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Power Finance Corporation (PWFC.BO): Initiate with Neutral
Better risk-reward elsewhere, initiate with Neutral rating
We initiate coverage on Power Finance Corporation (PFC)—a specialized
power financier—with a Neutral rating. In our view, the stock will remain
range-bound despite trading at the lower-end of its historical band (1X-
3.1X 1-year forward P/BV) based on: (1) Pressure on spreads: We
expect it to decline by 60 bp by 4QFY12E from a high of 2.7% in 3QFY11
as incremental borrowing cost exceeds the 75 bp rise in lending rates
over the past six months. We do not factor in potential spread decline
due to any government restructuring of SEB loans, which may require
financiers to provide discount on yields, (2) Potential restructured
loans/NPLs : In our view, the mounting losses for the SEBs and coal
deficit could impact utilization levels and project economics leading to
NPLs or loan restructuring. In addition, PFC’s exposure to the private
sector (which does not have any inherent guarantee) is rising. Of the new
loans approved in FY11, the share of the private sector is 25% vs. 7% of
outstanding loans. (3) Better risk-reward elsewhere: Given the macroeconomic headwinds, pressure on utilities, and regulatory risks for NBFCs,
we believe the risk-reward is more favourable for PSU banks (trading at
1.2x-1.5x vs. ROEs of 18%-22%) vs. PFC, (4) Sustainability of PFC’s
business model: Further in the long term, we believe PFC would need
to evolve its business model given: (a) core competency being restricted
to one sector, (b) potential slowdown in demand from the power sector
as we move from deficit to a surplus situation, and (c) increasing
competition from banks.
Not factoring restructuring risk in near-/medium-term earnings
We expect PFC to deliver EPS CAGR of 13.6% over FY11E-FY14E
supported by a loan growth of 22%, assuming no risk of restructuring
loans, given low visibility. We expect ROAs to decline by 20bp yoy to
2.5% by FY14E (reflecting pressure on spreads) and remain stable there
on. But we expect ROEs to improve to 17% in FY14E from 16% in FY12E
on increasing leverage post the recent follow-on offer. Long-term ROE,
however, would be capped as the company will find it difficult to
increase its leverage significantly above 7X (as IFCs are required to
maintain a minimum CAR of 15%), in our view.
Valuation
Our GS CAMELOT-based 12-month target price is Rs210, which implies
17% potential upside. While PFC has corrected and underperformed the
BSE Sensex by 38%-40% over the past 12 months, we initiate with a
Neutral rating, as we believe: (1) The risk-reward is more in favour of
banks and, (2) uncertainty on PFC’s asset quality and growth momentum
would keep the stock range-bound.
Key risks
Upside risks: (1) Higher growth given pull-back by banks/constrained
sector limits, and/or (2) higher NIMs. Downside risks: (1) Restructuring
of loans led by state governments requiring lenders to take a haircut, (2)
Stringent NPL norms for PFC and/or loans by banks to NBFCs.
Financiers may see power fluctuations, not blackout; initiate on PFC
Multiple concerns: Negative impact, but not a meltdown
Multiple concerns on the power sector—from supply deficit to surplus, SEB
losses, and coal non-availability—are impacting stock performance of NBFCs
with high exposure. Given the challenges in crystallizing these risks into our
estimates, we prefer banks to NBFCs. We believe the key concerns are:
(1) Risk to financiers from exposure to the sector (including SEBs) at
about 12% in FY11: Our analysis of 85% of the private sector thermal
projects expected to come onstream between FY12E-FY15E based on their fuel
linkage, PPA, and cost pass-through indicates that 31% of this capacity will be
at high risk, which could likely lead to lower income and/or NPLs for financiers.
It is difficult to estimate the impact on individual financiers given lack of
project-wise exposure details. In a worst-case scenario, banks could take a hit
of 0.6%-7.3% on FY13E PBT from rate reduction and 0.8%-17.7% on BVPS from
write-offs; however, NBFCs face higher risk and could take a hit of 13%-44% on
FY13E PBT and 7%-38% on BVPS. Most exposed: PFC—initiate with Neutral
and 12-m GS CAMELOT based TP of Rs210—and IDFC (Neutral; lower FY12EFY14E EPS by up to 4% and 12-m CAMELOT-based TP to Rs145 from Rs160);
least exposed: HDFC Bank (Neutral), IndusInd (CL- Buy), Kotak (Neutral).
(2) Surplus capacity: Our India utilities team expects power capacity
expansion of c.120GW (91GW of coal) between FY12E-FY15E, 14.7% CAGR vs.
9.3% in demand, leading to oversupply from FY14E. This could drive down
PLFs for coal capacity to 66% in FY15E vs. 71% in FY11, and min PLF of c.63%
required to break-even. Given rising risk aversion, in a potential scenario of
lower coal capacity addition of 69GW, coal PLFs could rise to 72%.
(3) Annual loss of c.Rs780 bn for SEBs in FY11 (Business Standard,
June 21, 2011) or c.1.07% of India’s GDP. We believe states will have to bail
out SEBs and banks may need to take a cut in interest income, but not on
principal amount. However, tariff hikes are essential to reduce annual losses
and load shedding, in order for SEBs to buy from fresh capacity being added.
(4) Coal shortage of c.118 mn tons (c. 20% of demand) by FY15E could lead
to lower PLFs of 54% and 59% in FY15E depending on coal capacity addition
of 69GW or 91GW, respectively, in our two scenarios; these PLFs are lower
than min required of 63% assuming current imported coal cost and 74% on
15% rise in cost. Assuming max coal imports, PLF rises to 66%/72%.
