Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Power Financing NBFCs
Risk quotient increasing
We initiate coverage on power financing NBFCs (Power Finance Corporation,
PFC and Rural Electrification Corporation, REC) with a negative view. While we
remain positive on demand in the medium term as outstanding sanctions are
robust, we expect credit growth to moderate due to the higher base. Asset
quality is healthy for now, but the concentrated loan profile, absence of buffers
on the balance sheet, mounting losses of state electricity boards (SEB), and
concerns over coal availability/power project execution heighten the balance
sheet risk, in our view. Valuations remain at a premium to PSU banks despite
similar RoE profiles (high RoEs for power financiers largely aided by near zero
provisions). We believe valuations could de-rate from current levels given the
(a) rising risk profile of the power sector, leading to apprehensions on asset
quality and (b) single-product nature of power financing NBFCs.
We rate PFC/REC as HOLD/SELL with target prices of Rs 265/Rs 230. Between
the two, we prefer PFC as underlying growth would be stronger due to higher
exposure to the generation (versus the distribution) segment. A key risk to our
call is meaningful reforms in the power sector which would reduce SEB losses.
Loan growth to remain healthy but lower than last 5-year average: Outstanding
sanctions of PFC/REC remain strong at Rs 1.7tn/1.6tn. This provides high visibility
on disbursals in the near term. Lower competition from banks (particularly those
with high exposure to the power sector) would also benefit the two power
financing NBFCs. However, we expect loan growth to slow from the historical
average (22%/26% over FY06-FY11 for PFC/REC) due to the higher base.
NIMs could come off from multi-year highs: NIMs of PFC/REC have improved
significantly from 3.74%/3.65% in FY08 to 4.1%/4.5% in 9MFY11 due to a
positive asset–liability mix (ALM) and a sharp decline in wholesale rates. Now,
with rising interest rates and asset re-pricing already in the base, we believe that
NIMs have peaked and could come off in the coming quarters. However, the rising
proportion of external commercial borrowings (ECB)—due to infrastructure
financing company (IFC) status—and positive ALM would provide some support.
Asset quality healthy but SEB losses a concern: Rising SEB losses due to a lack of
structural reform in the power distribution sector and concerns over coal
availability for power generation have increased the risk profile on the balance
sheets of NBFCs. Our power sector analyst believes that rising SEB losses are a
macro/fiscal risk and that probability of defaults are lower. However, we note
that power financing NBFCs are vulnerable to defaults as they have no buffer on
the balance sheet. An increasing proportion of private sector projects would also
raise the risk profile going forward, in our view.
Prefer select PSU banks over power financing NBFCs: Being specialised power
financiers, PFC and REC remain vulnerable to any shift in investment outlook and
profitability of the power sector. Both players have underperformed the BSE
Bankex in the last one year due to a weakening power sector outlook. We
believe that stock underperformance would continue and hence prefer PSU
banks which are trading at a discount despite better ROEs, diversified loan books
and healthy coverage ratios.
Investment rationale
Credit demand likely to remain healthy
India still a power-deficit country
We remain positive on credit demand from the power sector over the medium term as
India remains a power-deficit country and strong GDP growth is likely to exacerbate the
demand-supply imbalance. As per the Central Electricity Authority (CEA), India―s energy
deficit has increased to 84bn units in FY10 (10.1% of total energy demand) from 53bn
units in FY06 (8.4% of total energy demand), while peak deficit has risen marginally
from 12.3% of peak demand to 12.7% during the same period.
Robust investment required to address the deficit
In order to address the country―s rising power requirement and to upgrade transmission
and distribution (T&D) infrastructure, significant investments are required over the 11th
and 12th five year plans. As per the revised 11th plan, the total investment in the power
sector is likely to be at ~Rs 6.6tn (up from Rs 3.4tn in the 10th plan), of which ~43.7%
would be contributed by the private sector.
Our infrastructure sector research team estimates that total power sector capex in the
12th plan could be in the range of Rs 8.7tn, driven by capacity additions of ~100GW
(excludes addition of nuclear power due to a lack of clarity on the nuclear liability bill),
with commensurate investments in the T&D sector (calculated based on already
announced projects). However, our numbers could see some revision based on actual
execution or new projects announcements. Of this, the private sector could contribute
51% led by higher investments in the power generation and distribution segments.
