Power Finance Corporation: Buy

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Fresh investments can be considered in the Power Finance Corporation (PFC) stock that appears a good defensive bet within the financial sector.

The company's loan book grew at a strong pace of 20 per cent in 2009 despite lower demand for credit witnessed by the banking sector. At current market price of Rs 252, the PFC stock is trading at 10.5 times its estimated FY11 earnings and two times its estimated adjusted book value, which does not reflect the strong earnings growth posted by the company.

Near-zero non-performing assets and a high proportion of floating rate assets (87 per cent) allow PFC to pass on interest hikes and minimise credit risk. Strong earnings growth (36 per cent for nine months ended December 31, 2009, adjusted for extraordinary items), superior profitability (Return on Equity of 17 per cent) and the insatiable funding requirements of the power sector make for bright growth prospects.

The outlook for power financing looks promising given that investments of Rs 10 lakh crore are expected in the power generation alone over the next eight years. PFC being the market leader may corner a chunk of this pie.

With a minimum 70 per cent of every power generation project to be funded with debt, PFC may continue to witness high levels of sustainable loan book growth over next few years. That power companies have preferred the domestic market to overseas borrowings also benefits PFC.

The gap between PFC's sanctions and disbursements stood at around Rs 1.25 lakh crore by December 2009 due to project delays until previous quarter. However, in the third quarter, the disbursements outpaced sanctions, indicative of improving investment environment for power project development. Loans sanctioned (not disbursed) amount to 1.72 times its loan book.

A sovereign credit rating gives it opportunity to borrow at reasonable rates. The majority of liability profile is fixed allowing it to lock-in at low interest rates. Going forward, the asset-liability mismatch, however, is a lingering concern with loan tenures of over 15 years, while liabilities typically have the highest tenor of 10 years. Currently, the average maturity is 5.8 years for loans compared to 4.55 years on borrowings.

With interest rates hardening, PFC's margins may be held (4.2 per cent for nine months ended December 2009). Currently, the State electricity boards are the key borrowers, but the proportion is coming down. Incremental sanctions are likely to be driven by the private sector. PFC may also look at chipping in for the equity portion of power projects, which may bolster returns on investment.

Fee income may improve as new Ultra Mega Power Projects are awarded. The consultancy and APRDP (Accelerated Power Development and Reform Programme) also improve the fee income. The company is also entering coal mining and equipment financing.

PFC has a comfortable capital base (currently 17.6 per cent) allowing it to expand its loan book seamlessly without raising additional capital.

M.V.S. Santosh Kumar

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