Power Finance Corporation

Equity Research INDIA September 15, 2020 BSE Sensex: 38757 Power Finance Corporation BUY ICICI Securities Limited is the author and distributor of this report Myth and lore outweigh reality and certainty; alluring valuations Rs92 Initiating coverage For Power Finance Corporation (PFC), we believe, myth and lore have far outweighed reality and certainty, leading to underperformance (of 10-20% over one NBFCs year and three years) as well as steep valuation discount (trading at ~0.5x book). In our initiating coverage on Power Finance Corporation (PFC), we attempt to Target price Rs151 address several myths (with facts) and simultaneously, bring to the fore structural power sector reforms and visibility on its potential earnings power and dividend payout capability. Given balance sheet expansion of >10%, steady state RoE profile Shareholding pattern of >14%, dividend yields of ~10%, more than offsetting slower than anticipated Dec Mar Jun stress resolution and weakening health of utilities, we assign fair multiple of 0.75 ‘19 ‘20 ‘20 FY22E book to PFC. These translate to fair value for PFC at Rs151. Initiate coverage Promoters 56.0 56.0 56.0 Institutional on the stock with ‘BUY’. investors 39.2 39.3 38.6  First and foremost, power sector is not perennially MFs and other 13.7 13.8 14.5 Myths we want to debunk: 1) Banks/FIs 0.5 0.5 0.5 under stress and UDAY is not a complete failure (AT&C losses have reduced, ARR- Insurance 6.1 6.1 6.1 ACS gap has improved). 2) Despite deteriorating health and stretched cashflows of FIIs 18.9 18.9 17.5 Others 4.9 4.7 5.4 discoms, debt obligation is mere 10-12% of its revenues and PFC’s first charge on Source: NSE revenue escrow, quasi government guarantee would always protect it against any write-offs in state utilities’ exposures. 3) PFC is not a mere financial intermediary (as perceived) but through its strategic/unique relevance and advisory capabilities plays Price chart an integral role in power sector development. 4) Contrary to perception, loss funding is not more than 15% and disbursements are skewed more towards capex, 150 140 renewables etc. 5) A detailed account-by-account analysis of private projects 130 suggests incremental haircut of not more than 10-15% (in the worst case) and our 120 provisioning estimate of 80bps each for FY21/FY22 would be more than enough. 110  (Rs) 100 Reality and certainty to pay heed to: Passage of Electricity Amendment Act with 90 some of the most critical proposals will kickstart investment cycle. Also, GoI has upper 80 hand in approving National Tariff Policy and will be approved soon. Special discom 70 60 package will not only infuse the most needed liquidity in the value chain allaying asset quality risks, but boost disbursements for PFC (Rs340bn sanctioned by PFC). This, coupled with NIPs comprehensive capex plan (of Rs25tn by FY25), improves growth Mar-18 Mar-19 Mar-20 Sep-17 Sep-18 Sep-19 Sep-20 visibility for PFC.  Rewarding investment case at alluring valuations: Myths highlighted above coupled with deterioration in private sector asset quality have weighed on PFC’s valuations. Detailed account-by-account analysis suggests limited downside risk to stress accretion and would be more than offset by resolutions in advanced stages. NIMs may compress marginally, nonetheless, disbursement uptick and sub-1% credit cost will support >3% operating profit to assets. Even in the worst case, erosion of

Research Analysts: net worth that street is antedating seems unwarranted. Visibility on earnings power and sustenance of RoEs upwards of 14% only reaffirm certainty on dividend payout. Kunal Shah Assigning fair multiple of 0.75x FY22E book, we arrive at a fair value of Rs151. Initiate [email protected] coverage on the stock with ‘BUY’. +91 22 6637 7572 Market Cap Rs243bn/US$3.3bn Rahul Modi Year to March FY19 FY20 FY21E FY22E [email protected] Reuters/Bloomberg PWFC.BO/POWF IN Net revenue 97,355 120,944 125,768 134,413 +91 22 6637 7373 Shares Outstanding (mn) 2,640.1 Net profit 69,529 56,551 72,557 73,789

