Power of money

IPO REVIEW

Though Power Finance Corporation will benefit from the capacity additions in the power sector, its declining margins is a concern.

On the face of it, Power Finance Corporation (PFC) is in a great business. The economy is growing at a scorching pace, and there is acute shortage of power, especially during peak hours, across the country.

The government is addressing the issue by encouraging investments in power generation and distribution capacities.

PFC, a power sector focussed public financial institution, provides investors an opportunity through its initial public offer (IPO) to participate in the country's power reforms.

The company plans to raise about Rs 854-994 crore in the price band of Rs 73-85 by offering 11.7 crore shares, which will dilute the equity by around 10 per cent.

But PFC's financials are not encouraging for investors to jump into it blindly. In spite of the company being well placed in terms of business opportunities, its performance has not reflected the growth of the Indian power sector achieved so far.

However, analysts feel that the issue is reasonably priced and investors should have a long term horizon though there are equally good stocks available currently at similar valuations.

Reforms providing triggers
The government has gone a long way in boosting the Indian power sector with a series of reforms like the Electricity Act, Accelerated Power Development and Reform Programme (APDRP), Power for All by 2012, ultra-mega power projects and the recent opening up of transmission networks to private players.

But there are still many opportunities and a lot needs to be done to solve India's serious power shortage due to the lagging growth in power generation capacity as compared to actual requirements.

Analysts estimate that the capital spending in power generation alone in next decade will run into trillions of rupees. Thus PFC, which works closely with the power and finance ministries, is well placed in this regard.

Specialised power lender but...
The company offers a range of financial products and fee-based advisory services to infrastructure projects in the power and allied sectors. Its client include state, central and private power utilities involved in generation, transmission and distribution and power equipment manufacturers.

The company intends to diversify its borrower profile and include various other projects like funding coal, oil, lignite, oil and gas companies and projects of non-conventional energy sources such as wind farms, small hydro projects and bio-mass projects.

The company is also a nodal agency for the ultra-mega power projects. While all these make PFC well-poised to benefit from the growth in the sector, but there is a catch.

...profitability under pressure
Though sanctions and disbursements, loans and total assets have grown at a robust pace in the past few years, it has not trickled down to profitability in the same proportion. Its net interest margin"�the key parameter for assessing the profitability of the core business"�have been declining over the past few years.

Says Shyam Wadhera, director (projetcs), PFC, "Margins are lower in the market for almost all the players in the financial sector, who are betting on volumes."

Even Ajit Dange, analyst, UTI Securities agrees that the company does not have the pricing power as it is not the only one scurrying for power or infrastructure projects. Even banks have increased their lending to infrastructure projects in order to diversify their loan portfolios.Thus, margin pressure will continue.

But Kashyap Jhaveri, analyst, Emkay Shares and Stock Brokers feels that PFC is better placed as there is a limit to which banks can lend due to asset liability mismatch.

He expects the company's disbursements to continue to grow at 20 per cent over the next two to three years and margins to improve as the old loans will get re-priced with the PLR hike of about 100 basis points undertaken by the company in the last 12 months and interest rate re-set clause being applicable from July.

The key risk to the company's performance is the viability of power projects and expensive rupee term loans (the largest component in the company's borrowings) in the rising interest rate scenario. But this should not be a problem as being a NBFC focussed on power (infrastructure), it has flexibility to raise money overseas. 
 

LOW-VOLTAGE MARGINS
Rs crore	FY05	FY06	% chg	FY07*	% chg
Net interest income	1234.50	1155.50	-6.40	1278.00	10.60
NIM (%)	4.50	3.40		3.37#
Net total income	1241.50	1157.60	-6.80	1281.70	10.70
Operating profit	1188.30	1100.00	-7.40	1228.70	11.70
Net profit	776.10	849.60	9.50	824.40	-3.00
* annualised half yearly results                                                               # H1FY07

There is a silver lining
The key positive for the company is the fact that it is highly under-leveraged with a long-term debt to equity of 4-5 times (on diluted equity) as against an industry average of 10 times.

Thus, the company has a lot of headroom to improve its current low return on equity in the future. Jhaveri expects return on equity to touch 15-16 per cent in next two-three years.

Also, despite some of its borrowers incurring losses, its gross non-performing loans are negligible at less than 0.5 per cent as against the industry average of about 3 per cent.

Further, its administrative overheads as a percentage of total assets are about 0.12 per cent against the industry average of 2 per cent. Hence, the productivity is better than others.

Unimpressive financials...
In FY06, the company's net interest income declined 6 per cent though net profit before extraordinary items grew 9 per cent. If half yearly results of FY07 are annualised then, the net interest income would grow by about 10 per cent year on year in FY07, while net profit before extraordinary item is expected to decline by a marginal 3 per cent thanks to almost doubling of provisions and contingency.

... but valuations are reasonable
The issue is fairly priced at about 1.2-1.3 times and less about 1 times for estimated FY07 and FY08 book value respectively.

Some of the bigger banks like Bank of Baroda, having the lost cost advantage and a diversified portfolio are also available at a similar valuations, though infrastructure focussed player IDFC, is trading at a high valuation of around 3 times estimated FY08 book value.

Says Dange, "The issue looks decent at the lower end, while richly priced on the higher end."

Adds Kanan Shah, analyst, Networth Stock Broking, "IDFC is a better play if it were trading at similar valuations of PFC due to its wider exposure and also higher fee based income."

In any case, the issue is more suitable to long term investors looking for a power focussed play.