PFC, REC may be valued upwards

Both have managed to hold up their NIMs at 4.8-4.9% so far in FY17, and could again reach 6% in FY18

Even as many frontline stocks of non-banking financial companies (NBFCs) struggled to maintain their yearly gains in 2016, Power Finance Corporation (PFC) and Rural Electrification Corporation (REC) managed to defy the trend, closing the year with 36 and 24 per cent gains, respectively. This comes after both underperforming the Sensex in 2015 and both touching a two-year low in February 2016, after many questioned their road ahead. What really stands out is their outperformance relative to Sensex in 2016, which was backed by financials, especially from June quarter onwards. 

Three factors favour investment in PFC and REC. First, as both have 66-74 per cent exposure in state power distribution companies (discoms), rising participation of state electricity boards (SEBs) in Uday (Ujwal Discom Assurance Yojana, a restructuring effort to improve the financial health of SEBs) is helping PFC and REC increase their SEB share. Under Uday, as respective state governments take over SEB debt, the loan of financiers is repaid. Accordingly, PFC received Rs 21,315 crore in September quarter as repayment from SEBs, which helped it post net profit of Rs 1,873 crore, significantly higher than analyst estimates. Loan outstanding of assets under Uday for PFC now stands at Rs 24,000 crore. REC, which received a bulk of its SEB repayments in June quarter, also saw similar gains. 

In fact, with both financiers performing better than anticipated, analysts have revised their earnings target for PFC and REC upwards (see table). These inflows have also helped post 11 per cent and 26 per cent increase in loan disbursements for REC and PFC so far in FY17. This contrasts with the earlier notion that SEBs could stay away from building fresh capacities. Also noteworthy is generation-related loans have increased far better than expectation. PFC has increased its disbursements to power generation by 20 per cent so far in FY17; REC has more than doubled its disbursements to power generation projects. Last, as much of the financing requirements for PFC and REC are met through bond issuances, the falling bond yields lent another helping hand for these companies. PFC and REC have managed to hold up their net interest margins (or net interest income as percentage of total assets) at 4.8-4.9 per cent so far in FY17 and analysts believe that with bond yields still looking favourable, NIMs may once again bounce back to the six per cent zone in FY18. The three factors allay concerns on PFC and REC to a large extent. 

Going forward, if PFC and REC keep pace with loan disbursals (extremely critical), these stocks could witness some re-rating and benefit from unimpressive outlook for retail-oriented NBFCs.