Anshuman Ashit 52-week Range (Rs) 132/75 Diluted EPS (Rs) 26.3 21.4 27.5 27.9 [email protected] +91 22 6637 7419 Free Float (%) 44.0 BV (Rs) 164.0 171.1 186.1 202.1

Renish Bhuva FII (%) 17.5 Adj. BV (Rs) 123.2 133.8 153.0 170.7 [email protected] +91 22 6637 7465 Daily Volume (US$'000) 10,538 Price/book (x) 0.6 0.5 0.5 0.5

Chintan Shah Absolute Return 3m (%) 10.2 Price/ Adj book (x) 0.7 0.7 0.6 0.5 [email protected] Absolute Return 12m (%) (10.0) Diluted P/E (x) 3.5 4.3 3.3 3.3 +91 22 2277 7658 Sensex Return 3m (%) 15.4 Dividend yield (%) - 10.3 9.7 10.6

Sensex Return 12m (%) 4.8 RoE (%) 17.4 16.7 14.6 14.2

Please refer to important disclosures at the end of this report

Power Finance Corporation, September 15, 2020 ICICI Securities

TABLE OF CONTENTS

Story in Charts ...... 3 Myths we want to debunk ...... 6 Reality and certainty to pay heed to ...... 14 Rewarding investment case at alluring valuations ...... 19 Annexure ...... 22 Financial summary ...... 24 Index of tables and charts ...... 26

Power Finance Corporation, September 15, 2020 ICICI Securities

Story in Charts

Chart 1: Myths we want to debunk

Myth Myth Myth Myth Myth

PFC is a mere Primarily finances Power sector Knock to book value Stress in state utilities financial intermediary – state utilities losses & perennially under can be drastic always goes raises cheap money & stretched working stress – UDAY scheme unrecognised channelizes to capital cycle a failure stressed state utilities

Fact Fact Fact Fact Fact

Strategic relevance, More than 50% lent AT&C losses reduced 45% of private Debt obligations at 10- unique positioning, towards genco capex, to 22%; ARR-ACS gap exposure already 12% of revenues; PFC financing and advisory 8% Transco & less improved; a new recognised as stress has first charge on capabilities – funded than 15% working scheme will follow up with 55% provisioning; escrow, government >35-45% capex in past 5 capital finance another 30% towards guarantee protects years renewables against loss/write-offs

Source: I-Sec Research

Chart 2: Reality and Certainty to pay heed to

Reality Reality Reality Reality

Electricity Act to National Tariff Policy to National Infrastructure Atmanirbhar discom kickstart investments; be approved in the pipeline outlines package (sanctioned critical proposals next few months as comprehensive Rs680bn) to including ECEA for GOI now has upper Rs25trn capex plan for channelize liquidity into dispute resolution, hand in negotiations the period FY20-25 the value chain and disallow regulatory ease stress assets

Certainty Certainty Certainty Certainty

Disbursements to pick incremental business Merger of peer Visibility on potential up momentum (from at a lower spread, subsidiary with PFC earnings power and average of Rs670bn), downward loan not synergistic and we sustenance of RoEs improved visibility on repricing would drag assign a low upwards of 14%, sustaining asses growth NIMs below 3%; probability of it going certainty on dividend of 10-15% though capped above through payout capability is 2.5% high

Source: I-Sec Research

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 3: Power financiers funding 35-45% capex of the power sector

Power Capex (Rs bn) Disbs (Genco + Transco) PFC + REC (Rs bn) % Funding by PFC/REC

2,500 42.4 45.0 37.2 40.0 2,000 35.0 29.6 26.8 25.7 30.0 1,500 25.0 20.0 1,000 15.0

500 10.0 5.0 508 476 502 670 715 1,898 1,898 1,610 1,954 1,802 1,686 - 0.0 FY14 FY15 FY16 FY17 FY18

Source: Company data, I-Sec research

Chart 4: Power capex of Rs25tn estimated over FY20-FY25

Generation Distribution Transmission States Renewable Energy Atomic energy

4,749 5,000 4,563 4,500 4,266 327 3,980 3,941 283 4,000 331 215 283 3,500 3,000 2,063 1,510 2,500 1,440 1,700 2,170 2,170 116 (Rs bn) (Rs 387 2,000 758 630 485 331 305 515 1,500 515 415 581 539 507 1,000 600 700 857 549 420 442 500 211 538 638 635 650 507 0 301 FY20 FY21 FY22 FY23 FY24 FY25