(5) We believe neither the central nor state government would allow power
shortages to impact economic activity, thereby driving reforms.
Quantifying risk a challenge, but do not expect a meltdown
While the growth potential in India for both power manufacturers and financiers is
significant given low consumption and demand-supply gap (at 8.5% as of March 2011),
resolution of multiple challenges (SEB losses and coal availability) will determine the
extent and gestation of the problems for financiers.
Our analysis of 85% of the thermal power projects in the private sector being set-up
between FY12E-FY15E (assuming no delays/cancellation of projects) based on their fuel
linkage, and cost pass-through shows 31% of the capacity will be at high risk. Based on this
analysis, we believe there are likely to be some issues for the financiers – leading to
postponement/restructuring and some write-off of loans, and lower interest income.
However, we also believe the eventual outcome is unlikely to be significantly negative as
projects could get postponed (as financiers delay disbursements on lack of milestone
achievement), and the government would implement structural reforms to protect
economic growth. Nevertheless, the potential risk of lower PLF does exist till the state
governments sort out these problems.
Given the complication of the problem and lack of information in terms of project-wise
exposure, it is difficult to estimate the potential risk for individual financiers, which will
likely lead to volatility in stock price performance on newsflow, in our view. We, therefore,
prefer banks over NBFCs given their lower exposure to the power sector, and provide a
sensitivity analysis of our FY13E PBT and BVPS estimates. However, the potential risk is
unlikely to be uniform and based on our discussion with industry participants, it appears
that the private sector financiers may have been asking for more security for loans given
(from the parent company) and milestone achievements before disbursing funds.
Banks/NBFCs that have higher exposure to the power sector are PFC, REC, and IDFC;
financiers that face the least risk are HDFC Bank, IndusInd Bank, and Kotak Mahindra Bank.
In addition to the risk of exposure, we believe these NBFCs will also likely see pressure on
loan growth as it may be difficult to take incremental exposure to the power sector in view
of the uncertainties.
We initiate coverage on PFC with a Neutral rating and a 12-m CAMELOT-based target price
of Rs210. For IDFC, we cut our FY12E/FY13E/FY14E EPS by 1%/2%/4% to
Rs10.12/Rs12.15/Rs14.40 to factor in lower disbursement growth. Further, we lower our 12-
m SOTP-based target price to Rs145 (from Rs160 previously) to reflect the earnings
revision and higher risk associated with its significant exposure to the power sector.
Maintain Neutral. Upside risks: Stronger business volumes, recovering liquidity buoying
NIMs; Downside risks: Higher borrowing cost on tight liquidity.
Negative impact, but not a meltdown, difficult to quantify impact
Given the rising demand for loans, banking sector loans to the power sector has shown a
38% CAGR over FY05-FY11. The exposure of banks to the power sector stands at Rs 2.7 tn,
or 8% of gross banking credit in FY2011 vs. 4% in FY2005. If we also add the exposure of
NBFCs (IDFC, PFC, and REC (Not Covered)), then the total exposure to the power sector
reflects 31% CAGR over FY05-FY11 in loans of Rs4.8 tn or 13.2% of the total financial sector
credit. Additional funding requirement for new generation capacity under construction
between FY12E-FY15E is around Rs2 tn or 40% of outstanding credit in the sector. In
addition, there could likely be a demand from the distribution and transmission sectors as
well.
Given the significant exposure of banks and financiers to the power sector, we discuss in
detail key concerns that are affecting the sector and its impact on banks/financiers:
1. What will be the impact on banks/financers? Will financiers need to take interest
rate cuts and/or hair cut? What would be the impact on profits and book value of these
financiers?
GS view: Exposure of banks under our coverage to the power sector ranges from 1%-9.2%
of total exposure or 17%-130% of the banks’ net worth as of FY11. This is higher for the
NBFCs at 260%-650% of net worth. We believe this is significant and both the Central and
State governments would need to find a structural solution to the problems facing the
power sector to protect the financial sector and the economy in general.
In the interim, banks will likely restructure (similar to Dabhol Power Company, which
remained as a restructured loan for over 7-8 years)/evergreen loans and try and postpone
the problem. Nevertheless, we believe banks and NBFCs could take a hit both from lower
interest income and NPL provisioning over the next four to six years. However, this may
not be significant for banks as we believe possibility of projects in the inception phase
getting postponed till better clarity emerges is high, thereby limiting incremental
disbursements. According to our India utilities team, coal projects’ break-even PLF is 63%
and projects operating above this PLF will be able to pay debt financiers.
Our sensitivity analysis shows a 3%-5% cut in interest rates in 30% of power sector loans
could impact banks’ FY13E PBT by 0.6%-7.3% and 0.1%-1.3% of net worth, while a write-off
of 10%-20% would impair banks’ FY13E net worth by 0.8%-17.7%. On the other hand, the
impact is higher for specialized NBFCs like PFC and IDFC (given their higher exposure) at
13%-44% on income in the case of interest rate reduction and 7%-38% on BVPS.
2. Excess supply over demand: Our India utilities team expects overall capacity addition
to be higher at c.120GW (30GW per annum) or a CAGR of 14.7% between FY12E-FY15E vs.
consumption growth, which will be lower at 9.3%. As against this, the CAGR in capacity in
the past five years (FY06-10) was lower at 6.4% (average 8.2GW per annum) and the
growth in consumption was higher at 13.5% given latent demand.
