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Emerging from the woods
Huge lending opportunity to drive growth despite headwinds
PFC is well placed to leverage the strong demand for financing in the power sector, with
its leadership position and strong domain knowledge. Well matched asset-liability profile
has been cushioning PFC against interest rate r isks; however, r ising compet i t ion and
bulk borrowing rates are likely to impact spreads. We model PAT CAGR of 18% over FY11-
13, supported by lean cost structure and minimal credit cost. Heightened concerns over
SEB losses and expected slowdown in loan growth (due to environment clearance issues)
h a v e l e d t o a s h a r p 4 5% c o r r e c t i o n i n s t o c k p r i c e f r om t h e p e a k . We b e l i e v e c u r r e n t
valuations are attractive at 1.2x FY13E BV. We initiate coverage with a Buy recommendation
and a target price of Rs290 (1.6x FY13E BV), 37% upside.
Incremental lending opportunity of Rs8t+ over FY12-17: Recognizing its
importance in the country's overall economic growth, the government has made
high allocations towards the power sector in its 11th and 12th five-year plans.
Under the 12th plan alone, power sector fund requirement will be Rs11t — Rs5t for
gencos (~100GW to be added), Rs2.4t for transmission, and Rs3.7t for distribution.
In FY12 (last year of 11th plan), ~20GW is likely to be added, leading to fund
requirement of Rs1t. Thus, total fund requirement over FY12-17 is Rs12t. Assuming
debt equity of 70:30, this translates into a massive opportunity of Rs8t+ for lending
agencies. We expect PFC to clock 20% CAGR in loan disbursals over FY11-13
and consequently 23% CAGR in its loan book to Rs1.5t by FY13.
Niche power financiers are better placed to capitalize on this opportunity:
Total bank credit to the power sector has grown at a CAGR of 38% over FY05-
FY11 to Rs2.7t as against 22% for PFC (to Rs1t) and 24% for REC (to Rs800b).
However, with some banks approaching the lending limit approved by their respective
boards for the infrastructure segment, growth in bank loans to this segment would
be in line or marginally above industry average. For niche NBFCs, grant of IFC
status (enabling higher exposure to a single/group of borrowers) and better assetliability profile will provide an edge.
PFC's higher exposure to generation segment a big positive: Though SEBs
account for 65% of PFC's loan book, 85% of its loans are towards the generation
segment. This is a big positive, as unlike the state distribution companies
(Discoms), the state generation companies (Gencos) are largely cash positive.
Initiating coverage with a Buy rating and target price of Rs290: PFC is a
long-term bet on India's expanding power sector investments. It offers a good
combination of strong growth and value. Planned capital raising of ~Rs35b (overall
capital raising of ~Rs47b; government stake sale of ~Rs11.6b) would support
faster loan growth and provide the ability to take higher exposure to single/group
borrowers. We model PAT CAGR of 18% over FY11-13 and expect the return
ratios to remain strong, with RoA of ~2.7% and RoE of 16-17% (post dilution) for
FY12-13. PFC trades at attractive valuations of 1.3x FY12E and 1.2x FY13E BV
(post capital). We initiate coverage with a Buy rating and target price of Rs290
(1.6x FY13E BV), 37% upside.
Incremental lending opportunity of Rs8t+ over FY12-17
India’s power sector requires huge investments
India is plagued with a large energy deficit. According to CEA, the total energy deficit was 8%
and peak power deficit was 10% in March 2011. The shortages in energy and peak power have
b e e n p r i m a r i l y d u e t o s l u g g i s h c a p a c i t y a d d i t i o n a n d i n a d e q u a t e d i s t r i b u t i o n n e t w o r k .
Recognizing i ts impor tance in the count ry’s overal l economic growth, the government has
made high allocations towards the power sector in its 11th and 12th five-year plans. Under the
12th plan alone, power sector fund requirement will be Rs11t - Rs4.95t for Gencos (~100GW to
be added), Rs2.4t for transmission, and Rs3.7t for distribution. In FY12 (last year of 11th plan),
~20GW is likely to be added, leading to fund requirement of Rs1t. Thus, total fund requirement
is likely to be Rs12t over FY12-17. Assuming debt-to-equity ratio of 70:30, it translates into a
massive opportunity of Rs8t+ for lending agencies. Niche power financiers like PFC and REC
are better placed to capitalize on this opportunity.
