Tough times ahead for PFC, REC

After a weak Q4, the companies could see subdued loan growth and margin compression: Analysts

Stocks of power financiers Power Finance Corporation (PFC) and Rural Electrification Corporation (REC) have risen sharply in the past one year amid expectations of improving growth prospects and improvements in asset quality in the power sector. While PFC has surged 62 per cent, REC has gained 156 per cent in this period, beating the benchmark S&P BSE 100 index (up 20 per cent). However, their performance in the March quarter (Q4) did not match the yearly feat.

Falling interest income impacted the top line growth of the companies in the quarter. Most of this weakness can be attributed to a reversal of growth in interest income due to higher slippages. The key disappointment came from a sharp rise in provisions for bad loans — particularly on a sequential basis, which shows the incremental stress in the March quarter. Reducing the period of recognising a loan as a bad loan (after repayment stops) from 180 days to 120 days is a key reason behind the sharp rise in provisions for PFC. 

Both these companies have started following the RBI’s prudential norms on restructuring loans, which have pushed up their provisions in the quarter. Though both are confident of upgrading a large part of these accounts over the next couple of years, analysts have concerns.

“We believe that state governments and state electricity boards will negotiate lower rates of borrowing from PFC/REC after successfully reducing their borrowing costs from the Uday scheme. This, we estimate, could lead to a spread compression of about 150 basis points for PFC/REC during FY2016-19,” says Nischint Chawathe, analyst at Kotak Institutional Equities. He says that these companies’ return on equity ratio too could come down to 10-12 per cent by FY19 from 17-18 per cent now. The fact that the demand has been languishing despite high capacity additions in the power sector means loan growth for PFC and REC could be in low- to mid-single digits.

Harshit Toshniwal, analyst at ICICI Securities, says: “There were additional non-performing assets and restructured assets of around Rs 50,000 crore for PFC in Q4. According to the management, a significant amount of these restructured assets will be recovered in FY18 and FY19, and aid PFC’s profitability.” While the improving pace of upgrades and recoveries is a positive, investors must monitor whether the upgrades will be able to offset these pressures adequately.

At current levels, PFC and REC trade at 1 and 1.5 times the FY18 estimated book value, which is not expensive. However, most analysts say this number fails to capture the growth and profitability risks adequately.