Large sums needed for setting up power infrastructure augurs well for PFC, which has strong domain expertise and a good track record.
The power deficient situation in the country has seen various governments, both past and present, lay emphasis on attracting investments across the generation, distribution and transmission segments of the power sector. While the initiatives have led companies to commit to setting up new capacities, it entails huge investments. Thus, it has enhanced opportunities not only for power companies, but also for companies financing such projects including, Power Finance Corporation (PFC). While concerns pertaining to higher interest rate, tight liquidity conditions and fears over deteriorating asset quality haven’t spared most of the sectors including infrastructure financing, PFC has been relatively insulated with stable growth in loans, greater expertise and dominant position and, an ability to sustain spreads and asset quality.
Bright prospects
Even as huge investments are being made towards setting up power-related infrastructure, the growing energy requirements are relatively unmet—demand-supply gap pegged at close to 10 per cent. As India’s economy is expected to grow at over 7 per cent for many years, the current low per capita energy consumption of 600 units (kilowatt/hour) per head per year (around a third of China’s and a fourth of the world’s average) should inch towards international benchmarks. The government has already envisaged plans to add 79,000 MW of power generation capacity by 2012 with planned expenditure of about $200 billion to cover the demand-supply mismatch. Likewise, the addition of new generation capacity would require an equivalent amount towards allied activities in the transmission and distribution segments, which put together indicates a huge requirement of funds.
Strong position
A dominant position in the power financing business (20 per cent market share) has meant that PFC’s loans sanctioned to the power sector grew by 43 per cent on average in the last five years, while its loan book grew at 20 per cent. For nine months ended December 2008, its disbursements have grown by around 45 per cent, much faster than seen in the past (CAGR of 16 per cent in the last five years), which is indicative of robust loan sanctions done earlier and faster project implementation by power companies. With a jump of more than 120 per cent in sanctions in FY08, the disbursements would be healthy going forward into FY10. Also, considering that a power project (which takes an average 42-48 months to complete) sees maximum disbursements happening towards the end of a project implementation cycle, it also indicates robust disbursement in the future as well.
| POWERING AHEAD | |||
| in Rs crore | FY08 | FY09E | FY10E |
| Total income | 1,860 | 2,169 | 2,562 |
| Net profit | 1,210 | 1,447 | 1,739 |
| EPS | 10.52 | 12.58 | 15.12 |
| P/E (x) | 13.01 | 10.88 | 9.05 |
| P/BV (x) | 1.67 | 1.51 | 1.36 |
| E: Analyst estimates | |||
PFC has been designated as the nodal agency for implementation of various power schemes as well as Ultra Mega Power Projects (each costing around Rs 16,000 crore); this enables the company to undertake all activities necessary to obtain the appropriate clearances required to establish the UMPPs for a fee. Four UMPPs have already been awarded to successful bidders, and another nine are yet to be announced. With PFC being closely associated with the passage of these projects, there is also the possibility to lend to these projects.
Macro cushion
Even as the lending rates of banks are lower than power lending institutions like PFC (thanks to access to low-cost CASA deposits), regulatory framework as well as the humongous fund requirement provides enough growth opportunities for niche companies like PFC. As a specialised power financier and a track record (has funded 23 per cent of the total installed capacity in the country), PFC has vast domain expertise. As power projects involve a large portion (around 70 per cent) of debt financing, PFC would ensure easier accessibility of funds as a single source compared to banks, which typically have to adhere to caps on the amount of loans given to a single sector/company/business group. Being a NBFC, PFC is also not required to maintain statutory funds (like CRR, SLR in case of banks) thus, an exemption from blocking significant portion of funds in low-yielding assets. Banks would also have to provide for relatively lower risk weights (around 20 per cent) when they lend to institutions like PFC than when they directly lend to power projects. Likewise, given the increase in average project size and the huge investments of over $300 billion required by 2012, it would ensure that all funding agencies would have their share of the pie.
Stable spreads
Despite the movement in interest rates over the last year, PFC has been able to maintain interest spreads (difference between lending and borrowing rates) at around 1.9-2.1 per cent as well as asset quality. The recent fall in rates have enabled PFC to borrow at about 8.5-9.0 per cent (aided by its ‘AAA’ credit rating), thus, marking a steep decline of around 2.5 percentage point in the incremental cost of funds (11.0-11.5 per cent in Q3). Although, lending rates would be revised downwards (13.5-14.5 per cent currently), it would be with a lag, and thus, help sustain spreads. PFC is also likely to be allowed to raise funds through tax-free bonds, which whenever happens, will help in maintaining higher spreads. The management has indicated that spread would be maintained at around 2 per cent in FY10 as well.
Investment rationale
The softening of interest rates not only lowers costs for companies, it also reduces the likelihood of bad debts. PFC’s ability to turn down loans for quality than go for volume growth has helped to maintain asset quality with negligible net NPA (around 0.01 per cent as of December 2008).
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Opportunities also exist in rural electrification space (over a lakh villages are to be electrified) and increasing focus towards non-conventional sources of power like wind, biomass, etc. Large exposures to state utility companies with poor financials although seen as a concern, do not perturb significantly as government guarantees and separate escrow accounts would relatively insulate it from risks arising from them.
At Rs 138.80, the stock is trading at an estimated FY10 book value of 1.36 times and can deliver 18 per cent returns in a year’s time.