Aggressive thrust on power sector in 11th and 12th plans…
India has historically been beset by energy shortages, which have been rising over the
years. The demand for electricity has consistently exceeded supply, and the demandsupply gap has been widening. In FY10, peak energy deficit was 12.7% and total energy
deficit was 10.1%. According to CEA, the total energy deficit was 8% and peak power
deficit was 10% in March 2011.
Per capita electricity consumption in India is 566 units as compared to the global average
of 2,780 units (World Energy Outlook 2008, IEA). The relatively low per capita consumption
of electricity in India presents significant potential for sustainable growth in the demand
for electrical power in India. The World Energy Outlook 2008, IEA points out that India’s
energy requirement over the next 25-30 years is likely to grow at 3.5% CAGR, reflecting
the huge potential for investments in the energy sector in India.
Specialized NBFCs better placed to seize the opportunity
Banks restricted by exposure limits, asset-liability profile
Large banks and NBFCs specializing in infrastructure finance (PFC, REC, IDFC) have been the
key beneficiaries of the strong underlying demand for funds in the power sector. 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 grown at a CAGR of 38% over FY05-FY11 to
Rs2.7t as against 22% for PFC (to Rs1t) and 24% for REC (to Rs800b). However, with some banks
a p p r o a c h i n g t h e l e n d i n g l imi t a p p r o v e d b y t h e i r r e s p e c t i v e b o a r d s f o r t h e i n f r a s t r u c t u r e
segment, growth in bank loans to this segment would be in line or marginally above industry
average. For niche NBFCs, grant of IFC status (enabling higher exposure to a single/group of
borrowers) and better asset-liability profile will provide an edge.
Banks close to hitting their exposure limits
Over the last five years, infrastructure lending has been the fastest growing segment for
the banking sector (CAGR of 37% over FY05-11). With higher share of investment outlay
for power, bank credit to the power segment grew at a CAGR of 38% over the same
period.
As a result of the strong growth in bank loans to the infrastructure sector (and within it,
the power segment), the exposure of a number of banks to this sector is nearing the
internal limits set by their respective boards. We understand that boards usually restrict
total exposure to a particular sector at 15-20% of the total loan book. The exposure of the
banking system to infrastructure loans has increased from 6.9% in FY05 to 13.4% in
FY11 (power sector exposure has increased from 3.3% to 6.8% over the same period).
Hence, banks are likely to curtail loans to the infrastructure (and power) sector.
Well-matched asset-liability profile
Banks have limitations in lending to power projects due to the asset-liability mismatch
long-term lending creates. Power generation projects have long gestation periods, which
may extend to over 15 years. However, banks have an average liability tenor of 12-24
months. Thus, lending for power projects can create a huge asset-liability mismatch for
them. Specialized NBFCs borrow through long-term liabilities to match the exposure,
leading to lower asset-liability gap. For PFC, the average duration of assets is 6.4 years
while the average duration of liabilities is 5.2 years.
Niche players to gain market share; grant of IFC status an added advantage
With banks restricted by exposure limits, asset-liability profile, etc, niche NBFCs (PFC,
REC and IDFC) are likely to gain market share in infrastructure lending. Grant of IFC
status has further boost their growth trajectory. We believe that loan demand would remain
strong for PFC and REC, driven by robust investments planned in the power sector. PFC
had an outstanding sanctions book of Rs1.7t as at the end of March 2011 and REC had an
outstanding sanctions book of Rs1.3t as at the end of December 2010. This provides good
visibility on the disbursement front. Lower competition from banks could also benefit
them. We have estimated loan CAGR of 23% and 21% for PFC and REC respectively
over FY11-13.
In February 2010, RBI created a new classification – infrastructure financing company
(IFC) – to address key hurdles such as exposure norms and access to low-cost funding
faced by NBFCs specializing in infrastructure finance. IFCs enjoy relaxed exposure caps
and access to retail deposits and ECBs, enabling them to reduce their cost of borrowings
and also diversify their funding mix.