Power financing NBFCs and large banks to be key beneficiaries
Large banks and infrastructure financing NBFCs (PFC, REC, IDFC) would be key
beneficiaries of the underlying demand in the power sector. We believe that large banks
such as State Bank of India, ICICI Bank and Punjab National Bank would have a
competitive edge in financing infrastructure projects due to their large and diversified
balance sheets and strong capital positions. We note that the government is increasingly
relying on mega investment projects and therefore exposure to a single project or
borrower group is likely to increase going forward. Banks have been aggressive in
lending to the infrastructure sector in general and to the power sector in particular. Total
bank credit to the power sector has increased at a 37% CAGR through FY05-FY10 (to
Rs 1.9tn) as against 22% for PFC (to Rs 799bn) and 25% for REC (to Rs 665bn).
But banks close to hitting their exposure limits
With tremendous growth in advances to the power industry over the last decade,
lending exposure of banks to the sector has increased from 3.5% in 2005 to 6.2% in
2010. For the infrastructure sector, this has increased from 7.2% to 12.5% during the
same period (36.9% CAGR in loan book). Some banks are approaching the lending limit
approved by respective boards for both these verticals. As a result, total exposure to the
power sector from scheduled commercial banks is likely to grow in line or only
marginally above industry going forward.
Loan growth to remain healthy but lower than last 5-year average
We believe that loan demand would remain strong for PFC and REC driven by robust
investments planned in the power sector. PFC and REC have outstanding sanction books
of Rs 1.7/Rs 1.6tn at the end of December ―10; this provides good visibility on the
disbursement front. Lower competition from banks could also benefit these NBFCs going
forward.
At the same time, we believe that loan growth would slow from the historical average
(22%/26% for PFC/REC over FY06-FY11E) due to the higher base effect. Delays in
obtaining environment clearances, constraints in fuel linkages, inability to acquire land
and poor SEB financial health could hamper investment in the power sector. Banks as
well as power financing NBFCs like PFC/REC have already turned more circumspect
while lending to power projects and are factoring in more conservative PLF estimates
while appraising any proposal. Accordingly, we factor in a 17.0/16.4% CAGR in
disbursements and 20/21.6% CAGR in loan book for PFC/REC over FY11-FY13.
Asset quality healthy but risks are increasing
Asset integrity key given concentrated exposure
We believe asset quality is the key metric for the performance of PFC and REC stocks,
given the concentrated exposure of both companies to a few utilities and relaxed
exposure norms. For private sector projects, these players have to comply with exposure
norms specified by the RBI for infrastructure financing NBFCs (IFCs). However, exposure
norms for SEBs are much more relaxed (both NBFCs could take exposure of more than
100% to any state utilities).
Banks and NBFCs may have to restructure advances
In the absence of concrete reforms in the distribution sector, we believe SEB losses
could become untenable, leading to a slowdown in investment. This, in turn, would hurt
the prospects of power financing NBFCs due to the single-product nature of their
business model. These NBFCs and banks may also be compelled to restructure their
exposure to ailing SEBs if state governments fail to support their respective boards.
We note that REC had earlier rescheduled a part of its loans; however, total rescheduled
loans have come down in recent years due to the escrow mechanism. If these NBFCs
were to sacrifice the interest or principal in the course of restructuring, their profitability
could be significantly eroded.
The government has recently appointed a committee to look into the difficulties faced
by SEB and to identify potential corrective steps. This committee includes the CMDs of
PFC and REC and representatives of SEBs, central electricity boards and the Planning
Commission. This apart, the government has started a ‘Revised Accelerated Power
Development and Reforms Programme― (R-APDRP) with the aim of reducing AT&C
losses to ~15% (from ~30%+ at present) by upgrading the IT and T&D network of SEBs.
While any meaningful reform in the distribution sector, resulting in a significant
reduction in SEB losses, would be positive for the power sector and for power financing
NBFCs, we note that these reforms are still in the planning/execution phase and their
potential outcome is as yet unclear.