Further analysis of the thermal power projects being set up in India over FY12E-FY15E
shows that equipment order has been placed in all these projects and financial closure has
been achieved for 85.5% of the total thermal capacity being set up.
3. State electricity boards (SEBs) have been reporting huge losses at c.Rs229 bn
(c.US$5bn) in FY2009 while the accumulated losses on their books stood at Rs850 bn
(US$18.9 bn). As per the Planning Commission, the annual losses have increased to Rs400
bn in FY10 and as per media reports (Business Standard, June 21, 2011) to Rs780 bn in
FY11. The FY11 annual losses would translate to c.1.07% of India’s GDP for FY11. This
poses a few pertinent questions: (1) Can the above excess capacity being created be
absorbed by SEBs? (2) What will be the impact on utilization levels/ plant load factors
(PLFs) for the power sector? (3) Will this impact only new capacities being added or even
the existing ones?
Our views on points 2 and 3 above
If the above-mentioned c.120GW (91GW coal) of power capacity comes onstream,
overall PLF would reduce in FY15E to 53% from 61% in FY12E. If, however, total
capacity addition is lower at c.99GW, the overall PLF will inch up to 56% in FY15E.
Similarly, PLFs for coal will be 66% in FY15E vs. 71% in FY11. The minimum PLF
required to break even is around 63% assuming current landed imported coal cost and
rises to 74% based on a 15% rise in cost. Given multiple concerns and risk aversion, we
think banks will likely tighten their disbursement norms unless companies achieve
milestones (e.g., coal tie-up and comfort on capacity being utilized), likely leading to
delays in capacity addition. At lower coal capacity addition of 69GW, PLF could rise to
72%, thus reducing the potential risk to financiers.
However, loans disbursed to some of these projects would have to be restructured,
perhaps due to potential delays/lower profitability on falling PLF. We believe the
amount of disbursements to projects till FY11 (for projects coming onstream in FY14
and FY15) will be minimal for now.
Simultaneously, PLF could be lower, if SEBs decide to increase load shedding on
higher losses. The extent of cuts is difficult to estimate, but unlikely to be less than the
above PLF numbers. In our view, states would need to take serious steps to restructure
SEBs and absorb accumulated losses as additional credit from finance sector will be
difficult. Between the public and private banks under our coverage, PSU banks have
direct exposure to SEBs, which is estimated at 25%-50% of their total power sector
exposure as in FY11. The private banks under our coverage, in most cases, have
minimal or no direct exposure to SEBs.
Sensitivity analysis of 10% decline in PLF of generation companies under GS coverage
by our utilities team shows the impact on earnings over FY12E-FY14E could be around
14% to 18%, with interest cover reducing to 1.6X-5.6X from 1.7X-6X and debt-equity
ratio changing to 1.2X-4.7X from 1.2X-4.4X.
4. Will there be sufficient coal available to meet the power sector requirement?
The 91GW of coal capacities being set up over FY12E-FY15E is estimated to require c.335
mn tons of coal, with the shortfall estimated to be c.118 mn tons by FY15E. Will cost of
production increase from imported coal and also whether existing and upcoming plant
technology permit more than 30% imported coal usage?
GS view:
We believe lack of coal could translate to lower PLF for coal-based plants at around 54% by
FY15E, if the entire 91GW of coal capacity estimated by our utilities team were to come
onstream (Scenario 1). If however, the capacity expansion is lower at 69GW (Scenario 2),
the PLF would increase to 59%. In both cases, we assume no additional imports. In case the
shortfall is met through maximum coal imports (assuming upto 30% imports of total
demand), the PLF will increase to 66% and 72% in Scenario 1 and 2, respectively (Exhibits
23, 35, and 36).
Our utilities team estimates that a 10% increase in fuel cost would lead to average 7% -
12% decline in earnings for utilities over FY12E-FY14E. This risk exists for both companies
depending on domestic coal consumption and also for those that have contract for imports,
in particular, if overseas suppliers renege on their contract.
5. What will be the impact of an economic slowdown/pull back by financiers and
corporates on GDP and power consumption? Would huge power cuts have an
impact on elections?
GS view: We believe neither the Central nor the State government would allow a
slowdown in economic activity due to power shortages, and this will likely be the most
important driving factor for reforms. India has added 81GW of capacity over FY1997-
FY2011 and 41GW in the past five years. Lower capacity could have direct implication on
GDP growth.
Significant variation in risks: PFC, REC, IDFC, at most risk vs. HDFC
Bank, Kotak, and IndusInd at least risk
Banks’ exposure has risen sharply over the past five years
Reflecting the demand for funds, banking sector loans to the power sector has risen at a
38% CAGR over FY05-FY11 versus a 25% CAGR in total industry credit over the same
period. As of FY2011, the exposure of banks to the power sector stood at Rs2.7 tn (about
US$60bn), which is at 8% of total outstanding credit versus 3.7% in FY2005. Including
NBFCs (PFC, REC, and IDFC), the overall exposure to the power sector is Rs4.8 tn (US$106
bn), reflecting a 31% CAGR over FY05-FY11.
Given the projected power sector capacity additions over FY12E-FY15E and assuming a
debt:equity ratio of 70:30, we estimate the debt requirement for the additional 120GW
capacity at Rs4.3 tn (US$95bn). Assuming 50% of the funding requirement has already
been disbursed till FY11, the balance Rs2 tn will likely have to be funded by banks/NBFCs
between FY12E-FY15E, which is 40% of the outstanding power sector exposure as of
FY2011.
