PFC vs REC: Why a 23% power credit surge isn’t helping? Morgan Stanley downgrades both

The numbers explain the concern. PFC’s loan growth fell to 4% YoY in Q1FY27 from 16% a year earlier, while REC’s slowed to 1% from 10%. During the same period, bank credit to the power sector rose to 23.8% YoY from 7.7%, while system non-food credit growth increased to 18.3% from 8.9%.

Morgan Stanley said the recovery in PFC and REC’s lending growth is likely to be gradual. The brokerage cut its earnings estimates, lowered the price targets and said the stocks now have balanced risk-reward but lack a near-term catalyst.

Morgan Stanley on PFC: ‘Equal-weight’

Morgan Stanley cut its price target for Power Finance Corporation to Rs 410 from Rs 510 and moved the stock from ‘Overweight’ to ‘Equal-weight’. The brokerage reduced its core EPS estimates by 5.5% for F28 and 7% for F29, mainly because loan growth has been weaker than expected.

PFC had already seen its medium-term loan growth forecast reduced to an 8-9% CAGR after softer trends in the second half of F26. The latest quarter has now forced another cut. Morgan Stanley expects loan growth of 4.5% in F27, 6.2% in F28 and 7.9% in F29, compared with its earlier assumptions of 7.5%, 8.8% and 9.8%, respectively.

The issue is not asset quality. PFC continues to have strong asset quality, healthy return ratios and an inexpensive valuation. Morgan Stanley expects PFC to generate mid-teens core ROE through F27-F29, while margins remain broadly stable.

The brokerage, however, said, “However, we see sustained loan growth moderation at PFC amid acceleration in bank credit to the power sector as well as in overall system credit.”

That is the central problem. PFC can compete more aggressively for loans, but doing so could pressure margins. Protecting margins, on the other hand, could mean accepting slower loan growth.

PFC’s growth problem is showing up in earnings estimates

PFC’s Q1FY27 net interest income fell 4% YoY to Rs 5,233.5 crore, while net profit rose 5% to Rs 4,745.4 crore, helped in part by credit reversals. Its total assets under management stood at Rs 5.7 lakh crore at the end of the quarter.

Morgan Stanley now expects PFC’s net profit to fall 3% in F27 before rising 2% in FY28 and 9% in FY29. Core EPS is expected to decline 5% in FY27, remain broadly flat in F28 and grow 9% in FY29.

The brokerage also expects PFC’s core ROE to moderate from 20.6% in FY26 to 16.9% in FY27 and 14.3% by F29. Even with that moderation, returns remain strong by the standards of large lenders.

The valuation argument is therefore not enough on its own. Morgan Stanley said the stocks remain inexpensive relative to their return ratios, but the lending growth gap has become too wide.

Morgan Stanley on REC: ‘Equal-weight’

REC has received a similar downgrade. Morgan Stanley cut its price target to Rs 360 from Rs 430 and moved the stock from ‘Overweight’ to ‘Equal-weight’. Its EPS estimates were reduced by 5% for FY28 and 7% for FY29.

REC’s loan growth forecast has been cut to a 6% CAGR for FY26-FY28 from the earlier 9%. The revised estimates show loan growth of 4.7% in F27, 5.2% in F28 and 7.8% in F29.

The brokerage expects REC to continue generating mid-teens ROE, supported by stable margins and relatively strong asset quality. Yet, the same lending constraint seen at PFC is becoming harder to dismiss at REC.

Morgan Stanley said, “However, we see sustained loan growth moderation at REC amid acceleration in bank credit to the power sector as well as in overall system credit.”

REC ended Q1FY27 with total assets under management of Rs 5.9 lakh crore. Net interest income increased 5% sequentially but fell 4% YoY to Rs 5,438.3 crore. Net profit fell 7% YoY to Rs 4,149.5 crore.

Power credit is growing, but PFC and REC are not capturing it

The biggest takeaway from the report is the mismatch between the two lenders and the wider financial system.