Change in asset mix towards private utilities could raise risk profile
Going forward, incremental investment in the power sector will be skewed towards
private sector projects. According to our power sector research team, the private sector
is likely to add 67% of the total incremental capacity over FY11-FY15. As a result, the
share of private projects in total generation capacity is likely to increase from 18% in
FY10 to 36% in FY15. We believe this would increase the risk profile of PFC and REC as
these projects would not have implicit state government support.
NIMs already at peak levels
PFC and REC have reported significant improvement in interest spreads and NIMs in the
last two years due to the benign interest rate scenario and positive asset–liability
mismatch, which resulted in a higher yield on assets. Spreads/NIMs for PFC have
increased from 2.1%/3.75% in FY08 to 2.8%/4.1% in 9MFY11. For REC, these metrics
have improved from 3.6%/3.65% to 3.35%/4.5%over the same period.
However, with rising interest rates now putting pressure on incremental spreads and
benefits of asset re-pricing already in the base, we believe that NIMs have peaked out
and could come off in the coming quarters. At the same time, we note that PFC and REC
could raise lower-cost ECBs due to their infrastructure financing company (IFC) status
(RBI allows NBFC–IFCs to raise ECBs upto 50% of their total capital funds under the
automatic route). PFC/REC have already raised loans equivalent to US$ 260mn/470mn
in FY11. They are also eligible to issue tax-free infrastructure bonds where the coupon is
likely to be lower than industry. Issuances of ECBs and tax-free infrastructure bonds are
likely to mitigate some impact of rising rates in the near term. PFC―s NIMs would also be
supported by FPO float. We are currently factoring in a 7/40bps decline in NIMs for
PFC/REC over FY11-FY13.
ROEs similar to PSU banks despite lower credit costs
Operating expenses lower due to wholesale nature of the business
Being wholesale financiers, PFC and REC have very low operating expenses as they do
not require a large distribution network or employee base to run the business. As a
result, their cost-to-income ratios were at ~5-7% over FY06-FY10 while opex-to-asset
ratios are one of the lowest in the industry at 0.2%. We expect the latter ratio to remain
stable over FY11-FY13.
ROE similar to PSU banks despite negligible credit and operating costs
REC is likely to report an average ROE of 22% over FY11-FY13E whereas PFC―s would
be lower at 18% due to expected equity dilution and lower ROAs. While reported ROEs
are healthy, we note that return ratios for both players are supported by negligible credit
costs. PSU banks, on the other hand, have reported similar ROEs (averaging 21% over
FY11-FY13E) despite higher operating expenses and credit costs. Following recent RBI
guidelines of a minimum 70% loan loss provision coverage, NPA provisions of these
banks are healthy.
Any slippages from a large project could result in significant provisioning requirements
for PFC/REC due to the concentrated nature of their exposure. In this scenario, their
ROEs and operating profits could decline sharply. The RBI recently asked NBFCs to
provide standard asset provisions of ~25bps; however, this is currently not applicable to
PFC/REC as these are government-owned institutions.
Recent stock underperformance likely to continue
Uncertainty on distribution sector reform remains an overhang
PFC and REC have underperformed the BSE Bankex by 27%/26% in the last one year
due to concerns over asset quality (rising SEB losses) and NIMs (sharp rise in wholesale
funds). However, we note that these NBFCs are still trading at a premium to PSU banks
(comparative valuation in Fig 27) despite lower ROEs. Concentrated exposure to a few
utilities, the single-product nature of business and long gestation periods of financed
projects are also a risk in the long term, as PFC/REC remain vulnerable to any shift in
investment outlook and profitability of the power sector.
We believe these stocks would continue to underperform peers in the medium term due
to uncertainty on distribution sector reform, which could derail the recent strong
investment outlook for the power sector. We initiate coverage on PFC/REC with
HOLD/SELL ratings and target prices of Rs 265/Rs 230. Between the two, we prefer PFC
due to its lower exposure to the T&D segment that is more vulnerable to losses. PFC is
also likely to report stronger growth in the near term by dint of its leadership position in
the generation space.
Key risks
Reforms on the distribution side: Reforms on distribution, especially a hike in tariffs,
could lead to a sharp reduction in SEB losses and have a positive rub-off on power
financiers.
