Power Finance Corporation (PFC) Analysis – Follow-on Public Offering Buy/Sell Recommendation Not Bad but Not Great Either

Power Finance Corporation (PFC) will raise ~$1 billion through a follow-on-public offer (FPO) which is the first divestment by the Government for FY12.Note the government of India has set a target to raise $9 billion through divestment of public sector (PSU) companies stocks.PTC India Financial Services another company operating in the same segment offering finance to power generation companies came out with an IPO.Despite advantages of growth,a good business model in India’s booming Energy Sector,the valuation of the company had been kept too high leading to 20-30% losses from the IPO price.However PFC does not have a high valuation trading for around 9-10x P/E which is comparable to the competitors like REC.However the valuation is not very low also keeping in mind the rising interest rate environment which is making life tough for the Indian Banks and financial intermediaries.

Price Band,Dates and Offer Size of Power Finance Corporation

PFC price band has been set at  Rs 193-203 per share with a discount of 5 per cent in the issue price to retail investors and eligible employees. The FPO will opens on May 10 and close on May 13 with institutional bidders able to bid till 12 May only. It comprises a fresh issue of 17.2 crore shares and an offer for sale of 5.7, crore shares by the government.The government is divesting 5 per cent of its stake in the public sector company. The government first sold off  a 10 % stake through IPO in March 2007 which relieved a huge response.

Pros and Cons of Power Finance Corporation (PFC)

Advantages

1) Leading Position as a Strategic Organization in the Power Sector– Company has played a strategic role in, the GoI’s initiatives for the promotion and development of the power sector in India for more than two decades.Acted as the nodal agency for the UMPP and the R-APDRP and as a bid process coordinator for the ITP scheme.The company has  management significant experience in the power sector and the financial services industry.

2) Financial and Business Model – The Financial of the company are quite good though lower than REC and other.The Net Margin at more than 25% for the last 5 years is also quite good.The company has seen a profit of Rs 8000 crores with Rs 2250 crore of profit in FY 2010.

3) Growth – The company has been growing at a rapid pace since inception.Total loans  increased from  35581 crores in  2006 to  921,18 crores in  2010 with  a CAGR of 22.6% .The revenues and profits have also grown at a comparable aboe 20% CAGR.

4) Power Industry Attractiveness – The current revised capacity target for the 11th Plan is 78,700 MW. A tentative capacity addition of  approximately 100,000 MW has been envisaged for the 12th Plan. The total fund requirement to achieve the 11th Plan target was estimated as `10,316.00 billion. Similarly, the total fund requirement to achieve the targeted capacity addition under the 12th Plan is estimated at `11,000.00 billion.

5) Navratna and non-deposit taking systemically important NBFC (“NBFC”) IFC by RBI – The company is registered with the RBI as a non-deposit taking systemically important NBFC (“NBFC”) and were classified as an IFC in July 2010. We believe that our NBFC and IFC classification enables us to effectively capitalize on available financing opportunities in the power sector in India. In addition, as a government-owned NBFC, loans made by us to Central and State entities in the power sector are currently exempt from the RBI’s prudential lending (exposure) norms that are applicable to other non-government owned NBFCs

a) It is entitled to lend up to 25% of its owned funds to a single borrower in the infrastructure sector, compared to 20%
of owned funds by other NBFCs that have not been granted IFC status.

b) It is also eligible to raise ECBs up to 50% of owned funds without prior RBI approval.

c) It can raise capital through issuance of infrastructure bonds at comparatively lower yields, as holders of such bonds are entitled to tax benefits

6) Focus on Renewable Energy – Solar Power in India is expected to grow rapidly even as Wind Power in India has already become the 5th largest sector in the world.PFC is establishing a separate division to concentrate on this fast growing renewable energy sector.

Disadvantages

1) High Exposure to small number of Customers and Electricity Sector– PFC has almost 35% of its loans made to 5 customers which makes it vulnerable to a collapse of a major customer.Electricity Sector in India is looking like a Bubble as well (for the short term at least) as every Tom,Dick and Harry enters the power sector in India.Building a thermal power plant has become the latest hobby amongst every business group.This has already led to problems of merchant price crashing and coal prices skyrocketing.

2) Higher Interest Rate Spread and Margins will come down – PFC has had it  higher interest spreads under pressure due to rising interest rates as RBI throws in the kitchen sink to fight double digit inflation

3) Competition Rising in the Power Finance Sector – The company is facing increasing competition with a number of public sector infrastructure finance companies, public sector banks, private banks (including foreign banks), financial
institutions and other NBFCs entering the sector

Power Finance Corp Valuation

Despite its strong growth,the valuation of PFC is reasonable at  9-10x P/E and around 1.3x P/B post the FPO.The company has much same valuation compared to its listed peer REC and PTC and lower than compared to IDFC.

Summary

Power Finance Corporation has substantial advantages of growth,a good business model in India’s booming Electricity Sector where the List of Power Companies are growing exponentially.The valuation of the company also has been kept at a reasonable level at a discount of around 5% from the prevailing stock market price.The growth of the company has been impressive but a rising interest rate environment,competition from other power finance government providers like IFCI,IDFC,REC makes the issue neutral.It is always possible to buy the stock later or buy competitors in the same space like REC.The stock is a good buy for the long term given the fundamentals,good business sector,however current short term macro problems does not make it a great buy .