Benefits of being classified as IFC
Relaxed exposure norms (25% and 40% of owned funds to single and single group of
borrowers, respectively, compared to 15% and 25%, earlier)
Increased limit for banks to lend 20% to an IFC as against 15% of capital funds to a
single borrower
Risk weights on loans granted to IFC linked to their credit rating
Easier access to ECBs – IFCs allowed to raise up to 50% of their net worth under
automatic route
Allowed to issue tax-free bonds (long tenure bonds at attractive cost) but restricted to
25% of the incremental infrastructure investments made by the issuer during the
financial year
Other companies that have been awarded IFC status include IDFC, REC, L&T Infrastructure
Finance, PTC Finance, IFCI and Infrastructure Leasing and Financial Services
PFC's higher exposure to generation segment a big positive
Asset quality a key issue facing power finance companies
Sustenance of asset qual i ty is the key met r ic to gauge the per formance of power f inance
companies like PFC and REC, given their concentrated exposure to central and state utilities,
relaxed exposure norms, and no compulsion to create standard asset provisions. Though
SEBs account for 65% of PFC's loan book, 85% of its loans are towards the generation segment.
T h i s i s a b i g p o s i t i v e , a s u n l i k e t h e s t a t e d i s t r i b u t i o n c o m p a n i e s ( D i s c o m s ) , t h e s t a t e
g e n e r a t i o n c ompa n i e s (Ge n c o s ) a r e l a r g e l y c a s h p o s i t i v e . Howe v e r, h e a dwi n d s l i k e f u e l
avai labi l i ty, envi ronmental clearance, drop in shor t term rates, etc could al ter operat ional
parameters there by impact ing prof i tabi l i ty of power projects.
PFC's strong evaluation skills leading to healthy asset quality
Power projects take several years to implement. Given their long-term nature, they are
exposed to a higher degree of execution risk as well as regulatory and macroeconomic
risks. Such projects are also highly leveraged at ~3x, and to that extent, lending to them is
more risky. Further, with high concentration of loans, a single default can lead to a sharp
rise in NPAs. However, PFC's strong execution track record, decades of experience and
specialized knowledge of power financing provides comfort. Impeccable asset quality
with GNPA and NNPA at less than 1% demonstrates strong evaluation skills of PFC.
Government focusing on reform measures
Schemes such as Accelerated Power Development and Reform Program (APDRP) and
National Electricity Fund (NEF), which offer grants/subsidies for improving the financial
health of SEBs and reducing distribution losses, are steps in the right direction.
The Prime Minister’s Office (PMO) has appointed a high level committee headed by Mr
VK Shunglu to review the financials of SEBs, particularly in relation to the losses incurred
and projected distribution losses over the period April 2010 to March 2017. The committee
is likely to give its recommendations/suggestions on:
Required electricity tariffs, including the role of state governments, state tariff regulator
and SEBs / SDCs in periodic tariff revisions, after having examined the geographical
and spatial compulsions and determining their operational impact.
Organizational and managerial structure, manpower employed and future requirements
to achieve financial viability in distribution of power by 2017.
Long-term measures for sustainable health of SEBs key for earnings/
valuations
While in the near term, developments are positive for SEBs, long-term sustainable solutions
remain a key for the sector. Until concrete reforms to improve the health of SEBs are
implemented, the risk of bad debts/payment defaults would continue to reflect in the
earnings/valuations of power finance companies.
In our estimates, we have not built any default on loans for PFC (and REC), as state
government guarantees, escrow mechanism, etc provide a strong protection against
defaults. However, weak financial health of SEBs could trigger restructuring of loans or
may require states to pay additional subsidies. Further, lower power purchases by SEBs
could impact the profitability of power generators.
Initiating coverage with Buy and target price of Rs290
Healthy return ratios, valuations attractive
Capital raising to support faster loan growth: PFC is well placed to leverage the
strong demand for financing in the power sector, with its leadership position and strong
domain knowledge. Planned capital raising of ~Rs35b (overall capital raising of ~Rs47b;
government stake sale of ~Rs11.6b) would support faster loan growth and provide the
ability to take higher exposure to single/group borrowers.