Lower-than-expected wholesale funding rates: Benign liquidity conditions could lead to
wholesale funding rates coming in lower than our expectations, which could lead to
higher spreads.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Power Financing NBFCs
Risk quotient increasing
We initiate coverage on power financing NBFCs (Power Finance Corporation,
PFC and Rural Electrification Corporation, REC) with a negative view. While we
remain positive on demand in the medium term as outstanding sanctions are
robust, we expect credit growth to moderate due to the higher base. Asset
quality is healthy for now, but the concentrated loan profile, absence of buffers
on the balance sheet, mounting losses of state electricity boards (SEB), and
concerns over coal availability/power project execution heighten the balance
sheet risk, in our view. Valuations remain at a premium to PSU banks despite
similar RoE profiles (high RoEs for power financiers largely aided by near zero
provisions). We believe valuations could de-rate from current levels given the
(a) rising risk profile of the power sector, leading to apprehensions on asset
quality and (b) single-product nature of power financing NBFCs.
We rate PFC/REC as HOLD/SELL with target prices of Rs 265/Rs 230. Between
the two, we prefer PFC as underlying growth would be stronger due to higher
exposure to the generation (versus the distribution) segment. A key risk to our
call is meaningful reforms in the power sector which would reduce SEB losses.
Loan growth to remain healthy but lower than last 5-year average: Outstanding
sanctions of PFC/REC remain strong at Rs 1.7tn/1.6tn. This provides high visibility
on disbursals in the near term. Lower competition from banks (particularly those
with high exposure to the power sector) would also benefit the two power
financing NBFCs. However, we expect loan growth to slow from the historical
average (22%/26% over FY06-FY11 for PFC/REC) due to the higher base.
NIMs could come off from multi-year highs: NIMs of PFC/REC have improved
significantly from 3.74%/3.65% in FY08 to 4.1%/4.5% in 9MFY11 due to a
positive asset–liability mix (ALM) and a sharp decline in wholesale rates. Now,
with rising interest rates and asset re-pricing already in the base, we believe that
NIMs have peaked and could come off in the coming quarters. However, the rising
proportion of external commercial borrowings (ECB)—due to infrastructure
financing company (IFC) status—and positive ALM would provide some support.
Asset quality healthy but SEB losses a concern: Rising SEB losses due to a lack of
structural reform in the power distribution sector and concerns over coal
availability for power generation have increased the risk profile on the balance
sheets of NBFCs. Our power sector analyst believes that rising SEB losses are a
macro/fiscal risk and that probability of defaults are lower. However, we note
that power financing NBFCs are vulnerable to defaults as they have no buffer on
the balance sheet. An increasing proportion of private sector projects would also
raise the risk profile going forward, in our view.
Prefer select PSU banks over power financing NBFCs: Being specialised power
financiers, PFC and REC remain vulnerable to any shift in investment outlook and
profitability of the power sector. Both players have underperformed the BSE
Bankex in the last one year due to a weakening power sector outlook. We
believe that stock underperformance would continue and hence prefer PSU
banks which are trading at a discount despite better ROEs, diversified loan books
and healthy coverage ratios.
Investment rationale
Credit demand likely to remain healthy
India still a power-deficit country
We remain positive on credit demand from the power sector over the medium term as
India remains a power-deficit country and strong GDP growth is likely to exacerbate the
demand-supply imbalance. As per the Central Electricity Authority (CEA), India―s energy
deficit has increased to 84bn units in FY10 (10.1% of total energy demand) from 53bn
units in FY06 (8.4% of total energy demand), while peak deficit has risen marginally
from 12.3% of peak demand to 12.7% during the same period.
Robust investment required to address the deficit
In order to address the country―s rising power requirement and to upgrade transmission
and distribution (T&D) infrastructure, significant investments are required over the 11th
and 12th five year plans. As per the revised 11th plan, the total investment in the power
sector is likely to be at ~Rs 6.6tn (up from Rs 3.4tn in the 10th plan), of which ~43.7%
would be contributed by the private sector.
Our infrastructure sector research team estimates that total power sector capex in the
12th plan could be in the range of Rs 8.7tn, driven by capacity additions of ~100GW
(excludes addition of nuclear power due to a lack of clarity on the nuclear liability bill),
with commensurate investments in the T&D sector (calculated based on already
announced projects). However, our numbers could see some revision based on actual
execution or new projects announcements. Of this, the private sector could contribute
51% led by higher investments in the power generation and distribution segments.
