Stock Review: Power Finance Corporation (PFC)

The stock of the staterun lender Power Finance Corporation (PFC) fell over seven per cent in the last two days over lacklustre March quarter results. The scrip has underperformed the BSE Bankex by 27 per cent in the last one year due to concerns over asset quality deterioration given the growing state electricity boards (SEB) losses and a net-interest margin (NIM) contraction in a higher interest rate scenario. Further, uncertainty around the slow pace of project execution and availability of coal for power projects is also an overhang on its stock. On the positive side, quicker reforms in the power sector and reduction in SEB losses will be the key triggers for the stock. Moreover, its upcoming follow-on public offer (FPO) will push its capitaladequacy ratio to 22 per cent from over the prevailing 17 per cent. Analysts believe PFC's leadership position, coupled with its lower exposure to the transmission and distribution segment gives it an edge over its closest peer Rural Electrification Corporation (REC). In the near term, analysts believe the stock will continue to face downward pressure given its concentrated exposure (top 10 borrowers forming 54 per cent of loan book) and higher cost of funds.

MODERATING CREDIT GROWTH, NIMS

Factors such as poor SEB health, constraints in fuel linkages, slower pace of obtaining environment clearances could dampen the investment in the power sector, making power financiers such as the PFC, REC adopt amore cautious approach to lending. In addition, in order to protect their margins, they have also raised rates by 150200 basis points to 12-13 per cent in the past six months.

A strong sanctions pipeline of over `1.7 trillion till March, provides good visibility in the near term. However, owing to ahigher-base effect, PFC's loan growth will slowdown from the historical levels of 22 per cent plus to 17-20 per cent compound annual growth rate (CAGR) over FY11-13, believe analysts. Also, the return on equity (RoE) is estimated to fall by 200-300 basis points to 16–17 per cent over FY11-13 due to dilution.

While experts believe NIMs are near their peaks, the decline is likely to be checked by a higher share of lower-cost loans such as external commercial borrowings (ECBs) and tax-free infrastructure bonds that carry lower coupon rates. Further, PFC's FPO float would also support its margins. Its NIMs are set to hover at the 3.90-4.10 levels over FY11-13.

ASSET QUALITY, RISING COSTS KEY RISKS

Ballooning SEB losses have put the asset quality of power financiers such as PFC under the microscope. The SEB cash losses have risen from `6,500 in 2006-07 to `28,400 crore in 2008-09. Inadequate rate rises and slower turnaround of transmission and commission losses are the main culprits behind. While these SEBs have been regular in their payments to lenders such as the PFC, their drying cash-piles may not enable them to do so going forward. Though the government has taken initiatives to curtail the SEB losses, it may take a while before we can see any material impact, as these measures are still in the initial stages of planning.

While the PFC's gross and net NPAs have remained negligible in the last five years, defaults (it does not make provisions for loans turning bad) and higher credit costs could impact its balance sheet and earnings, respectively.

Analysts at Religare Research believe, a 100 basis points rise in credit costs is likely to compress PFC's RoE by 350–360 basis points and earnings per share (EPS) by 530 basis points.

MARCH NUMBERS DISAPPOINT

For the Jan-March quarter, PFC's net profit stood at `607 crore, registering a muted growth of one per cent yearon-year (y-o-y). While the loan book grew a strong 25 per cent y-o-y to `99,571 crore, net interest income (NII) growth remained subdued at 15 per cent y-o-y to `827 crore. The lower NII growth is attributed to a higher wholesale borrowing costs. Total income grew 25 per cent y-o-y to `2,623 crore.

Asset quality stood strong with gross non-performing assets (NPAs) of 0.01 per cent. Higher cost of funds resulted in an estimated 30 basis points y-o-y contraction in net interest margins (NIMs) in the quarter to 2.8 per cent.