23% CAGR in loan book: We expect PFC to clock a 20% CAGR in loan disbursals
over FY11-FY13 and consequently a 23% CAGR in its loan book to Rs1.5t by FY13. Well
matched asset-liability profile has been cushioning PFC against interest rate risks; however,
rising competition and bulk borrowing rates are likely to impact spreads.
18% PAT CAGR; RoE of 16-17%: We model PAT CAGR of 18% over FY11-13,
supported by lean cost structure and minimal credit cost. We expect the return ratios to
remain strong, with RoA of ~2.7% and RoE of 16-17% (post dilution) for FY12-13.
45% stock price correction from peak; Buy for 37% upside: Heightened concerns
over SEB losses and expected slowdown in loan growth (due to environment clearance
issues) have led to a sharp 45% correction in stock price from the peak. We believe
current valuations are attractive at 1.2x FY13E BV. We initiate coverage with a Buy
recommendation and a target price of Rs290 (1.6x FY13E BV), 37% upside
Key risks to our call
Delays in power project execution: India’s track record of executing power projects
has been dismal. If this persists, PFC’s loan sanctions will not translate into
disbursements, adversely impacting growth in loan book and earnings.
Drop in power rates to impact private players: SEBs have become reluctant in
purchasing high cost short term power, this is in turn could impact the profitability of
the power projects. PFC targets to increase the proportion of private sector loans to
35% by FY17.
Poor track record of state utilities and no standard provisions by PFC: PFC
has high exposure to state utilities, which have a poor financial track record. While
efforts are being made to improve SEB financials, we believe it would take time for
the benefits to show up.
Concentration risk and no buffer to absorb defaults: PFC has concentrated
exposure towards central and state utilities. The RBI recently asked NBFCs to provide
standard asset provisions of ~25bp; however, this was not applicable to PFC/REC, as
these are government-owned institutions. This exemption has kept profitability high.
However, we believe that no buffer to absorb defaults would increase volatility in
earnings in case of deterioration in asset quality
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Emerging from the woods
Huge lending opportunity to drive growth despite headwinds
PFC is well placed to leverage the strong demand for financing in the power sector, with
its leadership position and strong domain knowledge. Well matched asset-liability profile
has been cushioning PFC against interest rate r isks; however, r ising compet i t ion and
bulk borrowing rates are likely to impact spreads. We model PAT CAGR of 18% over FY11-
13, supported by lean cost structure and minimal credit cost. Heightened concerns over
SEB losses and expected slowdown in loan growth (due to environment clearance issues)
h a v e l e d t o a s h a r p 4 5% c o r r e c t i o n i n s t o c k p r i c e f r om t h e p e a k . We b e l i e v e c u r r e n t
valuations are attractive at 1.2x FY13E BV. We initiate coverage with a Buy recommendation
and a target price of Rs290 (1.6x FY13E BV), 37% upside.
Incremental lending opportunity of Rs8t+ over FY12-17: Recognizing its
importance in the country's overall economic growth, the government has made
high allocations towards the power sector in its 11th and 12th five-year plans.
Under the 12th plan alone, power sector fund requirement will be Rs11t — Rs5t for
gencos (~100GW to be added), Rs2.4t for transmission, and Rs3.7t for distribution.
In FY12 (last year of 11th plan), ~20GW is likely to be added, leading to fund
requirement of Rs1t. Thus, total fund requirement over FY12-17 is Rs12t. Assuming
debt equity of 70:30, this translates into a massive opportunity of Rs8t+ for lending
agencies. We expect PFC to clock 20% CAGR in loan disbursals over FY11-13
and consequently 23% CAGR in its loan book to Rs1.5t by FY13.
Niche power financiers are better placed to capitalize on this opportunity:
Total bank credit to the power sector has grown at a CAGR of 38% over FY05-
FY11 to Rs2.7t as against 22% for PFC (to Rs1t) and 24% for REC (to Rs800b).
However, with some banks approaching the lending limit approved by their respective
boards for the infrastructure segment, growth in bank loans to this segment would
be in line or marginally above industry average. For niche NBFCs, grant of IFC
status (enabling higher exposure to a single/group of borrowers) and better assetliability profile will provide an edge.