Power financing NBFCs and large banks to be key beneficiaries
Large banks and infrastructure financing NBFCs (PFC, REC, IDFC) would be key
beneficiaries of the underlying demand in the power sector. We believe that large banks
such as State Bank of India, ICICI Bank and Punjab National Bank would have a
competitive edge in financing infrastructure projects due to their large and diversified
balance sheets and strong capital positions. We note that the government is increasingly
relying on mega investment projects and therefore exposure to a single project or
borrower group is likely to increase going forward. Banks have been aggressive in
lending to the infrastructure sector in general and to the power sector in particular. Total
bank credit to the power sector has increased at a 37% CAGR through FY05-FY10 (to
Rs 1.9tn) as against 22% for PFC (to Rs 799bn) and 25% for REC (to Rs 665bn).
But banks close to hitting their exposure limits
With tremendous growth in advances to the power industry over the last decade,
lending exposure of banks to the sector has increased from 3.5% in 2005 to 6.2% in
2010. For the infrastructure sector, this has increased from 7.2% to 12.5% during the
same period (36.9% CAGR in loan book). Some banks are approaching the lending limit
approved by respective boards for both these verticals. As a result, total exposure to the
power sector from scheduled commercial banks is likely to grow in line or only
marginally above industry going forward.
Loan growth to remain healthy but lower than last 5-year average
We believe that loan demand would remain strong for PFC and REC driven by robust
investments planned in the power sector. PFC and REC have outstanding sanction books
of Rs 1.7/Rs 1.6tn at the end of December ―10; this provides good visibility on the
disbursement front. Lower competition from banks could also benefit these NBFCs going
forward.
At the same time, we believe that loan growth would slow from the historical average
(22%/26% for PFC/REC over FY06-FY11E) due to the higher base effect. Delays in
obtaining environment clearances, constraints in fuel linkages, inability to acquire land
and poor SEB financial health could hamper investment in the power sector. Banks as
well as power financing NBFCs like PFC/REC have already turned more circumspect
while lending to power projects and are factoring in more conservative PLF estimates
while appraising any proposal. Accordingly, we factor in a 17.0/16.4% CAGR in
disbursements and 20/21.6% CAGR in loan book for PFC/REC over FY11-FY13.
Asset quality healthy but risks are increasing
Asset integrity key given concentrated exposure
We believe asset quality is the key metric for the performance of PFC and REC stocks,
given the concentrated exposure of both companies to a few utilities and relaxed
exposure norms. For private sector projects, these players have to comply with exposure
norms specified by the RBI for infrastructure financing NBFCs (IFCs). However, exposure
norms for SEBs are much more relaxed (both NBFCs could take exposure of more than
100% to any state utilities).
Banks and NBFCs may have to restructure advances
In the absence of concrete reforms in the distribution sector, we believe SEB losses
could become untenable, leading to a slowdown in investment. This, in turn, would hurt
the prospects of power financing NBFCs due to the single-product nature of their
business model. These NBFCs and banks may also be compelled to restructure their
exposure to ailing SEBs if state governments fail to support their respective boards.
We note that REC had earlier rescheduled a part of its loans; however, total rescheduled
loans have come down in recent years due to the escrow mechanism. If these NBFCs
were to sacrifice the interest or principal in the course of restructuring, their profitability
could be significantly eroded.
The government has recently appointed a committee to look into the difficulties faced
by SEB and to identify potential corrective steps. This committee includes the CMDs of
PFC and REC and representatives of SEBs, central electricity boards and the Planning
Commission. This apart, the government has started a ‘Revised Accelerated Power
Development and Reforms Programme― (R-APDRP) with the aim of reducing AT&C
losses to ~15% (from ~30%+ at present) by upgrading the IT and T&D network of SEBs.
While any meaningful reform in the distribution sector, resulting in a significant
reduction in SEB losses, would be positive for the power sector and for power financing
NBFCs, we note that these reforms are still in the planning/execution phase and their
potential outcome is as yet unclear.
