Improving growth prospects powering Power Finance Corp, REC stocks

All analysts polled this month are bullish on the two power financiers and see further gains of 19-20 per cent in the next one year

There’s investment focus on Power Finance Corporation (PFC) and REC with the two power-sector lenders seeing strong credit expansion, as well as improved asset quality with lower defaults and lower credit costs. Future credit demand should be good due to the policy. The Revamped Distribution Sector Scheme (RDSS) will lead to disbursement of Rs 2 trillion -- equally shared by PFC and REC over financial year 2022-23 to 2024-25 (FY23-25). The late payment surcharge (LPS) scheme provides an opportunity of Rs 1 trillion over FY22-24.

For PFC, net interest income (NII) in the first quarter (Q1) for FY24 was Rs 3,500 crore (up 1 per cent year-on-year (Y-o-Y) and up 0.8 per cent quarter-on-quarter (Q-o-Q)). Net interest margin (NIM) was 3.34 per cent (down 35 basis points or bps Y-o-Y, down 2 bps Q-o-Q). Disbursement rose to Rs 22,800 crore (up 391 per cent Y-o-Y, down 41 per cent Q-o-Q) due to LPS and capex demand from renewables. 

Loan growth was 16.8 per cent Y-o-Y (up 2.3 per cent Q-o-Q). Pre-provision profit was Rs 3,670 crore (up 35.5 per cent Y-o-Y, down 3 per cent Q-o-Q). The sequential decline is due to absence of dividend received during Q1FY24 versus dividend of Rs 480 crore received in Q4FY23. The profit after tax (PAT) was Rs 3,000 crore (up 42.5 per cent Y-o-Y, down 14 per cent Q-o-Q).

Asset quality improved slightly. Provision was negligible at Rs 0.2 crore. The gross non-performing assets (NPA) and net NPA ratios were at 3.82 per cent (down 9 bps Q-o-Q) and 1.04 per cent (down 3 bps Q-o-Q), respectively. PFC deferred interim dividend payout, but announced a bonus of 1:4 (1 bonus share for 4 shares held). PFC is also looking at financing ports, metros and refineries. 

For REC, financing opportunity should imply steady 15 per cent growth in disbursement annually along with new opportunities in renewables, policy initiatives, etc. The loan book should see 16 per cent CAGR between FY23-FY26. Renewables share in loans should rise to 14 per cent (current 6 per cent) while non-power infra, logistics & electromagnetic components should contribute 23 per cent (current 16 per cent) and DISCOM share should stay around 30 per cent (current 32 per cent). 

For REC, asset resolution of Rs 2,200 crore is in place and GNPAs eased to 3.3 per cent in Q1FY24, declining 400 bps from a peak of 7.0 per cent in FY19. Incremental asset resolution of Rs 7,000 crore (Rs 5,000 crore under NCLT) should see GNPAs declining to 2.4 per cent in FY24 and to 2.0 per cent by FY26. Credit cost is estimated to dip to 15 bps or less over FY24-26 if NIM can be sustained at 3.6 per cent, looking at return on equity (RoE) of 16 per cent and return on assets (RoA) of 2.7 per cent over FY24-26. 

One factor for consideration is that PFC holds 52.6 per cent stake in REC. It paid Rs 14,500 crore to the government of India (GoI) in 2019 for this. The GoI directly holds 56 per cent in PFC so it keeps control of both. The credit exposure limit rose to 25 per cent of a bank’s net worth (from an earlier 20 per cent) after this crossholding deal. 

PFC negotiated with Power Grid Corporation (PGCIL) to sell the REC stake but the government rejected it. If there is a merger of PFC and REC, credit limits could change. A stake sale, even to public sector major PGCIL may also impact credit limits. Any such deal thus has implications for both operations and share prices. 

While REC has somewhat better financials, both stocks, which scaled new 52-week highs on Tuesday, may have potential upside due to improving prospects. 

According to Bloomberg, all six analysts polled in August have 'buy' ratings on PFC with an average one-year target price of Rs 329. The same stands for REC. All five analysts polled this month have a 'buy' on REC with an average target price of Rs 285.