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PFC/REC (POWF)/(RECL)
Banks/Financial Institutions
Switching on the dimmer. We turned more cautious on power finance companies
(PFC and REC) after our management meetings in Delhi. While developments with
respect to SEBs are positive, we believe performance (growth and NPLs) of their private
sector book (though this is only 9-11% of total loans as on September 2011) will drive
the stocks. We reduce estimates and target prices. Retain BUY; the stocks are trading at
distressed valuations. We believe resolution of macro issues will be the key sensitivity for
near-term stock performance.
Shifting focus to private sector loan book
Positive developments at SEBs. We are relatively more comfortable on the asset quality
performance of state sector loans (70% to 82% of loan book for PFC and REC as on September
2011) given the positive developments at state electricity boards (SEBs) over the past few months.
While recently-proposed tariff hikes may not, in themselves, drive turnaround at SEBs, a more
disciplined approach by SEBs and regulators is likely to reduce their credit risk in the medium-term.
Concerns in private sector will have an overhang. We believe stress in the private sector loan
book is likely to be reflected over the next few quarters. While the ‘long-term value’ of the
underlying assets may not be debated, early resolution of macro issues in the sector (availability
and supply of coal, (likely) renegotiation of power purchase agreements) will affect the fortunes of
these projects and hence drive the stock performance of PFC and REC. Recent developments are
somewhat positive: scrapping of the ‘No-go’ policy, increased mining activity (as indicated by a rise
in bank credit to the segment) and environment clearances for some projects.
Revision in estimates
We are reducing our estimates for PFC by 12% and 2% for FY2012 and FY2013 respectively, to
factor-in higher losses on forex loans, increased credit costs and lower loan growth. We are
reducing our target price to Rs210 from Rs225.
We are reducing our estimates for REC by 4% and 2% for FY2012 and FY2013 respectively
to factor-in increased credit costs and lower loan growth. We are reducing our target price
to Rs220 from Rs240.
Stocks trading at distressed valuations, retain BUY
PFC is trading at 4.9X PER and 0.8X PBR FY2013E. This works out to 1X FY2014E adjusted
PBR, if we build-in NPLs of 5.5%. This effectively implies that 95% of the private sector loan
book (as on September 2011) is written-off. PFC provides a dividend yield of 4%.
REC is trading at 4.7X PER and 0.9X PBR FY2013E. This works out to 1X FY2014E adjusted
PBR, if we build-in NPLs of 4%. This effectively implies that 45% of the private sector loan
book (as on September 2011) is written-off. REC provides a dividend yield of 6%.
Loan growth to moderate unless new proposals increase
We are reducing our loan growth estimates for PFC and REC by 2-3% for FY2013. We are
now modeling 14-15% loan growth in FY2014 against ~20% in earlier years.
�� We believe disbursements towards pre-approved projects (projects that have begun
construction activity) will drive business over the next few quarters. However, subdued
activity in new projects will hit loan growth from FY2014E unless the macro environment
improves.
�� In light of challenges in the sector, power finance companies have adopted more
stringent disbursement pre-conditions for projects approved from 2011 (like firm fuel
supply agreements and power purchase agreements). We believe it will be challenging to
promoters to meet some of these conditions at this juncture.
�� PFC and REC will continue/resume disbursements to SEBs that raised tariff, publish
financials and follow norms laid down by the joint committee of chief ministers.
Pricing power remains strong, expect NIMs to be stable
We believe lower competition from banks in lending to SEBs and (refinancing loans to
private power players) will be likely to improve the negotiating power of PFC and REC with
its borrowers. As such, we believe PFC and REC are well placed in maintaining their interest
spreads. We are modeling a marginal decline in spreads for REC (down 30 bps) in 2013 to
factor-in the impact of higher leverage and increase in non-performing assets.
We raise estimates for provisions
In order to factor likely deterioration in asset quality, we are now increasing our estimates
for loan losses for PFC and REC. We highlight that its is challenging to model the NPLs,
credit losses and restructured losses for PFC and REC given their large and lumpy exposures
to generation projects.
We are now modeling NPL provisions of Rs7.7 bn for PFC and Rs4 bn for REC between
FY2012 and FY2014. This works out to 8% and 4% of the current private sector loan book
for PFC and REC respectively.
�� Exposure to the hydel project in MP (Rs4 bn for REC and Rs7 bn for PFC) is considered a
standard restructured exposure by PFC while REC classified it as an NPL in 1QFY12. In
case the power company is unable to raise equity capital, this loan is likely to be classified
as an NPL by PFC as well. PFC has also extended a guarantee of Rs4 bn on this project. If
this devolves on PFC, the NPL will be Rs11 bn.
�� In light of a likely delay in commissioning of power projects (due to challenges in
arranging supply of fuel or otherwise), we expect PFC and REC to restructure loans as
well. Notably, unlike banks, PFC and REC have restructured loans in the past.
MTM losses on forex borrowings temper near-term earnings for PFC
We are raising our estimates for PFC’s MTM losses on forex borrowings on the back of
revision in the Rupee-US Dollar rates by our economist. We are now modeling the US Dollar
at Rs53.5 as on March 2012 compared with our previous estimate of about Rs50. PFC has
un-hedged forex exposure of (US$383 mn; JPY42 bn and Euro23 mn). REC recently hedged
most of its borrowings and currently has un-hedged forex exposure of US$50 mn.