Will banks continue to lend, or we could see capacity delays?
Will the power sector continue to see incremental investments till both the Central and
State governments fix the significant structural issues affecting the system? We believe
new projects will likely face challenges in getting funding hereon given concerns
surrounding banks’ exposure to the sector. We therefore believe that projects in the
pipeline could see delays if banks were to stop/delay loan disbursements. For e.g., for the
total thermal capacity of 93GW expected to come onstream in FY12E-FY15E, c.15% is yet to
achieve financial closure. Most of the private banks have indicated that power projects
would require to achieve certain milestones before they could disburse loans, even though
there might be a financial closure in place.
Impact on banks likely to vary depending on project risks
Our interactions with some of the banks and finance companies indicate that they are
running a stress test on their portfolios and do not expect any issues with their exposure to
the power sector. Nevertheless, project profitability and therefore banks’ exposure is open
to some risk, in our view.
However, given the multiple variables involved and lack of information on banks’ exposure
to individual projects, it is difficult to estimate the hit banks will take on their P&L or
balance sheet. Based on our analysis of the sector, we believe that banks will likely
postpone the problem by evergreening loans and/or restructuring the same. We think most
of the negative impact would likely surface in the next three to four years and depend on:
1. Which entities banks have exposure to i.e., private, central, SEBs. Between the
private and PSU banks, PSU banks have 25%-50% of their total power sector exposure
as of FY11 to the State sector – i.e, state and central utilities, and state electricity
boards (SEBs). We believe banks may be asked to take some interest rate cuts (as seen
recently in the case of another public sector company—Air India—where lenders are
being made to lower interest rates by 3%-4%) on restructuring of loans by states.
2. Risk from gas and coal availability: Do the manufacturers have protection on
quantity and price of coal/gas purchased? How much of coal can be imported, the
impact of higher coal prices on the same, and ability to import coal given issues
relating to logistics and technology. Do projects have PPAs, does this have full passthrough provision?
We analyze these issues as follows:
1. We have analyzed 93 projects, being set up over FY12E-FY15E, which account for
93GW of thermal capacity. Financial closure has been achieved for 85.5% of the
total capacity, 83% of the private capacities, and 89% of the public sector capacities.
On the other hand, equipment orders have been placed for all (Exhibit 12).
2. While financial closure has been obtained by a majority of these projects, actual
disbursements would depend on progress of execution of individual projects. At a
70:30 debt-equity ratio, we estimate the potential debt requirement for the 120GW
capacity planned at Rs4.3 tn. Of this, part of the loan amount would have already
been disbursed till FY11 and we estimate the balance requirement at Rs2 tn over
FY12E-FY15E (US$44bn), which is about 40% of the existing outstanding exposure
of key banks/NBFCs to the power sector. Note that this ignores any requirement
for loans from SEBs. We allocate disbursements of this amount among key
financiers in proportion of their existing outstanding exposure.
3. Further we have analyzed 85% of the thermal capacity being set up by the private
sector and bucketed projects under three categories: Low risk, Moderate risk, and
High risk, based on the project risk. This highlights the potential risk of NPLs. Our
analysis shows that 31% of these projects are placed in the high-risk category.
Assuming 10%-20% of power sector exposure will be written-off completely, we
calculate the impact on BVPS of banks/NBFCs under our coverage. Our analysis
shows the impact could range between 0.8%-17.7% of FY13E networth for banks
and 7%-38% for NBFCs.
4. Post this, we arrive at our sensitivity analysis to earnings assuming lower interest
rates or cut in interest expense (as seen during recent restructuring of Air India
and Kingfisher, where lenders were made to take interest rate cuts and equity
against loans, respectively) across 30% of all power sector loans – a worst-case
scenario. Our analysis shows the impact on FY13E PBT could range between 0.6%-
7.3% of loans for banks under our coverage and 13%-44% for NBFCs (PFC, IDFC).
5. Given the relatively lower exposure of banks to the sector, we prefer banks over
NBFCs. Note that not all NBFCs in this space will see similar risk, for e.g., IDFC
indicated that the company is largely lending to producers that have coal linkages,
and PPAs with fuel pass through.
From deficit to surplus by FY2015 if capacity expansion is high
In this report, we briefly discuss about the power sector’s potential in India, before
analyzing the challenges currently confronting the power sector. According to our utilities
team:
Generation capacity of c.120GW is likely to be added in the power sector over FY11-
FY12E, taking the installed capacity to about 290GW by FY15E, a CAGR of 14.7% over
the same period. A large part or about 50% of this capacity will come onstream in FY14
and FY15.
The higher capacity execution vs. target (80% during the Twelfth Five-year plan vs.
47%-54% in the past) is on the back of increasing private participation, estimated at
about 50% of incremental capacity over FY11-FY15E from 41% in FY11.
Assuming consumption CAGR of 9.3% over FY12E-FY15E, we believe this will lead to a
surplus capacity of about 6% by FY14E and 12% by FY15E versus the deficit of 8.5% as
of FY11.
If the c.120GW capacity as discussed above comes onstream, the PLF would decline to
53% in FY15E from 61% in FY11 (67% vs. 75% for coal-based), assuming surplus of
zero. However, if the capacity addition is lower at 97GW, the PLF in FY15E would
increase to 56% for overall sector and 72% for coal-based capacity.
