Power Finance Corporation: Buy

Investors can consider buying the Power Finance Corporation (PFC) stock at the current price of Rs 175 with a two-three-year investment horizon.

PFC had an exceedingly good first quarter ended June and appears set for exciting times ahead with huge investments projected to be made in the power sector in the next five years.

A strong balance-sheet with almost nil non-performing assets (NPA), focussed business model and lean cost-structure, lend confidence in the company. The stock has more than doubled from its February IPO price of Rs 85 and has risen by 68 per cent from its listing price of Rs 104.
Unique player

PFC is a unique player in the finance sector that specialises in lending to power projects and also offers non-fund-based services. The company mainly lends to thermal and hydel power generation and transmission and distribution projects. It also has a minor exposure to renovation and modernisation projects of existing power stations.

Its borrowers are predominantly State electricity boards and public electricity utilities; it has a minor portfolio of private borrowers who account for 8.4 per cent of gross outstanding loans.

The company is also the lead agency promoting the government’s ambitious ultra mega power projects (UMPP) where it is responsible for securing appropriate clearances to enable the successful bidders to implement their projects.

The positive offshoot of this is a fee for the services that it renders and the possibility of securing business from the UMPP players.
Strong financials

Despite being a lender to some of the most problematic borrowers in the country — state electricity utilities — PFC boasts of a strong balance-sheet with NPAs almost non-existent. The company employs different methods to ensure prompt repayment from borrowers such as a rebate for on-time repayment and an escrow mechanism to protect itself from potential default.

PFC also directly pays the suppliers of its borrowers rather than route the money through the latter. This ensures that the loan is used for the stated purpose of asset creation and is not used by the borrower for other purposes.

The company also closely monitors the financial health of its state-sector borrowers and has the ultimate option of the State government guarantee to encash if the borrowing utility defaults.

All these have helped reduce NPAs to 0.6 per cent of gross outstanding loans of Rs 45,200 crore in the first quarter. This is lower than the 0.10 per cent recorded in 2006-07. PFC is not required to follow RBI norms in this respect and, as per its own prudential norms, any loan where instalment and/or interest remain due for over six months is classified as an NPA.

The company has done extremely well to beef up its net interest margin (a measure of profitability for those in the financing business) at a time of great volatility in interest rates during the first quarter of this fiscal. Net interest margin, at 3.67 per cent during the first quarter, was 0.36 percentage points higher than the same period last year.

Similarly, the spread between borrowing and lending costs has also been widening; it was 1.93 percentage points in the first quarter against 1.71 per cent in the same period last year.

A substantial quantum of PFC’s loan assets is scheduled to come up for interest rate reset in the next couple of quarters and this is likely to increase the spread as also the net interest margin.

Presently, 61 per cent of PFC’s loan assets are subject to reset clause while 34 per cent is on fixed rate basis and a very minor 1.3 per cent is on floating basis.

Net interest income rose by 38 per cent during the first quarter to Rs 414.7 crore while disbursements were higher by 13 per cent at Rs 3,215 crore.
Growth acceleration

The Eleventh Plan envisages a capacity addition of over 68,000 MW from the central, state and private sectors by 2012.

Given the past, this may appear an ambitious figure but it looks attainable because projects adding up to about 31,000 MW are under construction.

Funding for these projects under construction is already tied up but PFC can hope to garner a slice of the remaining 37,000 MW of projects that have been committed. These would require about Rs 1,45,000 crore and those implementing them need to tie up the funds in the next few months.

Even a small slice of this would cause a substantial addition in its loan assets; PFC though, is hoping to fund about 20-25 per cent of this huge fund requirement.

The challenge will be in accessing funds at cheap rates especially because of the new RBI norms that curb banks from lending to non-banking finance companies more than 15 per cent of their (the bank) capital.

Term loans from banks account for almost half of PFC’s rupee borrowings and the new guideline could force the company to borrow from higher-cost sources. In the medium-term, this could cause a compression of spreads, especially if PFC is unable to on-lend at higher rates. This apart, the dependence on a single sector for business causes a concentration risk for the company but what lends confidence is the huge investment that is projected to be made in the power sector and the opportunity arising for PFC from that.

Investors can buy the stock with a medium-term perspective.