Source: NIP, I-Sec research

Chart 5: PFC to consistently support power sector with >10% portfolio growth

Loan Book (Rs bn) - LHS Growth YoY (%) - RHS 5,000 35% 31% 4,358 4,500 3,886 30% 4,000 25% 25% 24% 23% 3,449 3,500 3,147 25% 2,789 3,000 17% 18% 20% 15% 2,389 2,455 2,500 2,177 14% 1,890 13% 13% 2,000 12% 15% 1,605 10% 10% 1,500 1,302 996 10% 1,000 644 799 516 3% 5% 500 - 0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20 FY FY 17 FY21E FY22E Source: Company, I-Sec Research

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 6: Yields have remained sticky; lower funding cost supports NIMs

Yields Cost of Borrowing NIM (RHS) 6.0% 15% 4.9% 4.9% 4.9% 4.7% 13% 4.4% 5.0% 3.8% 4.0% 4.0% 3.9% 12% 3.7% 3.5% 3.4% 4.0% 3.2% 3.0% 2.9% 10% 3.0% 9% % 9.1% 9.0% 9.0% 2.0% 8.9% % 8.7% 8.6 8.5%

7% 8.4% 8.2% 8.1% 8.0 8.0% 7.8% 7.8% 7.8% 6% % 1.0% 10.1% 10.9% 10.8% 11.0% 11.3% 11.9% 12.3% 12.4 12.1% 11.5% 10.6% 10.6% 10.6% 10.5% 10.4% 4% 0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20 FY 17 FY FY21E FY22E Source: Company, I-Sec Research

Chart 7: Despite power sector stress, consistently delivering superior RoEs

RoA (%) RoE (%) 25.0% % 21.3% 20.2% 20.1% 20.0% 20.0 19.7% 18.0% 20.0% 18.0% 17.3% 16.2% 14.6% 14.4% 14.2%

15.0% 12.8% 12.1%

10.0% % % 3.2% 3.1% 3.0 2.9%

5.0% 2.8% 2.8% 2.6% 2.5% 2.4% 2.4% 2.3% 1.9% 1.8 1.7% 1.6%

0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20 FY 17 FY FY21E FY22E Source: Company, I-Sec Research

Chart 8: Consistent track record of high dividend payout

DPS (Rs) Dividend Payout (%) - RHS

16.0 70 13.9 14.0 60 12.0 50 9.5 10.0 9.0 9.1 7.8 40 8.0 7.0 6.0 30 6.0 5.0 5.0 20 4.0 2.0 10 - - FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source: Company

Power Finance Corporation, September 15, 2020 ICICI Securities

Myths we want to debunk

 Power financiers are mere financial intermediaries (like any other bank/FI and can be marginalised if banks compete) – PFC is merely viewed as financial intermediary that raises money at cheaper rates from debt market (backed by sovereign rating being government owned) and channelises funds into stressed power utilities (at higher yields with lower rating). However, what seems to be ignored is strategic relevance it holds being integral to promotion and development of various policies and structural/procedural reforms in the power sector. Also, we need to take cognisance of its unique positioning, not only by virtue of broad-based financing capabilities but also providing fee-based technical advisory (right from project conceptualisation to post commissioning stage). Banks have been averse in lending to power sector and their power portfolio is flat since past 6 years. During this period, its power financing NBFCs that have actively supported funding requirement of the sector. PFC, together with its peer, has funded almost 35-45% capex of power sector over the past few years. Chart 9: Banks averse to power sector lending; PFC actively supporting

