Don't be lured by PFC, REC valuations

Investors should gauge if they meet the promise on loan upgrades before taking new positions

At a time when the Street was giving up hopes on India’s exclusive power financiers Power Finance Corporation (PFC) and Rural Electrification Corporation (REC), the bailout plan for distressed state electricity boards (SEBs) and some traction from renewable power projects lent a helping hand to both. This is also reflecting in their September quarter (Q2) numbers. Yet, these are only temporary rescue measures.

The long-term pipeline for both does not look as strong as a few years ago, thanks to the slump in the sector. In the near term, protecting asset quality and reducing loan losses is crucial. To do so, it is important both witness upgrade or improvement in their stressed loan portfolios. Upgradation of an account would eliminate the need to provide for it and enable the financiers to recognise interest income as well.

Positively, PFC after its Q2 results has forecast Rs 8,300 crore of upgrades, most of which is likely to flow in the December quarter. For REC, the forecast is Rs 9,000 crore, which it expects would come from SEBs in the coming quarters. Thanks to upgrades worth Rs 11,000 crore, PFC was able to maintain a year-ago level of net profit, despite net interest income (NII) slipping five per cent.

For REC, its NII fell 16.6 per cent over a year (down 8.4 per cent sequentially), leading to a 17 per cent decline over a year in operating profit. As loan a private power generator had to be restructured, provisioning costs more than doubled, thereby resulting in a 30 per cent decline over a year in net profit to Rs 1,215 crore. The good thing is asset quality was kept under reasonable check.

Bettering expectations, PFC and REC posted seven per cent and 10 per cent increase, respectively, in their loan book, helped by demand from the power transmission and generation segment. They also maintained net interest margin at over four per cent, lower than the peak five per cent, still favourable compared to that of corporate-facing banks.

Therefore, when the loan book is improving, containing slippage and loan losses on a sustained basis are needed. Until PFC and REC do so, their benign valuations (1x FY18 price-to-book) alone don’t make them an attractive proposition. In fact, public sector banks and their private peers such as ICICI Bank, far more diversified, are now available at these valuations.