PFC

Investors with low-risk appetite can consider the Power Finance Corporation (PFC) stock, as the stock is trading at attractive valuations after being beaten down in the stock market crash. With markets in a corrective phase, investors should buy in small lots to take advantage of price declines. Stable Net Interest Margin, high demand for credit, government guarantees for its loans and lower risk weights assigned to the company (20 per cent of capital) place it in a better position than other NBFCs and banks.

At the current market price of Rs 123, the stock is trading at 1.6 times its September-end book value and 11.3 times its trailing one-year earnings. That is at a substantial premium to the nearest competitor — Rural Electrification Corporation (seven times). PFC’s larger balance sheet with high quality advances and stronger focus on the power generation sector make it a better investment option.
Business overview

PFC is a leader in power financing, with a 20 per cent market share. To meet India’s growing energy demand, the government has ambitious plans of adding 92,000 MW by 2012. Current installed capacity is 147 GW (1 GW=1000MW). More than Rs 10,31,600 crore investments is estimated to be required in the power sector during the Eleventh Five Year plan. PFC as a chief financier, a nodal agency and consultant to power generators will be one of the key players to tap into this opportunity. PFC lends to central government PSUs such as NTPC, NHPC, PGCL, Neyveli Lignite, state electricity boards and to private sector power generators as well as transmission and distribution players.

Low operating costs (4 per cent of operating profits in first half of the year), diversified incremental disbursals, ability to source funds in a tough market at lower rates and minimal regulatory intervention in its business are some of key competitive advantages that PFC has over peers in the financial services business.

Financials

The advances book of the company has been growing at 19 per cent CAGR in the last five years. In the first half of 2008-09, profit growth was at a modest 6 per cent though net interest income grew at 23 per cent.

NII growth was driven by a 24 per cent growth in advances and a stable NIM. Profit growth would have been higher if not for the forex loss (Rs 97 crore against Rs 12 crore profit in 2008) on foreign borrowing, which constitutes 5 per cent (part of which is not hedged) of the total borrowing.

But a stable rupee may help reverse these losses. Going forward, PFC appears capable of sustaining its margins as interest rates decline, as disbursals gain pace.

In recent quarters, PFC managed to maintain Net Interest Margin and spreads above 3.7 and 2 per cent, respectively. Though the longer “reset” periods on PFC’s loans led to lower NIMs in a rising interest rate scenario, they may actually help retain the NIMs in a falling interest rate scenario.
Loan mix

The loans extended by PFC to the state government entities now constitute 75 per cent of the loan book, having come down from 77 per cent in FY08. Though the state electricity boards are making losses, the loans given by PFC are relatively insulated from these losses as separate government guarantees and escrow accounts are maintained to shield PFC from the risks in lending to SEBs. While Central government entities account for a good portion of PFC’s new funds sanctioned, it is the State entities that continue to get the major part of disbursals. In the first half of 2008-09, PFC’s outstanding disbursal/sanction ratio fell to 33 per cent. The asset quality of PFC’s book is very high with NPA being as low as 0.02 per cent, though 46 per cent of the advances book is unsecured.
Funding

In order to fund its lending activities, PFC borrows mainly through bond issues and from the banking system.

Though the company does not have access to a low-cost fund base such as banks, PFC’s high credit rating, equivalent to sovereign rating overseas, enables it to source funds at lower costs.

PFC’s NBFC status may help it benefit from any revision of bank limits for lending to NBFCs.
Growth prospects

Given the gap between sanctions and disbursals, PFC has substantial room to grow advances. Loans sanctioned and yet to be disbursed stand at Rs 1,13,467 crore as on September 30, in addition to the new funding requirements.

With many players wanting to enter power equipment, this sector too offers substantial potential, given the ongoing funds crunch.

Unlike banks and other NBFCs, PFC need not invest in low-yielding securities to meet regulatory requirements; this helps lift the overall yield on assets.

PFC has a 16.6 per cent stake in the newly set up Power Exchange, and this may also add to the other income of PFC. PFC has already exceeded its credit offtake target for the year.
Risks and concerns

The prospects for PFC hinge to a large extent on the pace of progress in capital projects in the power sector. Delays in capital spends in the sector or a postponement or scaling down of power projects may lead to slower growth for PFC. Project delays could also force defaults or delayed payments, which may lead to lower asset quality.

Delays in awarding bids under the Ultra Mega Power Projects, for which PFC acts as nodal agency, will deprive it of fees and also represent opportunity lost for funding.