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Power Finance Corporation (PWFC.BO): Initiate with Neutral
Better risk-reward elsewhere, initiate with Neutral rating
We initiate coverage on Power Finance Corporation (PFC)—a specialized
power financier—with a Neutral rating. In our view, the stock will remain
range-bound despite trading at the lower-end of its historical band (1X-
3.1X 1-year forward P/BV) based on: (1) Pressure on spreads: We
expect it to decline by 60 bp by 4QFY12E from a high of 2.7% in 3QFY11
as incremental borrowing cost exceeds the 75 bp rise in lending rates
over the past six months. We do not factor in potential spread decline
due to any government restructuring of SEB loans, which may require
financiers to provide discount on yields, (2) Potential restructured
loans/NPLs : In our view, the mounting losses for the SEBs and coal
deficit could impact utilization levels and project economics leading to
NPLs or loan restructuring. In addition, PFC’s exposure to the private
sector (which does not have any inherent guarantee) is rising. Of the new
loans approved in FY11, the share of the private sector is 25% vs. 7% of
outstanding loans. (3) Better risk-reward elsewhere: Given the macroeconomic headwinds, pressure on utilities, and regulatory risks for NBFCs,
we believe the risk-reward is more favourable for PSU banks (trading at
1.2x-1.5x vs. ROEs of 18%-22%) vs. PFC, (4) Sustainability of PFC’s
business model: Further in the long term, we believe PFC would need
to evolve its business model given: (a) core competency being restricted
to one sector, (b) potential slowdown in demand from the power sector
as we move from deficit to a surplus situation, and (c) increasing
competition from banks.
Not factoring restructuring risk in near-/medium-term earnings
We expect PFC to deliver EPS CAGR of 13.6% over FY11E-FY14E
supported by a loan growth of 22%, assuming no risk of restructuring
loans, given low visibility. We expect ROAs to decline by 20bp yoy to
2.5% by FY14E (reflecting pressure on spreads) and remain stable there
on. But we expect ROEs to improve to 17% in FY14E from 16% in FY12E
on increasing leverage post the recent follow-on offer. Long-term ROE,
however, would be capped as the company will find it difficult to
increase its leverage significantly above 7X (as IFCs are required to
maintain a minimum CAR of 15%), in our view.
Valuation
Our GS CAMELOT-based 12-month target price is Rs210, which implies
17% potential upside. While PFC has corrected and underperformed the
BSE Sensex by 38%-40% over the past 12 months, we initiate with a
Neutral rating, as we believe: (1) The risk-reward is more in favour of
banks and, (2) uncertainty on PFC’s asset quality and growth momentum
would keep the stock range-bound.
Key risks
Upside risks: (1) Higher growth given pull-back by banks/constrained
sector limits, and/or (2) higher NIMs. Downside risks: (1) Restructuring
of loans led by state governments requiring lenders to take a haircut, (2)
Stringent NPL norms for PFC and/or loans by banks to NBFCs.
Financiers may see power fluctuations, not blackout; initiate on PFC
Multiple concerns: Negative impact, but not a meltdown
Multiple concerns on the power sector—from supply deficit to surplus, SEB
losses, and coal non-availability—are impacting stock performance of NBFCs
with high exposure. Given the challenges in crystallizing these risks into our
estimates, we prefer banks to NBFCs. We believe the key concerns are:
(1) Risk to financiers from exposure to the sector (including SEBs) at
about 12% in FY11: Our analysis of 85% of the private sector thermal
projects expected to come onstream between FY12E-FY15E based on their fuel
linkage, PPA, and cost pass-through indicates that 31% of this capacity will be
at high risk, which could likely lead to lower income and/or NPLs for financiers.
It is difficult to estimate the impact on individual financiers given lack of
project-wise exposure details. In a worst-case scenario, banks could take a hit
of 0.6%-7.3% on FY13E PBT from rate reduction and 0.8%-17.7% on BVPS from
write-offs; however, NBFCs face higher risk and could take a hit of 13%-44% on
FY13E PBT and 7%-38% on BVPS. Most exposed: PFC—initiate with Neutral
and 12-m GS CAMELOT based TP of Rs210—and IDFC (Neutral; lower FY12EFY14E EPS by up to 4% and 12-m CAMELOT-based TP to Rs145 from Rs160);
least exposed: HDFC Bank (Neutral), IndusInd (CL- Buy), Kotak (Neutral).
(2) Surplus capacity: Our India utilities team expects power capacity
expansion of c.120GW (91GW of coal) between FY12E-FY15E, 14.7% CAGR vs.
9.3% in demand, leading to oversupply from FY14E. This could drive down
PLFs for coal capacity to 66% in FY15E vs. 71% in FY11, and min PLF of c.63%
required to break-even. Given rising risk aversion, in a potential scenario of
lower coal capacity addition of 69GW, coal PLFs could rise to 72%.
(3) Annual loss of c.Rs780 bn for SEBs in FY11 (Business Standard,
June 21, 2011) or c.1.07% of India’s GDP. We believe states will have to bail
out SEBs and banks may need to take a cut in interest income, but not on
principal amount. However, tariff hikes are essential to reduce annual losses
and load shedding, in order for SEBs to buy from fresh capacity being added.
(4) Coal shortage of c.118 mn tons (c. 20% of demand) by FY15E could lead
to lower PLFs of 54% and 59% in FY15E depending on coal capacity addition
of 69GW or 91GW, respectively, in our two scenarios; these PLFs are lower
than min required of 63% assuming current imported coal cost and 74% on
15% rise in cost. Assuming max coal imports, PLF rises to 66%/72%.