PFC's higher exposure to generation segment a big positive: Though SEBs
account for 65% of PFC's loan book, 85% of its loans are towards the generation
segment. This is a big positive, as unlike the state distribution companies
(Discoms), the state generation companies (Gencos) are largely cash positive.
Initiating coverage with a Buy rating and target price of Rs290: PFC is a
long-term bet on India's expanding power sector investments. It offers a good
combination of strong growth and value. Planned capital raising of ~Rs35b (overall
capital raising of ~Rs47b; government stake sale of ~Rs11.6b) would support
faster loan growth and provide the ability to take higher exposure to single/group
borrowers. We model PAT CAGR of 18% over FY11-13 and expect the return
ratios to remain strong, with RoA of ~2.7% and RoE of 16-17% (post dilution) for
FY12-13. PFC trades at attractive valuations of 1.3x FY12E and 1.2x FY13E BV
(post capital). We initiate coverage with a Buy rating and target price of Rs290
(1.6x FY13E BV), 37% upside.
Incremental lending opportunity of Rs8t+ over FY12-17
India’s power sector requires huge investments
India is plagued with a large energy deficit. According to CEA, the total energy deficit was 8%
and peak power deficit was 10% in March 2011. The shortages in energy and peak power have
b e e n p r i m a r i l y d u e t o s l u g g i s h c a p a c i t y a d d i t i o n a n d i n a d e q u a t e d i s t r i b u t i o n n e t w o r k .
Recognizing i ts impor tance in the count ry’s overal l economic growth, the government has
made high allocations towards the power sector in its 11th and 12th five-year plans. Under the
12th plan alone, power sector fund requirement will be Rs11t - Rs4.95t for Gencos (~100GW to
be added), Rs2.4t for transmission, and Rs3.7t for distribution. In FY12 (last year of 11th plan),
~20GW is likely to be added, leading to fund requirement of Rs1t. Thus, total fund requirement
is likely to be Rs12t over FY12-17. Assuming debt-to-equity ratio of 70:30, it translates into a
massive opportunity of Rs8t+ for lending agencies. Niche power financiers like PFC and REC
are better placed to capitalize on this opportunity.
Aggressive thrust on power sector in 11th and 12th plans…
India has historically been beset by energy shortages, which have been rising over the
years. The demand for electricity has consistently exceeded supply, and the demandsupply gap has been widening. In FY10, peak energy deficit was 12.7% and total energy
deficit was 10.1%. According to CEA, the total energy deficit was 8% and peak power
deficit was 10% in March 2011.
Per capita electricity consumption in India is 566 units as compared to the global average
of 2,780 units (World Energy Outlook 2008, IEA). The relatively low per capita consumption
of electricity in India presents significant potential for sustainable growth in the demand
for electrical power in India. The World Energy Outlook 2008, IEA points out that India’s
energy requirement over the next 25-30 years is likely to grow at 3.5% CAGR, reflecting
the huge potential for investments in the energy sector in India.
Specialized NBFCs better placed to seize the opportunity
Banks restricted by exposure limits, asset-liability profile
Large banks and NBFCs specializing in infrastructure finance (PFC, REC, IDFC) have been the
key beneficiaries of the strong underlying demand for funds in the power sector. 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 grown at a CAGR of 38% over FY05-FY11 to
Rs2.7t as against 22% for PFC (to Rs1t) and 24% for REC (to Rs800b). However, with some banks
a p p r o a c h i n g t h e l e n d i n g l imi t a p p r o v e d b y t h e i r r e s p e c t i v e b o a r d s f o r t h e i n f r a s t r u c t u r e
segment, growth in bank loans to this segment would be in line or marginally above industry
average. For niche NBFCs, grant of IFC status (enabling higher exposure to a single/group of
borrowers) and better asset-liability profile will provide an edge.
Banks close to hitting their exposure limits
Over the last five years, infrastructure lending has been the fastest growing segment for
the banking sector (CAGR of 37% over FY05-11). With higher share of investment outlay
for power, bank credit to the power segment grew at a CAGR of 38% over the same
period.
