The Hindu Business Line : Power Finance Corporation: Invest at cut-off

Investors can consider subscribing to the initial public offering of shares by Power Finance Corporation (PFC). The company has a highly focussed business model and its financial contours appear pleasing despite it being a lender to some of the riskiest borrowers in the country — State electricity boards.

PFC has a decent track record and its future prospects, as such, appear good. The pricing of the offer at a PEM of 12 (based on fully diluted equity and annualised earnings of first half 2006-07) appears reasonable leaving scope for capital appreciation in the medium-term.

Focussed business

PFC is a long-term financier for the power sector and lends mainly for projects in generation, transmission and distribution of power. It also lends to renovation and modernisation projects. The generation segment — thermal and hydel — accounts for two-thirds of its outstanding loans while transmission and distribution segments account for 11 and 6 per cent respectively.

State power utilities, as in electricity boards and unbundled distribution utilities, are PFC's biggest borrowers, accounting for 78 per cent of the outstanding loans followed by central power utilities such as NTPC and NHPC with 10 per cent. Private power companies account for just 8 per cent of total outstanding loans as on September 30, 2006. PFC also offers non-fund based services such as consultancy and studies. It spearheads the government's ambitious push for ultra mega power projects (UMPP) and has floated separate special purpose vehicle subsidiaries for each of the identified UMPP projects. These subsidiaries are responsible for securing all statutory clearances and will be transferred to the successful bidders of these projects.

Apart from this, PFC is also involved in the implementation of the Accelerated Generation and Supply Programme (AGSP) and Accelerated Power Development and Reform Programme of the government. PFC lends at subsidised rates to state utilities under the AGSP for which it is reimbursed by the government.

Impressive financial contours

For a company that lends to one of the most troubled sectors of the economy, PFC can boast of an impressive financial profile. Its net interest margin of 3.43 per cent, average cost of funds of 7.07 per cent and average interest yield of 8.9 per cent in 2005-06, rank with the best in the financial services industry.

Of course, net interest margin has been on a downtrend over the last three years — it was 5.95 per cent in 2003-04 and 4.45 per cent in 2004-05 — but this was primarily due to restructuring of rates on some loan accounts and the cut-throat competition that prevailed during this period of low interest rates. Suffice it to say that the present margin of 3.43 per cent (3.47 per cent in the first half of 2006-07) is still good enough if PFC is able to keep it from falling further.

PFC's non-performing assets, at less than 1 per cent of total outstanding loans, is noteworthy as is its capital-to-risk-weighted assets ratio of about 18 per cent. The RBI norms on maintenance of liquid assets and creation of reserve funds do not apply to PFC by virtue of it being a government company and the company has used its own prudential norms to classify loan assets as non-performing assets.

The company's term loans are secured either by a charge on the assets of the borrower or by a guarantee from the concerned State government where the borrower is an electricity board. Besides this, it also employs the escrow mechanism to secure its interests; almost 97 per cent of its loans to State electricity boards have an escrow mechanism in place.

The company's operating income grew by a compounded annual growth rate (CAGR) of 9.45 per cent in the last four years while its loan assets grew by a good 21.28 per cent in the same period. But the bottomline growth has been erratic in the last three years; profit after tax fell in 2003-04 and 2004-05 compared to their respective previous years but was marginally higher in 2005-06 compared to 2004-05.

What to watch out for

The biggest risk for PFC stems from its concentration on a single sector for business. But this must be considered in the light of the fact that the power sector is set to witness a surge in investment, given the government's ambitious push to expand capacity from 1.27 lakh MW now to 2 lakh MW by 2012. There is a big opportunity for those servicing this industry and PFCs domain expertise in the sector acquired over the years should stand it in good stead. The company is also planning to diversify its borrower portfolio by funding those producing fuel such as coal, lignite and gas and those involved in transportation of the fuel.

Almost half the company's outstanding loans are accounted for by ten large borrowers, which is a big concentration risk. While such exposures are secured either by a charge on the assets or by government guarantee, the fact is that a default can cause a temporary disruption to the cash flows, which can harm the business. Incidentally, the company has a negative cash flow presently due to the increased lending activity.

A recent RBI guideline is the cause for some concern. The guideline seeks to change the status of companies such as PFC, which is a government company under the Companies Act, to bring them under the ambit of the RBI's NBFC regulations. PFC will have to submit a road-map to the regulator by March 31, 2007 for complying with these regulations. The impact of this move is uncertain at this point in time.

Yet another recent RBI notification has reduced the exposure of banks to non-banking finance companies such as PFC from 25 per cent of the capital funds to 15 per cent.

This could limit PFC's ability to borrow from banks and force it to look for other sources that may prove to be dearer. Term-loans from banks account for about 45 per cent of PFC's rupee borrowings presently.

The offer of 11.73 crore shares in the price band of Rs 73-85 is open between January 31 and February 6 and is lead-managed by Enam Financial Consultants and ICICI Securities.

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