(5) We believe neither the central nor state government would allow power
shortages to impact economic activity, thereby driving reforms.
Quantifying risk a challenge, but do not expect a meltdown
While the growth potential in India for both power manufacturers and financiers is
significant given low consumption and demand-supply gap (at 8.5% as of March 2011),
resolution of multiple challenges (SEB losses and coal availability) will determine the
extent and gestation of the problems for financiers.
Our analysis of 85% of the thermal power projects in the private sector being set-up
between FY12E-FY15E (assuming no delays/cancellation of projects) based on their fuel
linkage, and cost pass-through shows 31% of the capacity will be at high risk. Based on this
analysis, we believe there are likely to be some issues for the financiers – leading to
postponement/restructuring and some write-off of loans, and lower interest income.
However, we also believe the eventual outcome is unlikely to be significantly negative as
projects could get postponed (as financiers delay disbursements on lack of milestone
achievement), and the government would implement structural reforms to protect
economic growth. Nevertheless, the potential risk of lower PLF does exist till the state
governments sort out these problems.
Given the complication of the problem and lack of information in terms of project-wise
exposure, it is difficult to estimate the potential risk for individual financiers, which will
likely lead to volatility in stock price performance on newsflow, in our view. We, therefore,
prefer banks over NBFCs given their lower exposure to the power sector, and provide a
sensitivity analysis of our FY13E PBT and BVPS estimates. However, the potential risk is
unlikely to be uniform and based on our discussion with industry participants, it appears
that the private sector financiers may have been asking for more security for loans given
(from the parent company) and milestone achievements before disbursing funds.
Banks/NBFCs that have higher exposure to the power sector are PFC, REC, and IDFC;
financiers that face the least risk are HDFC Bank, IndusInd Bank, and Kotak Mahindra Bank.
In addition to the risk of exposure, we believe these NBFCs will also likely see pressure on
loan growth as it may be difficult to take incremental exposure to the power sector in view
of the uncertainties.
We initiate coverage on PFC with a Neutral rating and a 12-m CAMELOT-based target price
of Rs210. For IDFC, we cut our FY12E/FY13E/FY14E EPS by 1%/2%/4% to
Rs10.12/Rs12.15/Rs14.40 to factor in lower disbursement growth. Further, we lower our 12-
m SOTP-based target price to Rs145 (from Rs160 previously) to reflect the earnings
revision and higher risk associated with its significant exposure to the power sector.
Maintain Neutral. Upside risks: Stronger business volumes, recovering liquidity buoying
NIMs; Downside risks: Higher borrowing cost on tight liquidity.
Negative impact, but not a meltdown, difficult to quantify impact
Given the rising demand for loans, banking sector loans to the power sector has shown a
38% CAGR over FY05-FY11. The exposure of banks to the power sector stands at Rs 2.7 tn,
or 8% of gross banking credit in FY2011 vs. 4% in FY2005. If we also add the exposure of
NBFCs (IDFC, PFC, and REC (Not Covered)), then the total exposure to the power sector
reflects 31% CAGR over FY05-FY11 in loans of Rs4.8 tn or 13.2% of the total financial sector
credit. Additional funding requirement for new generation capacity under construction
between FY12E-FY15E is around Rs2 tn or 40% of outstanding credit in the sector. In
addition, there could likely be a demand from the distribution and transmission sectors as
well.
Given the significant exposure of banks and financiers to the power sector, we discuss in
detail key concerns that are affecting the sector and its impact on banks/financiers:
1. What will be the impact on banks/financers? Will financiers need to take interest
rate cuts and/or hair cut? What would be the impact on profits and book value of these
financiers?
GS view: Exposure of banks under our coverage to the power sector ranges from 1%-9.2%
of total exposure or 17%-130% of the banks’ net worth as of FY11. This is higher for the
NBFCs at 260%-650% of net worth. We believe this is significant and both the Central and
State governments would need to find a structural solution to the problems facing the
power sector to protect the financial sector and the economy in general.
In the interim, banks will likely restructure (similar to Dabhol Power Company, which
remained as a restructured loan for over 7-8 years)/evergreen loans and try and postpone
the problem. Nevertheless, we believe banks and NBFCs could take a hit both from lower
interest income and NPL provisioning over the next four to six years. However, this may
not be significant for banks as we believe possibility of projects in the inception phase
getting postponed till better clarity emerges is high, thereby limiting incremental
disbursements. According to our India utilities team, coal projects’ break-even PLF is 63%
and projects operating above this PLF will be able to pay debt financiers.
Our sensitivity analysis shows a 3%-5% cut in interest rates in 30% of power sector loans
could impact banks’ FY13E PBT by 0.6%-7.3% and 0.1%-1.3% of net worth, while a write-off
of 10%-20% would impair banks’ FY13E net worth by 0.8%-17.7%. On the other hand, the
impact is higher for specialized NBFCs like PFC and IDFC (given their higher exposure) at
13%-44% on income in the case of interest rate reduction and 7%-38% on BVPS.
2. Excess supply over demand: Our India utilities team expects overall capacity addition
to be higher at c.120GW (30GW per annum) or a CAGR of 14.7% between FY12E-FY15E vs.
consumption growth, which will be lower at 9.3%. As against this, the CAGR in capacity in
the past five years (FY06-10) was lower at 6.4% (average 8.2GW per annum) and the
growth in consumption was higher at 13.5% given latent demand.
