Power Finance Corporation’s (PFC’s) Q3FY16 PAT (profit after tax) of R15.8 bn (up 2.5% y-o-y) came in lower than our estimates. The divergence was due to Essar Mahan (R16 bn) and Jas Infra (R2 bn) slipping into NPA (non-performing assets) and upfronting of standard asset provisioning on restructured assets (to 4.25% from 3.5% at R2.5 bn against requirement to meet it by FY17). Corollary of higher interest income reversal was the 30bps q-o-q decline in NIMs (net interest margins), leading to muted revenue momentum (NII down by >2% q-o-q). However, controlled opex (down >50% y-o-y) supported profitability. Disbursements gained traction (up 8% y-o-y at R108 bn) feeding into 12.5% y-o-y loan growth. Implementation of project UDAY (wherein state governments will take over debt of SEBs) means lower yields for PFC putting current NIMs under risk. We expect some pressure on growth as well with limited avenues for working capital funding going forward, and slower than expected investment cycle in power sector. Despite favourable valuations at 0.5x FY18e P/ABV, (price-to-book ratio) near-to-medium term challenges and riskier impaired loans seem to fairly price the stock. We maintain ‘HOLD’.
GNPLs rise, up-fronted provisions strain earnings
GNPLs (gross non-performing loans) inched up to 1.89% (1.23% in Q2FY16) following slippage of couple of accounts (Essar Mahan and Jas Infra totaling R18 bn). Restructured portfolio rose to R241 bn (R223 bn in Q2FY16); this being >90% of its private sector exposure, progress on these projects warrant closer look. Further, PFC made upfront provision of R2.5 bn (requirement on restructured book at 4.25%), which strained profitability.
Disbursements improve, lower NIMs affect revenue momentum
Disbursements perked up to R108 bn (up 6% y-o-y) feeding into loan growth of 12.5%. Further, given higher interest income reversal, NIMs fell by ~30bps q-o-q to sub-5% levels, restricting revenue growth to <13% y-o-y.
Outlook and valuations: UDAY dims outlook; maintain ‘HOLD’
Though implementation of UDAY potentially augurs well for the entire power value chain, it poses risks to PFC’s near to medium term earnings. We pay heed to undemanding valuations, but uncertainty could challenge PFC’s high returns profile, and risks surrounding its impaired loans seem to fairly price the stock. We maintain ‘HOLD/SU’ with TP (target price) of R240.
NIMs drop to 4.98%, sustainability key
After two sequential quarters of reporting impressive NIMs (>5%), NIMs for the quarter dropped by 29bps and came in at 4.98%. This was following lower yields on advances (down 39bps to 12.02%) and higher interest income reversals. On the other hand, there was no respite from funding costs, which reduced a tad 10bps and came in at 8.58%. Pursuant to Project UDAY and as earlier highlighted by us in our report: “Project UDAY: Dimming power financier outlook”, we have been conscious of infra financiers such as PFC/REC enjoying industry-leading NIMs (around 5%) on higher lending yields (~12%) coupled with lower funding costs (AAA rated on government ownership) and sustainability of the same was anyways a key risk. Going forward, with state governments set to take over debt of discoms (potentially at 8.2%, much below lending rates of PFC) forming ~23% of PFC’s loan book, we find NIMs compression a logical corollary. In addition, potentially an argument of lower lending yields across the value chain (generation & transmission) poses further risk to NIMs.
Disbursements improve, sanctions remain tepid
Even after disbursements perked up in Q2FY16 (up 19% y-o-y), largely led by disbursements to transitional finance, Q3FY16 disbursements stood at R108 bn (up >5.5% y-o-y/7.8% q-o-q). Positive has been disbursement growth being led by generation (up 9.3% y-o-y/ 32.4% q-o-q) while disbursements towards transitional finance continued to be at similar level. However, owing to dearth of financing opportunities in transmission segment, disbursements fell ~41% y-o-y/47% q-o-q. Sanctions remained tepid, registering 30% y-o-y/16% q-o-q drop (albeit on higher base) and stood at R195 bn. Sanctions in generation segment in 9mFY16 overshoot amount sanctioned in full year FY15. With takeover of discom debt by state governments, we are a bit skeptical about growth and build in loan CAGR of 8% over FY16-18e.