According to news reports, the regulatory bodies may allow companies to capitalize forex
losses on borrowings. In this scenario, the losses in the forex account are likely to be much
lower.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
PFC/REC (POWF)/(RECL)
Banks/Financial Institutions
Switching on the dimmer. We turned more cautious on power finance companies
(PFC and REC) after our management meetings in Delhi. While developments with
respect to SEBs are positive, we believe performance (growth and NPLs) of their private
sector book (though this is only 9-11% of total loans as on September 2011) will drive
the stocks. We reduce estimates and target prices. Retain BUY; the stocks are trading at
distressed valuations. We believe resolution of macro issues will be the key sensitivity for
near-term stock performance.
Shifting focus to private sector loan book
Positive developments at SEBs. We are relatively more comfortable on the asset quality
performance of state sector loans (70% to 82% of loan book for PFC and REC as on September
2011) given the positive developments at state electricity boards (SEBs) over the past few months.
While recently-proposed tariff hikes may not, in themselves, drive turnaround at SEBs, a more
disciplined approach by SEBs and regulators is likely to reduce their credit risk in the medium-term.
Concerns in private sector will have an overhang. We believe stress in the private sector loan
book is likely to be reflected over the next few quarters. While the ‘long-term value’ of the
underlying assets may not be debated, early resolution of macro issues in the sector (availability
and supply of coal, (likely) renegotiation of power purchase agreements) will affect the fortunes of
these projects and hence drive the stock performance of PFC and REC. Recent developments are
somewhat positive: scrapping of the ‘No-go’ policy, increased mining activity (as indicated by a rise
in bank credit to the segment) and environment clearances for some projects.
Revision in estimates
We are reducing our estimates for PFC by 12% and 2% for FY2012 and FY2013 respectively, to
factor-in higher losses on forex loans, increased credit costs and lower loan growth. We are
reducing our target price to Rs210 from Rs225.
We are reducing our estimates for REC by 4% and 2% for FY2012 and FY2013 respectively
to factor-in increased credit costs and lower loan growth. We are reducing our target price
to Rs220 from Rs240.
Stocks trading at distressed valuations, retain BUY
PFC is trading at 4.9X PER and 0.8X PBR FY2013E. This works out to 1X FY2014E adjusted
PBR, if we build-in NPLs of 5.5%. This effectively implies that 95% of the private sector loan
book (as on September 2011) is written-off. PFC provides a dividend yield of 4%.
REC is trading at 4.7X PER and 0.9X PBR FY2013E. This works out to 1X FY2014E adjusted
PBR, if we build-in NPLs of 4%. This effectively implies that 45% of the private sector loan
book (as on September 2011) is written-off. REC provides a dividend yield of 6%.
Loan growth to moderate unless new proposals increase
We are reducing our loan growth estimates for PFC and REC by 2-3% for FY2013. We are
now modeling 14-15% loan growth in FY2014 against ~20% in earlier years.
�� We believe disbursements towards pre-approved projects (projects that have begun
construction activity) will drive business over the next few quarters. However, subdued
activity in new projects will hit loan growth from FY2014E unless the macro environment
improves.
�� In light of challenges in the sector, power finance companies have adopted more
stringent disbursement pre-conditions for projects approved from 2011 (like firm fuel
supply agreements and power purchase agreements). We believe it will be challenging to
promoters to meet some of these conditions at this juncture.
�� PFC and REC will continue/resume disbursements to SEBs that raised tariff, publish
financials and follow norms laid down by the joint committee of chief ministers.
Pricing power remains strong, expect NIMs to be stable
We believe lower competition from banks in lending to SEBs and (refinancing loans to
private power players) will be likely to improve the negotiating power of PFC and REC with
its borrowers. As such, we believe PFC and REC are well placed in maintaining their interest
spreads. We are modeling a marginal decline in spreads for REC (down 30 bps) in 2013 to
factor-in the impact of higher leverage and increase in non-performing assets.
We raise estimates for provisions
In order to factor likely deterioration in asset quality, we are now increasing our estimates
for loan losses for PFC and REC. We highlight that its is challenging to model the NPLs,
credit losses and restructured losses for PFC and REC given their large and lumpy exposures
to generation projects.
We are now modeling NPL provisions of Rs7.7 bn for PFC and Rs4 bn for REC between
FY2012 and FY2014. This works out to 8% and 4% of the current private sector loan book
for PFC and REC respectively.
�� Exposure to the hydel project in MP (Rs4 bn for REC and Rs7 bn for PFC) is considered a
standard restructured exposure by PFC while REC classified it as an NPL in 1QFY12. In
case the power company is unable to raise equity capital, this loan is likely to be classified
as an NPL by PFC as well. PFC has also extended a guarantee of Rs4 bn on this project. If
this devolves on PFC, the NPL will be Rs11 bn.
�� In light of a likely delay in commissioning of power projects (due to challenges in
arranging supply of fuel or otherwise), we expect PFC and REC to restructure loans as
well. Notably, unlike banks, PFC and REC have restructured loans in the past.
MTM losses on forex borrowings temper near-term earnings for PFC
We are raising our estimates for PFC’s MTM losses on forex borrowings on the back of
revision in the Rupee-US Dollar rates by our economist. We are now modeling the US Dollar
at Rs53.5 as on March 2012 compared with our previous estimate of about Rs50. PFC has
un-hedged forex exposure of (US$383 mn; JPY42 bn and Euro23 mn). REC recently hedged
most of its borrowings and currently has un-hedged forex exposure of US$50 mn.
According to news reports, the regulatory bodies may allow companies to capitalize forex
losses on borrowings. In this scenario, the losses in the forex account are likely to be much
lower.
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