Power Finance - Cutting earnings to reflect higher risk :: Macquarie Research,

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Power Finance
Cutting earnings to reflect higher risk
Event
 We cut our earnings and TP sharply (to Rs190 from Rs290) for Power
Finance (PFC) to take into account possible restructurings/NPLs in the sector.
We maintain our OP rating because we believe eventual losses on those
restructurings are likely to be low and valuations more than factor in the
negatives.
Impact
 Factoring in possible asset quality stresses. We believe PFC may have to
take in credit costs of ~2% over the next three years to take into account
possible restructurings/NPLs. Much of the pain is likely in FY13 and 14. We
have thus increased our credit costs to 80bp in FY13E and FY14E.
State sector exposure – restructurings likely – In our view, the key
variable for PFC given its large exposure to state electricity utilities is the
possible restructurings in that portfolio. We believe that given the
social/political imperatives the loans are likely to be restructured rather
than slip into NPLs. Eventual losses may be minimal here. We believe up
to 50% of PFC’s exposure to the loss-making state electricity boards
(SEBs), ie, ~22% of PFC’s total loan book, may have to be restructured
over FY13/14, for which it would have to make provisions.
Private sector exposure – no government back-stopping, but small
overall. We did a risk analysis of 11 large private thermal projects. The
variables examined were PPA with fuel pass-through, promoter leverage,
location in state with a loss-making discom and dependence on imported
coal. Our analysis showed that 40% of the capacity was under risk of
restructuring. We have built in 30% of PFC’s portfolio of private projects
getting restructured and another 10% slipping into NPLs. However, we
note that PFC’s exposure to private projects is only ~10%, so the hit on
credit costs from this is much less.
 Building in standard asset provisioning – We believe PFC may have to
eventually make standard asset provisioning of 0.4% of book, as suggested
by the RBI working group on NBFC. We estimate a Rs4bn one time hit in
FY12E.
Earnings and target price revision
 We have cut EPS by 17–26% for FY12–14E on higher provisioning. Our
earnings are 22% below consensus, and our TP is 24% below.
Price catalyst
 12-month price target: Rs190.00 based on a Gordon Growth methodology.
 Catalyst: positive movement in power sector.
Action and recommendation
 Maintain OP. Valuations are cheap, in our view, as sustainable ROEs are in
the ~17% range. Our TP values the stock at 1.1x FY13E BVPS.

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