Tuesday, September 1, 2009


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.

To see full report: POWER FINANCE