Banks REC PFC 14.0

12.0 3.4 3.4

10.0 3.1 2.4 2.4 2.8 2.8 2.5 2.5 8.0 2.2 1.9 1.9 3.2 3.2 2.8 2.8 2.0 2.0 1.8 2.4 2.4 (Rs tn) (Rs 2.0 2.0 6.0 1.6 1.5 1.5 1.3 1.3 1.3 1.3 4.0 1.0 1.0 0.8 0.8 5.8 5.7 5.7 5.6 5.6 5.6 5.6 5.3 5.3 5.2 5.2 4.9 4.9

2.0 4.2 3.3 3.3 2.7 2.7 1.9 1.9 1.2 1.2 - 1.0 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY 17 FY18 FY19 FY20

Source: Company data, RBI, I-Sec research

Chart 10: Power financiers funding 35-45% capex of the power sector

Power Capex (Rs bn) Disbs (Genco + Transco) PFC + REC (Rs bn) % Funding by PFC/REC

2,500 42.4 45.0 37.2 40.0 2,000 35.0 29.6 26.8 25.7 30.0 1,500 25.0 20.0 1,000 15.0

500 10.0 5.0 508 476 502 670 715 1,898 1,898 1,610 1,954 1,802 1,686 - 0.0 FY14 FY15 FY16 FY17 FY18

Source: Company data, I-Sec research

Power Finance Corporation, September 15, 2020 ICICI Securities

 Disbursements are skewed towards state utilities’ loss funding – There is misapprehension with deteriorating discom health and debt piling up, that major part of balance sheet growth of PFC was led by loss funding to state discoms. However, evaluating its cumulative disbursements of Rs3trn over FY16-20, we realised >50% was lent towards generation, 8% towards transmission capex and lending to discoms entities (constituting ~30% of disbursements) though perceived as loss funding but is towards capex. Our assessment suggests pure short term working capital financing at mere 15%. Chart 11: Cumulative disbursements of PFC over past 5 years; ST loans at 15%

MT loan - Genco Others, 5% & transco, 6%

Thermal, 32% MT loan - dist, 14%

Transitional Fin, 4%

Hydel, 2%

ST loans, 15% Transmission, 6% Urban distribution, Wind, 3% Solar, 4% 8%

Source: Company, I-Sec research

Table 1: Outstanding portfolio of PFC: Distribution, ST loans and others at <25% of the book H1 Rs mn FY16 FY17 FY18 FY19 H1FY20 FY16 FY17 FY18 FY19 FY20 Generation - Thermal 14,14,695 15,21,559 16,62,938 17,34,286 17,64,151 59.2% 62.0% 59.6% 55.1% 54.2% - Hydro 1,36,902 1,23,616 1,43,931 1,24,618 1,29,008 5.7% 5.0% 5.2% 4.0% 4.0% - Wind 16,682 20,063 58,220 69,609 71,465 0.7% 0.8% 2.1% 2.2% 2.2% - Solar 5,569 23,158 55,237 74,840 1,05,388 0.2% 0.9% 2.0% 2.4% 3.2% Corporate term loan 1,16,191 1,19,806 77,083 74,819 70,203 4.9% 4.9% 2.8% 2.4% 2.2% Renovation and modernization - Thermal generation 42,590 43,508 44,955 44,624 44,866 1.8% 1.8% 1.6% 1.4% 1.4% - Hydro generation 4,156 4,255 4,482 4,205 4,000 0.2% 0.2% 0.2% 0.1% 0.1% Transmission (including R&M) 1,46,133 1,66,074 1,96,463 2,36,015 2,55,080 6.1% 6.8% 7.0% 7.5% 7.8% Distribution 73,873 2,05,908 2,99,973 4,76,734 6,04,666 3.1% 8.4% 10.8% 15.2% 18.6% Short-term loans 36,416 58,139 1,13,010 1,25,823 91,706 1.5% 2.4% 4.1% 4.0% 2.8% Transitional finance 3,64,795 91,195 88,610 79,728 - 15.3% 3.7% 3.2% 2.5% 0.0% Others 31,202 77,972 44,246 1,01,367 1,13,809 1.3% 3.2% 1.6% 3.2% 3.5% Total 23,89,202 24,55,253 27,89,147 31,46,669 32,54,341 100.0% 100.0% 100.0% 100.0% 100.0% Source: Company, I-Sec research