Bank credit to the power sector grew 23.8% YoY in Q1FY27, compared with just 7.7% a year earlier. PFC and REC, which have historically been major providers of power-sector financing, recorded loan growth of only 4% and 1%, respectively.

Morgan Stanley had expected some moderation, but the size of the gap has changed the assessment.

The brokerage said, “The growth disconnect has been much greater than we thought.”

That creates a difficult choice for the two lenders. Pricing loans more aggressively could help them regain market share, but would restrict the scope for higher margins. Holding spreads could protect profitability but leave loan growth weaker.

Morgan Stanley described the trade-off in direct terms: “The growth and margins trade-off means that PFC and REC can defend market share by pricing more competitively, but this limits margin upside and ultimately NII growth.”

Merger removes one source of competition

The proposed merger between PFC and REC adds another element to the story. The companies have announced a share exchange ratio of 88 PFC shares for every 100 REC shares, while PFC expects the merger to be completed by April 1, 2027, subject to approvals.

Morgan Stanley does not expect major cost savings because both companies already operate with low costs. There could be revenue benefits from greater scale and the removal of competition between the two lenders, although the brokerage said these benefits are not very obvious at this stage.

The merger therefore does not solve the immediate lending-growth issue. It may improve the structure of the combined business over time, but the underlying question remains whether the two lenders can regain momentum while preserving their margins.

Asset quality remains a strength, but that support is fading

There is one part of the PFC and REC story that Morgan Stanley is not worried about. Asset quality remains strong.

PFC’s gross NPA ratio was 1.11% in Q1FY27, compared with 1.92% a year earlier, while its net NPA ratio remained at 0.15%. REC’s gross NPA ratio stood at 0.23%, down from 1.05%, while its net NPA ratio was 0.11%.

Both lenders have also benefited from several years of recoveries. Morgan Stanley noted that PFC had experienced four years of net recoveries from F23 to F26, meaning recoveries from NPAs exceeded incremental slippages.

But there is a catch. With impaired asset ratios already close to historical lows, there is less room for another round of recovery-led earnings upgrades.

In other words, asset quality can protect the downside, but it cannot provide the same earnings lift it did in previous years.

PFC Vs REC: Which stock offershigher returns at low valuations

The downgrade is not a rejection of the businesses. Morgan Stanley continues to see good asset quality, healthy return ratios and low valuations at both companies.

PFC is projected to trade at a core price-to-earnings multiple of 5.3 times in F28 and 4.8 times in F29, while its core price-to-book ratio is estimated at 0.7 times and 0.6 times, respectively.

REC is projected at 5.7 times earnings for both F28 and F29, with price-to-book ratios of 0.8 times and 0.7 times. Its dividend yield is estimated at 5.3% in F28 and 5.8% in F29.

The contrast is important. The stocks are inexpensive, but the market needs a reason to pay more for them. Morgan Stanley does not see that reason yet.

What could change Morgan Stanley’s view?

The brokerage has left the door open for a more positive stance. A sustained pickup in loan growth would be the key trigger.

For PFC, Morgan Stanley said it could become more constructive if loan growth returns to at least the low double digits, particularly given the much faster expansion in bank and system credit to the power sector.

For now, Morgan Stanley expects PFC’s loan growth to recover gradually towards high single digits over the next few years. REC is also expected to move towards stronger growth, but not quickly enough to provide a near-term earnings catalyst.

Disclaimer: This article is based on a research report published by Morgan Stanley and is intended solely for informational and journalistic purposes. The ratings, price targets, earnings estimates, forecasts and views cited in the article are those of Morgan Stanley and do not constitute independent investment advice or a recommendation by The Financial Express or the author to buy, sell or hold any security. Readers should independently assess the risks and suitability of any investment and consult a SEBI-registered investment adviser before making investment decisions. The Financial Express and the author are not acting as investment advisers or research analysts in publishing this article. Any investment decision remains solely the responsibility of the reader. The article may contain information sourced from third parties, and no representation is made regarding the completeness or accuracy of such information. Past performance is not indicative of future returns.