ICICI Direct : Buy Power Finance Corporation

(BSE: 532810 | NSE: PFC | ISIN: INE134E01011)

Company Background Power Finance Corporation (PFC) is a leading public financial institution and an NBFC providing fund and non-fund based support for the development of the power sector. In 1999, the government granted a mini navratna status to PFC. PFC’s clients include power utilities, both central and state, power departments, private power utilities (including independent power producers), joint sector power utilities, power equipment manufacturers and power utilities run by local municipalities. The company channels investments into the power sector and functions as a vehicle to develop the sector. PFC came out with its first public issue in Feb 2007. In FY07, the company clocked a net profit of Rs 1,152 crore.

Investment rationale Huge opportunities in power sector The government has set an ambitious target of providing ‘Power for All’ by 2012. Based on the 16th Electricity Power Survey prepared by the Central Electricity Authority (CEA), India would require additional capacity creation of nearly 100,000 MW by 2012 to achieve this goal. Investments amounting to US$ 155 billion have been lined up in the power sector over FY07-12E. PFC’s leadership position in power financing with superior domain knowledge is expected to provide further fillip business.

High capital adequacy ratio, low leverage PFC’s capital adequacy ratio as on Dec 2007 was 19.07%. The company has leveraged its equity by 5.85x, which gives ample scope to leverage its balance sheet further. The company’s loan book grew 16% during the first 9 months of FY08 to Rs 47,129 crore. During the 10 Five-Year plan (2002-07), PFC contributed close to 23% of loans to the power sector fund allocation the requirement. Of total loan book, power generation sector occupies about 67% of total disbursements. We believe the company would continue to maintain its share and should grow its loan book at 23% CAGR over FY07-09E. Resource profile is skewed towards debt bonds making 42% of total liabilities.

Improving spreads to boost net interest income Yield on assets has improved 102 bps and cost of funds increased by 72 bps giving an overall jump 30 bps in spreads for 9MFY08. Re-pricing of assets at higher rates in recent past has helped PFC improve its net interest income by 39% during the first nine months. Net interest margins (NIMs) jumped 44 bps to 3.75% from 3.31%. We expect the NIMs to be in the range of 3.5% -4% going forward.

High operating efficiency PFC has a low-cost model with hardly a few outlets and hence its operating costs are low. Employee cost forms a major part of total cost (405), which may go up slightly in next year due to wage revision. Still operating expenses/assets ratio is one of the lowest at 0.1% for 9MFY08. This has led to maintaining higher profits and RoA for the company.

Key Concerns

  • Power projects carry certain inherent risks attached to them. These could adversely affect business and financial performance as losses can be lumpy at times.
  • Significant shortages in the supply of crude oil, natural gas or coal could adversely affect the Indian economy and the power sector projects to which company has exposure.
  • Political instability or changes in the government could delay the liberalisation of the Indian economy and adversely affect economic conditions in the country.

Financials As of December 31, 2007, the company made cumulative sanctions of Rs 43,607 crore and cumulative disbursements of Rs 9,726 crore to power sector projects. PFC posted a net profit of Rs 911 crore for 9MFY08 as compared to Rs 615 crore during same period last year, recording a growth rate of 48% (this was on the back of healthy 39% growth in the net interest income, over 100% growth in other income and low operating expenses-to-assets ratio). The average interest spread has increased from 1.72% in 9MFY07 to 2.0% in 9MFY08. In addition, there has also been a decline in the gross NPAs from 0.21% to 0.03%. We expect a 30% CAGR in PAT over FY07-9E.

Valuations PFC has improved its RoNW to 14.36% from 12.15% giving a jump of 221 bps. Return on assets (ROA) has been consistently improving since listing with 9mFY08 annualised ROA at 2.45% as against 2.34% for FY07. Consultancy and advisory fees from power projects is also increasing rapidly showing 100% jump in first nine months. With business potential being huge for PFC, we believe at 2x FY09E P/BV, the stock has more upsides. We value the stock at 2.5x FY09E BV giving a target price of Rs 224, a 20% upside from current levels.

Technical Outlook The stock is currently trading near its 200-day EMA of Rs 194. Volumes have been gradually increasing along with the rise in prices, an indication the stock is being accumulated at current levels. We can expect a strong positive breakout in the coming days. On the charts, the stock has been trading range-bound between Rs 156 and Rs 185. A decisive move above the Rs 198 levels with good volumes could further propel it to Rs 210-232. On the downside, it has strong support at Rs 166. A fall below this level could see it go further down to Rs 148 levels

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Every week ICICIdirect research team will select a stock based on fundamental and/or technical parameter, which is likely to return 20% over a 3-6 month perspective.

Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.