PFC issue priced reasonably, but it's one for the long term

By VS Fernando

Power Finance Corporation (PFC), a government company, is offering shares to the public in the price range of Rs 193-203. It has a high growth potential and the pricing is reasonable from a medium-term perspective.

Given that the company finances long-gestation projects, it is more likely to be a steady long-term compounder of your money rather than something to offer immediate gains. The retail discount of 5% increases the comfort level of individual bidders.

Issue Objective

The objective behind the fresh issue of equity is to augment the capital base, comply with capital adequacy norms and meet future capital requirements. The offer for sale is to carry out the government of India’s disinvestment programme.

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Parentage

Incorporated in 1986, the New Delhi-registered PFC is a non-deposit taking, non-banking financial company (NBFC) promoted by the government of India to finance, facilitate and promote India’s power sector. PFC was notified on 22 June 2007 as a Navratna company by the government and was conferred the status of an infrastructure finance company (IFC) on 28 July 2010.

The company made its maiden issue of equity through an IPO in February 2007. The present issue is a follow-on public offer comprising an offer of sale by the government and a fresh issue of equity by the company to augment capital. After the issue, the shareholding of the government of India in PFC will come down to 73.72%.

Business

PFC is a financial institution focused on the power sector. The company works in close unison with the Union government, state governments and public sector utilities for implementing the policies and structural and procedural reforms in the power sector. The company has been appointed by the government as a nodal agency for the ultra-mega power projects (UMPP) programme and the restructured accelerated power development reform programme apart from being the bid process coordinator for independent transmission projects (ITP).

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PFC provides a comprehensive range of financial products, both fund and non-fund based, as well as offering advisory services to clients in the power sector.

Between fiscal 2006 and the nine-month period ended 31 December 2010, PFC’s loan book grew from Rs 35,582 crore to Rs 92,118 crore at a compounded annual growth rate (CAGR) of 22%. During this period, the operating income grew at a healthy 26 percent, increasing from Rs 3,113 crore to Rs 9,939 crore (annualised). Over the years, equally impressive has been the consistent improvement in the net interest margin, which moved up to 4.1 percent by the end of the nine-month period ended 31 December 2010.

A large part of the growth in PFC’s loan book is on account of its lending to the state sector and central sector entities, which together accounted for 84.8 percent of the loans at the end of 31 December 2010. Advances to joint sector and private sector borrowers stood at 8.1 percent and 7.1 percent respectively. PFC’s low non-performing assets (bad loans) during the last five years, which have ranged between 0.03 percent and 0.01 percent of the loan book, appear to be largely due to its overwhelming exposure to government entities.

Prospects

As against the planned capacity addition of 78,700 mw during the current 11th five-year plan, the actual addition achieved till 31 December 2010 was 44,623 mw, or 56 percent. It was estimated that fund requirements for achieving the planned capacity addition during the 11th plan would be of the order of Rs 10,31,600 crore. Even if the targeted addition does not fully come on board by the end of the 11th plan, the fund requirement would still be enormous.

What’s more, the ensuring 12th plan, which targets an addition of 1,00,000 mw to power generation capacity puts the funds requirement at an additional Rs 11,00,000 crore.

Considering that PFC’s loan book is in the region of Rs 1,00,000 crore, the potential for growth is huge. However, the company will have to manage the twin challenges of being able to raise low-cost resources as well as keep the ratio of delinquent loans at a manageable level. While the issue of bonds and domestic borrowings contributed about 94 percent of the total financial indebtedness of the company (as on 31 March 2011), it must increasingly look for ways to lower its cost of funds as well as raise external commercial borrowings (ECBs) of US$ 500 million per year, as permitted by virtue of its status as an IFC.

Concerns

• There is an audit qualification on profits being overstated by Rs 774.45 crore and Rs 616.52 crore in fiscal years 2009 and 2010 respectively.

• By design, PFC is exposed to a large concentration in loans to borrowers. As of 31 December 2010, its single largest borrower accounted for 8% of the loans while the top five and top 10 borrowers accounted for a cumulative 32.4 percent and 54.1 percent of loans respectively.

• As of 31 December 2010, 16.5 percent of PFC’s loans were unsecured.

VALUATION

From a valuation perspective, PFC’s offer price at the lower end of the price band discounts its 2010-11 earnings per share (EPS) of Rs 22.82 8.5 times. It has a book value of Rs134.28. Compared to peers, PFC’s valuation looks reasonable as the following table bears out. On the dividend front, too, PFC offers a good yield of about 2.25% on the fresh public offering price.

PFC’s FPO offers a discount of 5% in the offer price to retail individual bidders and eligible employees.

Syndicated by India Aarthik Research

VS Fernando is a veteran IPO Analyst who has been tracking domestic Public Offerings since 1986.