Further analysis of the thermal power projects being set up in India over FY12E-FY15E
shows that equipment order has been placed in all these projects and financial closure has
been achieved for 85.5% of the total thermal capacity being set up.
3. State electricity boards (SEBs) have been reporting huge losses at c.Rs229 bn
(c.US$5bn) in FY2009 while the accumulated losses on their books stood at Rs850 bn
(US$18.9 bn). As per the Planning Commission, the annual losses have increased to Rs400
bn in FY10 and as per media reports (Business Standard, June 21, 2011) to Rs780 bn in
FY11. The FY11 annual losses would translate to c.1.07% of India’s GDP for FY11. This
poses a few pertinent questions: (1) Can the above excess capacity being created be
absorbed by SEBs? (2) What will be the impact on utilization levels/ plant load factors
(PLFs) for the power sector? (3) Will this impact only new capacities being added or even
the existing ones?
Our views on points 2 and 3 above
If the above-mentioned c.120GW (91GW coal) of power capacity comes onstream,
overall PLF would reduce in FY15E to 53% from 61% in FY12E. If, however, total
capacity addition is lower at c.99GW, the overall PLF will inch up to 56% in FY15E.
Similarly, PLFs for coal will be 66% in FY15E vs. 71% in FY11. The minimum PLF
required to break even is around 63% assuming current landed imported coal cost and
rises to 74% based on a 15% rise in cost. Given multiple concerns and risk aversion, we
think banks will likely tighten their disbursement norms unless companies achieve
milestones (e.g., coal tie-up and comfort on capacity being utilized), likely leading to
delays in capacity addition. At lower coal capacity addition of 69GW, PLF could rise to
72%, thus reducing the potential risk to financiers.
However, loans disbursed to some of these projects would have to be restructured,
perhaps due to potential delays/lower profitability on falling PLF. We believe the
amount of disbursements to projects till FY11 (for projects coming onstream in FY14
and FY15) will be minimal for now.
Simultaneously, PLF could be lower, if SEBs decide to increase load shedding on
higher losses. The extent of cuts is difficult to estimate, but unlikely to be less than the
above PLF numbers. In our view, states would need to take serious steps to restructure
SEBs and absorb accumulated losses as additional credit from finance sector will be
difficult. Between the public and private banks under our coverage, PSU banks have
direct exposure to SEBs, which is estimated at 25%-50% of their total power sector
exposure as in FY11. The private banks under our coverage, in most cases, have
minimal or no direct exposure to SEBs.
Sensitivity analysis of 10% decline in PLF of generation companies under GS coverage
by our utilities team shows the impact on earnings over FY12E-FY14E could be around
14% to 18%, with interest cover reducing to 1.6X-5.6X from 1.7X-6X and debt-equity
ratio changing to 1.2X-4.7X from 1.2X-4.4X.
4. Will there be sufficient coal available to meet the power sector requirement?
The 91GW of coal capacities being set up over FY12E-FY15E is estimated to require c.335
mn tons of coal, with the shortfall estimated to be c.118 mn tons by FY15E. Will cost of
production increase from imported coal and also whether existing and upcoming plant
technology permit more than 30% imported coal usage?
GS view:
We believe lack of coal could translate to lower PLF for coal-based plants at around 54% by
FY15E, if the entire 91GW of coal capacity estimated by our utilities team were to come
onstream (Scenario 1). If however, the capacity expansion is lower at 69GW (Scenario 2),
the PLF would increase to 59%. In both cases, we assume no additional imports. In case the
shortfall is met through maximum coal imports (assuming upto 30% imports of total
demand), the PLF will increase to 66% and 72% in Scenario 1 and 2, respectively (Exhibits
23, 35, and 36).
Our utilities team estimates that a 10% increase in fuel cost would lead to average 7% -
12% decline in earnings for utilities over FY12E-FY14E. This risk exists for both companies
depending on domestic coal consumption and also for those that have contract for imports,
in particular, if overseas suppliers renege on their contract.
5. What will be the impact of an economic slowdown/pull back by financiers and
corporates on GDP and power consumption? Would huge power cuts have an
impact on elections?
GS view: We believe neither the Central nor the State government would allow a
slowdown in economic activity due to power shortages, and this will likely be the most
important driving factor for reforms. India has added 81GW of capacity over FY1997-
FY2011 and 41GW in the past five years. Lower capacity could have direct implication on
GDP growth.
Significant variation in risks: PFC, REC, IDFC, at most risk vs. HDFC
Bank, Kotak, and IndusInd at least risk
Banks’ exposure has risen sharply over the past five years
Reflecting the demand for funds, banking sector loans to the power sector has risen at a
38% CAGR over FY05-FY11 versus a 25% CAGR in total industry credit over the same
period. As of FY2011, the exposure of banks to the power sector stood at Rs2.7 tn (about
US$60bn), which is at 8% of total outstanding credit versus 3.7% in FY2005. Including
NBFCs (PFC, REC, and IDFC), the overall exposure to the power sector is Rs4.8 tn (US$106
bn), reflecting a 31% CAGR over FY05-FY11.
Given the projected power sector capacity additions over FY12E-FY15E and assuming a
debt:equity ratio of 70:30, we estimate the debt requirement for the additional 120GW
capacity at Rs4.3 tn (US$95bn). Assuming 50% of the funding requirement has already
been disbursed till FY11, the balance Rs2 tn will likely have to be funded by banks/NBFCs
between FY12E-FY15E, which is 40% of the outstanding power sector exposure as of
FY2011.
