PFC FPO Review by India Infoline (Apply)

Review By India Infoline Ltd on May 10, 2011

Issue opens: 10-May-11
Issue closes: 13-May-11
Price band (Rs): 193-203
Face value (Rs): 10
Issue size (mn nos): 229.6
Issue size (Rs bn): 44.3 - 46.6
M-cap @ lower and upper band (Rs bn): 255 - 268
Issue type: 100% Book building
Industry: NBFC

PFC provides a comprehensive range of financial products and related advisory and other services for companies in the power sector, including for generation (conventional and renewable), transmission and distribution projects as well as for related renovation and modernization projects. Its clients include the power utilities of state, central and private sector. Company provides fund based financial assistance (project finance, short-term loans, buyer's line of credit, etc) as well as non-fund based assistance (default payment guarantees, letters of comfort, etc). PFC also provides various feebased technical advisory and consultancy services for power sector projects. In addition, company is involved in various Government programs for the power sector, including acting as the nodal agency for the UMPP (Ultra Mega Power Projects) program and the R-APDRP (Restructured Accelerated Power Development and Reforms Program) and as a bid process coordinator for the ITP (Independent Transmission Projects) scheme.

PFC's project financing activities have been focused primarily on thermal and hydro generation projects. Generation projects constituted about 85% of the company's loan assets and 74% of the outstanding sanctions. Company has highest exposure (65% of loan assets) to state power utilities (SPUs) and state electricity boards (SEBs). Company has also strategically expanded its focus areas to include projects that represent forward and backward linkages to the core power sector projects.

Proxy play on the power capex in the country

India has continuously experienced shortages in energy and peak power requirements. According to CEA's monthly review published in March 2011, the total energy deficit and peak power deficit for March 2011 were approximately 7.5% and 10.3%, respectively. The demand for electricity has consistently exceeded the supply, and the demandsupply gap has been widening. During the 10th Five Year Plan, there was significant underachievement of the power generation target and even during the 11th Plan, capacity additions are running behind schedule. A tentative capacity addition of 100,000 MW has been envisaged for the 12th Plan. The total fund requirement to achieve the 11th Plan and the 12th Plan targets has been estimated at ~Rs10.3tn and Rs11tn, respectively. This huge requirement of funds simply indicates the future opportunities for financing in the power sector.

In this scenario, PFC has witnessed a robust loan CAGR of 23% over FY06-11. More importantly, growth has been consistent in the aforesaid period. Quarterly sanctions and disbursements have picked up over the past few quarters. Loan growth for FY11 stood strong at 25%. With substantial visibility in the form of outstanding sanctions of
Rs1.7tn (1.7x loan book), we anticipate PFC to register a 20%+ loan CAGR over the next three years.

Access to competitive cost of funds

PFC's financial strength, strong credit ratings and IFC (Infrastructure Finance Company) status (accorded in July 2010) enables it to access funds at competitive rates from various sources. Company's primary sources of funds are rupee-denominated bonds and commercial borrowings. Being an IFC, PFC is eligible to issue infrastructure bonds that offer certain tax benefits and raise ECBs up to 50% of its owned funds under the automatic route. Further, a bank's exposure to PFC now attracts a lower risk weight of 20% v/s 100% earlier as PFC is 'AAA' rated IFC. During the 9m FY11, company's cost of funds stood at competitive 8.4% despite most borrowings being unsecured.

Spread and margin likely to stabilize in the medium term

PFC witnessed a sharp decline in spread and margin in Q4 FY11 due to a spike in the cost of funds driven by re-pricing of a large liability. Over the medium term, margin is likely to stabilize or improve, aided by improvement in system's liquidity (will ease wholesale rates), re-pricing of sizeable loan assets (higher than liabilities) and benefit from the ongoing equity issuance.

Strong asset quality; escrow protection for Govt exposure

PFC's GNPL have been historically negligible in the range of 0.01-0.03% of the loan assets despite having significant exposure to SEBs and SPUs. Majority of the loan assets in case of public sector clients are secured either by a charge on the project assets or by a State Government guarantee, or both. In addition, as of December 2010, 84% of loan exposure to Central and State sector borrowers had an escrow mechanism, which ensures that in case of default in payment of dues by such borrowers, the escrow agent would make available the default amount to the company on demand. In case of private sector clients, company's loan is secured through a charge on the relevant project assets, collaterals such as pledges of shares held by promoters, personal/corporate guarantees and trust and retention arrangements.

RoA and RoE impressive; subscribe as FPO valuations are attractive

PFC has been earning a much higher RoA at close to 3% as compared to commercial banks despite the latter's advantage of materially lower cost of funds. Superior RoA has been driven by robust NIMs, marginal cost/income ratio and negligible provisioning for NPLs. RoE too has been impressive near 20%. Going ahead, RoA would improve on account of equity issuance while RoE may correct marginally.

PFC has significantly underperformed (by 33%) the broader market over the past 6 months on account of various concerns such as potential spike in NPLs due to high state exposure, possible moderation in disbursements amid execution issues in the power sector and adverse impact of increasing rates and tight liquidity. Most of these concerns have been overplayed as company's performance on these issues has been better-than-expected in the recent quarters. We recommend subscribing in the FPO as the implied valuations are attractive at 1.4-1.5x P/BV as at December 2010.

Key risks include

Interest rate and liquidity risks - 65% of PFC's borrowings are at fixed rates with remaining at floating rates as compared to a large part of loan assets which carry fixed interest rates with a three year reset clause. Further, company's borrowings have a shorter maturity as compared to its loan assets.

Significant exposure to SEBs and SPUs - 65% of PFC's loan assets exposure is to historically loss making SEBs and SPUs. The latter also face high operational risks. There have been frequent instances of loan restructuring.

Intrinsically linked to the fortune of the power sector - Being a power financing company, PFC's performance is intrinsically linked to the execution and profitability of power projects financed. Issues with respect to land acquisition and environmental clearances and increasing interest rates have been moderating the pace of capacity additions.

Power Finance Corporation (PFC), a Government-owned specialized NBFC, has witnessed strong growth in loan assets over the past five years driven by significant investments in the power sector. Company's NIM has been robust and RoA/RoE have been impressive. PFC has come out with an FPO to augment its capital base so as to support medium term loan growth.

Conclusion / Investment Strategy

We recommend investors to subscribe in the issue, which has a price band of Rs 193 - 203 (4-9% discount to market price), as implied valuation is attractive at 1.4-1.5x P/BV as at December 2010.

Reviewer recommends Subscribing to the issue.

Review By India Infoline Ltd on May 10, 2011

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