Power sector perennially under stress; UDAY too has been a failure – As against many sections of opinion suggesting UDAY a failure, we believe the outcome suggests otherwise. AT&C losses and annual losses of discoms have reduced to 22% and Rs496bn in FY19 (reached a low of Rs294bn in FY18), lower than FY15 levels of 25.7% and Rs550bn, respectively. At the same time, over FY15- FY19, generation in per unit term has increased significantly (by 27%), income (on subsidy received basis) of discoms has increased 18% (from Rs5.97/kWh in FY15 to Rs7.03/kWh in FY19), while losses have declined 28% (from loss of Rs0.72/kWh in FY15 to loss of Rs0.52/kWh in FY19).

Power Finance Corporation, September 15, 2020 ICICI Securities

Losses are not near the levels anticipated at the end of UDAY’s term (ended on 31st Mar’20), and particularly in the wake of the current unprecedented situation, we believe a new scheme is required. The upcoming tariff policy along with several measures announced by the government recently will go a long way in improving the health of discoms in particular and the sector as a whole.

Chart 12: AT&C losses consistently improving Chart 13: ARR-ACS (Rs/kWh) gap has improved post UDAY (%) too

28 Pre-UDAY Post-UDAY Pre-UDAY Post-UDAY 1.0 0.94 26 26.8 26.4 26.6 0.9 0.83 24 0.77 25.5 25.21 0.8 0.72 0.67 0.68 22 0.7 0.63 23.44 23.5 0.61 0.59 22.16 22.33 20 22.01 0.6 0.52

(%) 0.5

18 (Rs/kWh) 0.4 16 0.3 14 0.2 0.1 12 0.0 10 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 Source: Company, I-Sec research Source: Company, I-Sec research

Chart 14: DISCOM losses were contained post UDAY

Pre-UDAY Post-UDAY 800 720 701 680 700 633 600 530 546 496 500

(Rs bn) (Rs 400 338 290 294 300 200 100 0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19

Source: Company, I-Sec research

Power Finance Corporation, September 15, 2020 ICICI Securities

 Knock to book value can be drastic under stress scenario: Presently, 45% of private sector exposure for PFC is already recognised as stress. Over the period, with resolutions being delayed, PFC has provided 55% towards these impaired assets. To further determine the level of haircut and adequacy of provisioning coverage, we have conducted an account-by-account analysis (refer table 2) for the same. Based on our comprehensive assessment, we estimate base case haircut on stressed assets at ~50% and worst case at 65%. o What we understand is 30-40% of impaired assets are in advanced stages of resolution for PFC. Projects including India Power Haldia, RKM Powergen, Ind Barath Utkal, Jal Power, Jhabua Power – are in advanced stages with their resolution plans approved, or successful bids received under NCLT. Even outside NCTL, several projects are being actively resolved – namely Gati, Dans Energy, Rattan India Nashik, TRN Energy, etc. o Evaluating the top exposures of PFC suggests that besides a handful accounts (at the most), stage-3 asset pool will not show any further stress. There seems to be more confidence as over two-third of un-impaired assets now constitute renewable exposure. Around 3-4 projects are constantly monitored on liquidity issues (despite adequate PPAs and on-track performance) as there is likelihood of some technical delays/deferment with value chain getting impacted by demand slowdown. Chart 15: ~45% of private sector exposure already stressed with 55% coverage

Gross NPA (%) - LHS Net NPA (%) - LHS Coverage Ratio (%) - RHS 14% 70% 12.5% 12% 60% 9.6% 10% 9.4% 50% 8.1% 8% 7.5% 7.3% 40%

6% 30%

4% 3.2% 20%

1.2% 2% 0.0% 0.0% 1.0% 0.7% 0.7% 10% 0.0% 0.2% 0% 0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20 FY 17 FY FY21E FY22E Source: Company, I-Sec Research