Will banks continue to lend, or we could see capacity delays?
Will the power sector continue to see incremental investments till both the Central and
State governments fix the significant structural issues affecting the system? We believe
new projects will likely face challenges in getting funding hereon given concerns
surrounding banks’ exposure to the sector. We therefore believe that projects in the
pipeline could see delays if banks were to stop/delay loan disbursements. For e.g., for the
total thermal capacity of 93GW expected to come onstream in FY12E-FY15E, c.15% is yet to
achieve financial closure. Most of the private banks have indicated that power projects
would require to achieve certain milestones before they could disburse loans, even though
there might be a financial closure in place.
Impact on banks likely to vary depending on project risks
Our interactions with some of the banks and finance companies indicate that they are
running a stress test on their portfolios and do not expect any issues with their exposure to
the power sector. Nevertheless, project profitability and therefore banks’ exposure is open
to some risk, in our view.
However, given the multiple variables involved and lack of information on banks’ exposure
to individual projects, it is difficult to estimate the hit banks will take on their P&L or
balance sheet. Based on our analysis of the sector, we believe that banks will likely
postpone the problem by evergreening loans and/or restructuring the same. We think most
of the negative impact would likely surface in the next three to four years and depend on:
1. Which entities banks have exposure to i.e., private, central, SEBs. Between the
private and PSU banks, PSU banks have 25%-50% of their total power sector exposure
as of FY11 to the State sector – i.e, state and central utilities, and state electricity
boards (SEBs). We believe banks may be asked to take some interest rate cuts (as seen
recently in the case of another public sector company—Air India—where lenders are
being made to lower interest rates by 3%-4%) on restructuring of loans by states.
2. Risk from gas and coal availability: Do the manufacturers have protection on
quantity and price of coal/gas purchased? How much of coal can be imported, the
impact of higher coal prices on the same, and ability to import coal given issues
relating to logistics and technology. Do projects have PPAs, does this have full passthrough provision?
We analyze these issues as follows:
1. We have analyzed 93 projects, being set up over FY12E-FY15E, which account for
93GW of thermal capacity. Financial closure has been achieved for 85.5% of the
total capacity, 83% of the private capacities, and 89% of the public sector capacities.
On the other hand, equipment orders have been placed for all (Exhibit 12).
2. While financial closure has been obtained by a majority of these projects, actual
disbursements would depend on progress of execution of individual projects. At a
70:30 debt-equity ratio, we estimate the potential debt requirement for the 120GW
capacity planned at Rs4.3 tn. Of this, part of the loan amount would have already
been disbursed till FY11 and we estimate the balance requirement at Rs2 tn over
FY12E-FY15E (US$44bn), which is about 40% of the existing outstanding exposure
of key banks/NBFCs to the power sector. Note that this ignores any requirement
for loans from SEBs. We allocate disbursements of this amount among key
financiers in proportion of their existing outstanding exposure.
3. Further we have analyzed 85% of the thermal capacity being set up by the private
sector and bucketed projects under three categories: Low risk, Moderate risk, and
High risk, based on the project risk. This highlights the potential risk of NPLs. Our
analysis shows that 31% of these projects are placed in the high-risk category.
Assuming 10%-20% of power sector exposure will be written-off completely, we
calculate the impact on BVPS of banks/NBFCs under our coverage. Our analysis
shows the impact could range between 0.8%-17.7% of FY13E networth for banks
and 7%-38% for NBFCs.
4. Post this, we arrive at our sensitivity analysis to earnings assuming lower interest
rates or cut in interest expense (as seen during recent restructuring of Air India
and Kingfisher, where lenders were made to take interest rate cuts and equity
against loans, respectively) across 30% of all power sector loans – a worst-case
scenario. Our analysis shows the impact on FY13E PBT could range between 0.6%-
7.3% of loans for banks under our coverage and 13%-44% for NBFCs (PFC, IDFC).
5. Given the relatively lower exposure of banks to the sector, we prefer banks over
NBFCs. Note that not all NBFCs in this space will see similar risk, for e.g., IDFC
indicated that the company is largely lending to producers that have coal linkages,
and PPAs with fuel pass through.
From deficit to surplus by FY2015 if capacity expansion is high
In this report, we briefly discuss about the power sector’s potential in India, before
analyzing the challenges currently confronting the power sector. According to our utilities
team:
Generation capacity of c.120GW is likely to be added in the power sector over FY11-
FY12E, taking the installed capacity to about 290GW by FY15E, a CAGR of 14.7% over
the same period. A large part or about 50% of this capacity will come onstream in FY14
and FY15.
The higher capacity execution vs. target (80% during the Twelfth Five-year plan vs.
47%-54% in the past) is on the back of increasing private participation, estimated at
about 50% of incremental capacity over FY11-FY15E from 41% in FY11.
Assuming consumption CAGR of 9.3% over FY12E-FY15E, we believe this will lead to a
surplus capacity of about 6% by FY14E and 12% by FY15E versus the deficit of 8.5% as
of FY11.
If the c.120GW capacity as discussed above comes onstream, the PLF would decline to
53% in FY15E from 61% in FY11 (67% vs. 75% for coal-based), assuming surplus of
zero. However, if the capacity addition is lower at 97GW, the PLF in FY15E would
increase to 56% for overall sector and 72% for coal-based capacity.
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