Change in asset mix towards private utilities could raise risk profile
Going forward, incremental investment in the power sector will be skewed towards
private sector projects. According to our power sector research team, the private sector
is likely to add 67% of the total incremental capacity over FY11-FY15. As a result, the
share of private projects in total generation capacity is likely to increase from 18% in
FY10 to 36% in FY15. We believe this would increase the risk profile of PFC and REC as
these projects would not have implicit state government support.
NIMs already at peak levels
PFC and REC have reported significant improvement in interest spreads and NIMs in the
last two years due to the benign interest rate scenario and positive asset–liability
mismatch, which resulted in a higher yield on assets. Spreads/NIMs for PFC have
increased from 2.1%/3.75% in FY08 to 2.8%/4.1% in 9MFY11. For REC, these metrics
have improved from 3.6%/3.65% to 3.35%/4.5%over the same period.
However, with rising interest rates now putting pressure on incremental spreads and
benefits of asset re-pricing already in the base, we believe that NIMs have peaked out
and could come off in the coming quarters. At the same time, we note that PFC and REC
could raise lower-cost ECBs due to their infrastructure financing company (IFC) status
(RBI allows NBFC–IFCs to raise ECBs upto 50% of their total capital funds under the
automatic route). PFC/REC have already raised loans equivalent to US$ 260mn/470mn
in FY11. They are also eligible to issue tax-free infrastructure bonds where the coupon is
likely to be lower than industry. Issuances of ECBs and tax-free infrastructure bonds are
likely to mitigate some impact of rising rates in the near term. PFC―s NIMs would also be
supported by FPO float. We are currently factoring in a 7/40bps decline in NIMs for
PFC/REC over FY11-FY13.
ROEs similar to PSU banks despite lower credit costs
Operating expenses lower due to wholesale nature of the business
Being wholesale financiers, PFC and REC have very low operating expenses as they do
not require a large distribution network or employee base to run the business. As a
result, their cost-to-income ratios were at ~5-7% over FY06-FY10 while opex-to-asset
ratios are one of the lowest in the industry at 0.2%. We expect the latter ratio to remain
stable over FY11-FY13.
ROE similar to PSU banks despite negligible credit and operating costs
REC is likely to report an average ROE of 22% over FY11-FY13E whereas PFC―s would
be lower at 18% due to expected equity dilution and lower ROAs. While reported ROEs
are healthy, we note that return ratios for both players are supported by negligible credit
costs. PSU banks, on the other hand, have reported similar ROEs (averaging 21% over
FY11-FY13E) despite higher operating expenses and credit costs. Following recent RBI
guidelines of a minimum 70% loan loss provision coverage, NPA provisions of these
banks are healthy.
Any slippages from a large project could result in significant provisioning requirements
for PFC/REC due to the concentrated nature of their exposure. In this scenario, their
ROEs and operating profits could decline sharply. The RBI recently asked NBFCs to
provide standard asset provisions of ~25bps; however, this is currently not applicable to
PFC/REC as these are government-owned institutions.
Recent stock underperformance likely to continue
Uncertainty on distribution sector reform remains an overhang
PFC and REC have underperformed the BSE Bankex by 27%/26% in the last one year
due to concerns over asset quality (rising SEB losses) and NIMs (sharp rise in wholesale
funds). However, we note that these NBFCs are still trading at a premium to PSU banks
(comparative valuation in Fig 27) despite lower ROEs. Concentrated exposure to a few
utilities, the single-product nature of business and long gestation periods of financed
projects are also a risk in the long term, as PFC/REC remain vulnerable to any shift in
investment outlook and profitability of the power sector.
We believe these stocks would continue to underperform peers in the medium term due
to uncertainty on distribution sector reform, which could derail the recent strong
investment outlook for the power sector. We initiate coverage on PFC/REC with
HOLD/SELL ratings and target prices of Rs 265/Rs 230. Between the two, we prefer PFC
due to its lower exposure to the T&D segment that is more vulnerable to losses. PFC is
also likely to report stronger growth in the near term by dint of its leadership position in
the generation space.
Key risks
Reforms on the distribution side: Reforms on distribution, especially a hike in tariffs,
could lead to a sharp reduction in SEB losses and have a positive rub-off on power
financiers.
Lower-than-expected wholesale funding rates: Benign liquidity conditions could lead to
wholesale funding rates coming in lower than our expectations, which could lead to
higher spreads.
No comments:
Post a Comment