in NBFCs to 15% of its capital funds (against 25% previously).
PFC’s gross NPA is at low levels. Any major slippage or ineffective recoveries can raise
its NPAs significantly, adversely affecting its profitability and future growth.
Presence in the power sector exposes PFC to project-specific and general risks.
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