As a result of the strong growth in bank loans to the infrastructure sector (and within it,
the power segment), the exposure of a number of banks to this sector is nearing the
internal limits set by their respective boards. We understand that boards usually restrict
total exposure to a particular sector at 15-20% of the total loan book. The exposure of the
banking system to infrastructure loans has increased from 6.9% in FY05 to 13.4% in
FY11 (power sector exposure has increased from 3.3% to 6.8% over the same period).
Hence, banks are likely to curtail loans to the infrastructure (and power) sector.
Well-matched asset-liability profile
Banks have limitations in lending to power projects due to the asset-liability mismatch
long-term lending creates. Power generation projects have long gestation periods, which
may extend to over 15 years. However, banks have an average liability tenor of 12-24
months. Thus, lending for power projects can create a huge asset-liability mismatch for
them. Specialized NBFCs borrow through long-term liabilities to match the exposure,
leading to lower asset-liability gap. For PFC, the average duration of assets is 6.4 years
while the average duration of liabilities is 5.2 years.
Niche players to gain market share; grant of IFC status an added advantage
With banks restricted by exposure limits, asset-liability profile, etc, niche NBFCs (PFC,
REC and IDFC) are likely to gain market share in infrastructure lending. Grant of IFC
status has further boost their growth trajectory. We believe that loan demand would remain
strong for PFC and REC, driven by robust investments planned in the power sector. PFC
had an outstanding sanctions book of Rs1.7t as at the end of March 2011 and REC had an
outstanding sanctions book of Rs1.3t as at the end of December 2010. This provides good
visibility on the disbursement front. Lower competition from banks could also benefit
them. We have estimated loan CAGR of 23% and 21% for PFC and REC respectively
over FY11-13.
In February 2010, RBI created a new classification – infrastructure financing company
(IFC) – to address key hurdles such as exposure norms and access to low-cost funding
faced by NBFCs specializing in infrastructure finance. IFCs enjoy relaxed exposure caps
and access to retail deposits and ECBs, enabling them to reduce their cost of borrowings
and also diversify their funding mix.
Benefits of being classified as IFC
Relaxed exposure norms (25% and 40% of owned funds to single and single group of
borrowers, respectively, compared to 15% and 25%, earlier)
Increased limit for banks to lend 20% to an IFC as against 15% of capital funds to a
single borrower
Risk weights on loans granted to IFC linked to their credit rating
Easier access to ECBs – IFCs allowed to raise up to 50% of their net worth under
automatic route
Allowed to issue tax-free bonds (long tenure bonds at attractive cost) but restricted to
25% of the incremental infrastructure investments made by the issuer during the
financial year
Other companies that have been awarded IFC status include IDFC, REC, L&T Infrastructure
Finance, PTC Finance, IFCI and Infrastructure Leasing and Financial Services
PFC's higher exposure to generation segment a big positive
Asset quality a key issue facing power finance companies
Sustenance of asset qual i ty is the key met r ic to gauge the per formance of power f inance
companies like PFC and REC, given their concentrated exposure to central and state utilities,
relaxed exposure norms, and no compulsion to create standard asset provisions. Though
SEBs account for 65% of PFC's loan book, 85% of its loans are towards the generation segment.
T h i s i s a b i g p o s i t i v e , a s u n l i k e t h e s t a t e d i s t r i b u t i o n c o m p a n i e s ( D i s c o m s ) , t h e s t a t e
g e n e r a t i o n c ompa n i e s (Ge n c o s ) a r e l a r g e l y c a s h p o s i t i v e . Howe v e r, h e a dwi n d s l i k e f u e l
avai labi l i ty, envi ronmental clearance, drop in shor t term rates, etc could al ter operat ional
parameters there by impact ing prof i tabi l i ty of power projects.
PFC's strong evaluation skills leading to healthy asset quality
Power projects take several years to implement. Given their long-term nature, they are
exposed to a higher degree of execution risk as well as regulatory and macroeconomic
risks. Such projects are also highly leveraged at ~3x, and to that extent, lending to them is
more risky. Further, with high concentration of loans, a single default can lead to a sharp
rise in NPAs. However, PFC's strong execution track record, decades of experience and
specialized knowledge of power financing provides comfort. Impeccable asset quality
with GNPA and NNPA at less than 1% demonstrates strong evaluation skills of PFC.
