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Positive moves
Resolution of state power ministers to curtail losses and improve finances of
SEBs is a positive step. While we did not expect SEBs to default on PPA, these
initiatives may also encourage investments. However, we still see fuel supply
as key risk over the next few years, hence prefer low-risk companies. This
may also abate asset quality concerns for PFC and REC as loans to states is
66-83% of loans. However, our concern has been on loan growth where see
moderation to 16-20% over FY12-13. Earnings growth will be lower due to
pressure on spreads and increased provisioning. PFC is a better bet on the
improving growth outlook than REC as PFC faces lower competition risks.
Power ministers agree to take steps to curtail SEB losses
q Most proposals are actually restatement of the provisions in the Electricity Act– like
(1) automatic pass through of fuel costs (Section 62 (4)), (2) advance payment of
subsidies in the future (Section 65) and (3) annual filing of tariff petition by states.
q Key new proposals announced were (1) state government to consider conversion of
loans into equity (Rs400bn- 14% of assets in FY09), (2) states to clear outstanding
subsidies & dues and (3) widening of scope of R-APDRP scheme to smaller towns.
Positive for gencos as well, but we still prefer low-risk models
q We never expected default from SEBs on PPAs, but better finances of SEBs would
imply higher utilization of assets and in turn improve profitability.
q Improving finances of SEBs by any of the measures proposed would be a positive
outcome for power generation utilities and would encourage investments.
q Fuel supply (both coal and gas), however, still remains the key concern for gencos.
q The recent dilution in norms by MoEF could improve domestic supply of coal in
medium term; however, next couple of years are expected to be tough.
q Our preference is for low risk business model i.e. NTPC, Power Grid and Tata Power.
Positive for financiers, but inline with base-case
q These recommendations should abate concerns on asset quality of largest exposure
of PFC and REC (66-83% of loans are to states)- this is also inline with our view.
q Looking forward we focus on two key questions (1) has the risk to our loan growth
estimates for FY12-13 abated considerably and (2) are valuations attractive enough
to drive a significant re-rating from here.
PFC and REC to face pressure on earnings growth
q We see moderation in loan growth to 20% in FY12 and 16-17% in FY13 as the
impact of recent events and shortage of fuel supply will be evident with a lag.
q Earnings growth could be even lower (~10% Cagr over FY11-13) because we see
pressure on spreads and increase in provisioning costs.
q We see ~30bps compression in spreads over FY11-13 due to rise in cost of
wholesale funds; forex gains/ loss is a wild card.
q We think 15% of exposure to private gencos (7-10% of loans) may become NPL or
have to be restructured- this may appear high, but exposures are concentrated.
q This along with expected RBI’s norm on standard asset provision will lead to rise in
provisioning - we build 25bps general provision on new loans over FY12-13.
Prefer PFC over REC
q We think valuations of PFC and REC will remain closer to those of profitable and
well capitalised PSU banks like PNB and BOB that also have the advantage of
diversified loan-mix and better liability-mix.
q We believe that PFC (O-PF) is a better bet on the improving growth outlook in the
power financing sector than REC (U-PF) as we believe that PFC faces lower risk of
market share loss to banks due to higher share of generation portfolio (larger ticket
size and longer duration of project).
q Recent developments at state government level warrant some re-rating which we
build in 10-12% upgrade to target prices.
q Our target prices for PFC (Rs250) and REC (Rs245) are based on 1.5-1.6x FY13
adjusted PB and imply 10-18% upside.
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