 Stress in state utilities always goes unrecognised – Currently, impaired book of PFC only constitutes private projects. Though health of state utilities has been deteriorating and running stretched working capital cycle as well as debt service coverage, one must realise over the past one decade, there is no instance of loss/write-off in exposure to state utilities. This vindicates the relevance of the first charge on the revenue escrow, most projects are asset backed with attached quasi government guarantee. Also, despite stretched balance sheet, preference to repay financiers takes precedence over other liabilities. At a pan-India level, discom revenues were Rs6.7trn in FY19 while debt obligations (by way of interest of Rs476bn and repayments at ~Rs300-350bn) were manageable at 10-12% of revenues. We would, therefore, not be too obsessed with stress in state utilities though would not want to disregard the possibility of some deferment/delay (that will eventually be made good with interest, penal charges etc).

Power Finance Corporation, September 15, 2020 ICICI Securities

Table 2: Account by account analysis of PFC’s stressed private sector exposure suggest ~50% haircut in the base case (Rs mn) Expected PFC Expected Project Name State Fuel Capacity Status Recovery Remarks Exposure Recovery % amount Stressed projects being resolved under NCLT Successful bidder under NCLT & in documentation stage Ind-Barath (Utkal) Orissa Coal (domestic) 700 Partly commissioned 13,680 35% 4,788 JSW Energy has been listed as the successful bidder via NCLT route. Jhabua Power Madhya Pradesh Coal (domestic) 600 Commissioned 7,640 60% 4,584 NTPC has been selected as successful bidder via NCLT route Jal Power - HEP Sikkim Hydro 120 Under construction 3,860 40% 1,544 NHPC has been selected as successful bidder via NCLT route Others 3 units has been commissioned, the 4th unit is in progress. PPA with KSK Mahanadi Power Chhattisgarh Coal (domestic) 2,400 Partly commissioned 33,000 55% 18,150 TNEB 500MW @ 4.91, UP for 1000MW, AP 400MW. Co has been referred this to NCLT. PPA for almost 90% in place. South East U.P. - Transmission NA Partly commissioned 24,760 50% 12,380 Generates Rs240m per month as revenue from phase 1 600MW is commissioned and earns EBITDA of Rs3bn annually. Balance Lanco Amarkantak Power Chhattisgarh Coal (domestic) 1,920 Partly commissioned 24,730 50% 12,365 1320MW has coal linkage and is pit-head; no PPA Shri Maheshwar Hydel Project - 90% project complete. Project got stranded due to promoters incapability Madhya Pradesh Hydro 400 Partly commissioned 13,630 10% 1,363 HEP to infuse equity. Is a good project and can be revived Coal (domestic Under Land is acquired, plant near domestic coal source and port. However, No East Coast Energy Andhra Pradesh 1,320 11,930 10% 1,193 & imported) construction/uncertain BTG installed and no PPA. Ind-Barath (Madras) Tamil Nadu Imported coal 660 Under construction 4,420 20% 884 No PPA. Konaseema Gas Power Andhra Pradesh Gas 445 Commissioned 4,250 10% 425 No PPA. Under Land is acquired, plant near domestic coal source and port. However, No KVK Nilanchal Coal (domestic) 1,050 3,990 15% 599 Odisha construction/uncertain BTG installed and no PPA. Krishna Godavari Power Andhra Pradesh Imported coal 60 Commissioned 770 20% 154 No PPA. Astonfield - Solar 270 20% 54 Resolution Plan approved – Outside IBC RKM Power Gen Chhattisgarh Coal (domestic) 1,440 Commissioned 51,050 60% 30,630 PPA for 75% capacity. PPA was delayed leading to stress. India Power Haldia West Bengal Imported coal 450 Commissioned 9,590 65% 6,234 No PPA. Now the Co is looking to sign with WB R.S India - Wind Maharashtra Wind 100 Commissioned 2,240 75% 1,680 Essar Power Transmission Commissioned 4,380 100% 4,380 Project has been resolved. Resolution plan under implementation – Outside IBC Project has been commissioned. Has coal linkage. No PPA. RattanIndia Nashik Maharashtra Domestic Coal 1,350 Commissioned 30,010 50% 15,005 Restructuring underway Essar Power - Mahan Madhya Pradesh Domestic Coal 1,200 Commissioned 13,450 60% 8,070 Part PPA GVK Ratle J&K Hydro 330 Under Construction 8,170 60% 4,902 No PPA Inpriciple approval of PPA received from Haryana. Final approval Shiga Energy – Hydro Sikkim Hydro 200 Commissioned 5,220 75% 3,915 awaited Inpriciple approval of PPA received from Haryana. Final approval Dans Energy – Hydro Sikkim Hydro 193 Commissioned 5,030 75% 3,773 awaited Co has 85% PPA, only issue with payment delays from UP. Maybe TRN Energy Chhattisgarh Domestic coal 600 Commissioned 11,400 90% 10,260 restructured to reflect true cashflows