Government focusing on reform measures
Schemes such as Accelerated Power Development and Reform Program (APDRP) and
National Electricity Fund (NEF), which offer grants/subsidies for improving the financial
health of SEBs and reducing distribution losses, are steps in the right direction.
The Prime Minister’s Office (PMO) has appointed a high level committee headed by Mr
VK Shunglu to review the financials of SEBs, particularly in relation to the losses incurred
and projected distribution losses over the period April 2010 to March 2017. The committee
is likely to give its recommendations/suggestions on:
Required electricity tariffs, including the role of state governments, state tariff regulator
and SEBs / SDCs in periodic tariff revisions, after having examined the geographical
and spatial compulsions and determining their operational impact.
Organizational and managerial structure, manpower employed and future requirements
to achieve financial viability in distribution of power by 2017.
Long-term measures for sustainable health of SEBs key for earnings/
valuations
While in the near term, developments are positive for SEBs, long-term sustainable solutions
remain a key for the sector. Until concrete reforms to improve the health of SEBs are
implemented, the risk of bad debts/payment defaults would continue to reflect in the
earnings/valuations of power finance companies.
In our estimates, we have not built any default on loans for PFC (and REC), as state
government guarantees, escrow mechanism, etc provide a strong protection against
defaults. However, weak financial health of SEBs could trigger restructuring of loans or
may require states to pay additional subsidies. Further, lower power purchases by SEBs
could impact the profitability of power generators.
Initiating coverage with Buy and target price of Rs290
Healthy return ratios, valuations attractive
Capital raising to support faster loan growth: PFC is well placed to leverage the
strong demand for financing in the power sector, with its leadership position and strong
domain knowledge. Planned capital raising of ~Rs35b (overall capital raising of ~Rs47b;
government stake sale of ~Rs11.6b) would support faster loan growth and provide the
ability to take higher exposure to single/group borrowers.
23% CAGR in loan book: We expect PFC to clock a 20% CAGR in loan disbursals
over FY11-FY13 and consequently a 23% CAGR in its loan book to Rs1.5t by FY13. Well
matched asset-liability profile has been cushioning PFC against interest rate risks; however,
rising competition and bulk borrowing rates are likely to impact spreads.
18% PAT CAGR; RoE of 16-17%: We model PAT CAGR of 18% over FY11-13,
supported by lean cost structure and minimal credit cost. We expect the return ratios to
remain strong, with RoA of ~2.7% and RoE of 16-17% (post dilution) for FY12-13.
45% stock price correction from peak; Buy for 37% upside: Heightened concerns
over SEB losses and expected slowdown in loan growth (due to environment clearance
issues) have led to a sharp 45% correction in stock price from the peak. We believe
current valuations are attractive at 1.2x FY13E BV. We initiate coverage with a Buy
recommendation and a target price of Rs290 (1.6x FY13E BV), 37% upside
Key risks to our call
Delays in power project execution: India’s track record of executing power projects
has been dismal. If this persists, PFC’s loan sanctions will not translate into
disbursements, adversely impacting growth in loan book and earnings.
Drop in power rates to impact private players: SEBs have become reluctant in
purchasing high cost short term power, this is in turn could impact the profitability of
the power projects. PFC targets to increase the proportion of private sector loans to
35% by FY17.
Poor track record of state utilities and no standard provisions by PFC: PFC
has high exposure to state utilities, which have a poor financial track record. While
efforts are being made to improve SEB financials, we believe it would take time for
the benefits to show up.
Concentration risk and no buffer to absorb defaults: PFC has concentrated
exposure towards central and state utilities. The RBI recently asked NBFCs to provide
standard asset provisions of ~25bp; however, this was not applicable to PFC/REC, as
these are government-owned institutions. This exemption has kept profitability high.
However, we believe that no buffer to absorb defaults would increase volatility in
earnings in case of deterioration in asset quality
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