>POWER FINANCE (IDFC SSKI)

Alleviating 'power'ty

The significant policy focus on reducing the acute power shortage prevalent in the system is driving huge investments into the power sector. This translates into a lucrative opportunity for power financiers like PFC and REC given that power projects typically entail a debt to equity ratio of 3:1. Based on the Rs10.3tn spend on power sector envisaged during the 11th 5-Year Plan period, we arrive at Rs1.3tn of disbursements opportunity for PFC and Rs1.2tn for REC (an aggregate 40% of the estimated debt component). On their part, the lenders are well-placed to capitalize on the prospects owing to competitive funding costs and a lean operating structure. Accordingly, we expect the growth momentum to propel 22- 29% CAGR in earnings (pre-exceptional) of PFC and REC over FY09-11. Given the high earnings visibility and improving return ratios, valuations appear attractive. Initiating coverage with an Overweight stance and Outperformer on PFC and REC.

■ High growth visibility: In view of the acute energy deficits and deficiencies in T&D infrastructure, massive investments are lined up in the power sector during the 11th (Rs10.3tn) and 12th (Rs11.4tn) 5-Year Plans. With rich experience in lending to the sector, PFC and REC are well-positioned to leverage the emergent financing opportunities. Accordingly, we expect 21% and 27% CAGR in disbursements for PFC and REC respectively over FY09-11.

■ Earnings momentum to remain strong: We expect structurally competitive funding costs to support healthy margins for PFC and REC in the near term. Robust business growth and steady margins are likely to propel a 23-28% rise in NII over the period. Also, while superior asset quality will keep credit costs insignificant, operating expenses are likely to be low, and PFC and REC would witness a strong 22% and 29% CAGR in pre-exceptional earnings over FY09-11.

■ Attractive valuations; we see 23-30% upside: Considering the high growth visibility, valuations of 1.8x-1.9x FY11E book are attractive. While PFC has historically traded at a 24% premium to REC, the premium differential has narrowed owing to REC’s improving growth prospects, steady margins and a stronger RoE. We are Overweight on the sector with our target prices offering 30% upside on PFC (based on 2.4x FY11E book) and 23% on REC (2.3x) from CMP.

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