2,87,470 1,47,331 Source: Company, I-Sec Research

Power Finance Corporation, September 15, 2020 ICICI Securities

 Moratorium on 50-70% of quarterly dues is obnoxiously high: Out of the total dues, 50-70% was under moratorium cumulatively under morat 1.0 as well as morat 2.0. However, as repayment schedules are over elongated periods, if we ideally measure it as the proportion of overall loan book, it would normalise to <25%. Also, as liquidity flows into the system through AtmaNirbhar discom package, we believe most of the states would start honouring the obligations. Chart 16: PFC’s state-wise exposure

Others, 15% TN, 13%

WB, 4% Telangana , 12% Karnataka , 5%

MP, 7% Raj, 11% Chhattisgarh , 7%

MH, 7% UP, 11% AP, 9%

Source: Company

 NIMs are not sustainable at such a high level: Right since the implementation of UDAY scheme, there have been constant apprehensions about sharp contraction in spreads and NIMs. However, given low competitive intensity, high pricing power and continued stress in utilities, PFC have been able to adequately price the loan and yields have sustained at 10.6% over the past three years. Concomitantly, one must also not ignore the sharp reduction in funding cost (by 40-50bps) as these entities have commanded very fine borrowing spread in debt market. Incrementally, they are raising 3-year and 5-year paper at sub-7.5%, respectively. However, we will not deny some near-term pressure imminent on spreads/NIMs as i) capex-related disbursements would be slow in the near term and growth will be largely led by transitional loans under the special package carrying relatively lower spread. ii) Besides this, downward repricing of the loan book in a falling interest rate environment (1-3 year reset) will create further pressure on yields, thereby, offsetting the benefit of declining funding costs. We are building in NIMs of <3% for FY21/22E.

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 17: Yields have remained sticky; lower funding cost supports NIMs

Yields Cost of Borrowing NIM (RHS) 6.0% 15% 4.9% 4.9% 4.9% 4.7% 13% 4.4% 5.0% 3.8% 4.0% 4.0% 3.9% 12% 3.7% 3.5% 3.4% 4.0% 3.2% 3.0% 2.9% 10% 3.0% 9% 9.1% 9.0% 9.0% 2.0% 8.9% 8.7% 8.6% 8.5%

7% 8.4% 8.2% 8.1% 8.0% 8.0% 7.8% 7.8% 7.8% 6% 1.0% 10.1% 10.9% 10.8% 11.0% 11.3% 11.9% 12.3% 12.4% 12.1% 11.5% 10.6% 10.6% 10.6% 10.5% 10.4% 4% 0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20 FY 17 FY FY21E FY22E Source: Company, I-Sec Research

Chart 18: Assets and liabilities skewed towards longer term maturity

Deposits, Borrowings & Foreign Currency Liabilities Advances

2,000 1,903 1,800 1,600

1,400 1,277 1,200 1,000 710 690 (Rs bn) (Rs

800 592 560 600 264 259 400 223

200 24 - < 3 mnths 3m - 1 yr 1 - 3 yrs 3 - 5 yrs > 5 yrs

Source: Company, I-Sec Research

 MTM loss on unhedged forex to keep earnings volatile: PFC has more than 60% of its overseas borrowings unhedged (100% of long-tenure forex exposure is unhedged and 26% of less than 5-years forex borrowings are not hedged). With movement in INR-USD rate and concurrent notional loss/gain on forex liabilities as well as derivative contracts will tend to keep earnings volatile. In FY20, with 5-7% rupee depreciation, PFC had provided Rs26bn of notional loss (equivalent to >25% of operating profit). Only point we would want to drive here is the rationale for keeping long-tenure forex unhedged. Lack of depth makes risk premium not ripe for hedging in long-tenure bucket and unnecessarily elevates the cost. The company should sensibly wait for residual tenure to reduce to a level where premiums are rational and then time the hedging process depending on market depth.

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 19: Forex translation losses make earnings volatile

Forex translation loss 30,000 26,334 25,000

20,000

15,000 (Rs mn) (Rs 10,000 5,202 4,247 5,000 3,761 1,337 - FY16 FY17 FY18 FY19 FY20

Source: Company

Chart 20: Forex borrowings >5 years maturity not hedged; 26% of <5 years forex exposure is unhedged

< 1 year, 7%

1-3 years, 24%

> 5 yrs, 48%

3-5 years, 21%

Source: Company

Power Finance Corporation, September 15, 2020 ICICI Securities

Reality and certainty to pay heed to

 Special Atmanirbhar discom package to channelise liquidity: Power financiers have received interest from discoms under special long term government guaranteed transitional loans to the tune of Rs900bn. Of this, Rs680bn is already sanctioned and >Rs240bn disbursed. Given SEBs are comfortable with the conditions, time lag for second tranche will be less than 3-4 months. We believe disbursements under this package will channelise liquidity into the value chain by clearing dues of CPSU gencos, transcos, IPPs and ease systemic stress. Table 3: PFC/REC scheme – status so far (data till 8th Sep’20) Loan sanctioned (Rs bn) Loan disbursed (Rs bn) State REC PFC Total REC PFC Total Andhra Pradesh 33 33 66 16.5 16.5 33 Telangana 63.26 63.26 126.52 31.37 31.5 62.87 Maharashtra 25 25 50 25 25 Uttar Pradesh 104.7 104.7 209.4 52.35 52.35 104.7 Punjab 20 20 40 5 5 10 Manipur 0.56 0.56 1.11 Rajasthan 20.32 20.32 40.63 3.65 3.65 7.31 West Bengal 5.1 5.1 10.21 1.95 1.92 3.86 Uttarakhand 4 4 8 Karnataka 36.23 36.23 72.47 Puducherry 1.5 0 1.5 J&K 22.9 22.9 45.8 J&K (under UDAY) 5 5 10 Total 341.57 340.07 681.64 135.82 110.92 246.74 Source: Company, I-Sec research

Table 4: PFC/REC scheme – loan applications status (data till 8th Sep’20) State Rs bn Remarks Meghalaya 13.5 Under processing Odisha 39.19 Receivables certificate from state govt. awaited for Rs3.09bn; further Rs36bn indicated Himachal Pradesh 1.2 State has requested loan as per Jun'20 dues Jharkhand 50.4 LoI submitted; formal application awaited Tamil Nadu 326.8 Proposal under examination Bihar 35.1 Proposal under examination J&K 38.8 Indicated Total 504.9 Source: Company, I-Sec research

 Electricity Act amendment to kickstart investment cycle: Passage of this bill will be instrumental to kickstart the investment cycle as it aims at strengthening the intermediaries that are integral for demand growth. Of the many proposals, we believe some of the most critical ones are: o Formation of ECEA for contractual dispute resolution in a time-bound manner (ensuring sanctity of contracts, which were lately being challenged by many); o Disallowing the creation of regulatory assets, and focusing on recovering the entire cost of supply in tariffs and reducing cross-subsidies (which is the biggest reason for the liquidity crunch of discoms as they were selling 40-45% of their volumes to industry, which contributed 65-70% of their revenues); o Exclusion of state subsidies in tariff determination, which will pave the way for DBT for subsidised consumers (reducing power theft); o Inclusion of hydro in RPOs;

Power Finance Corporation, September 15, 2020 ICICI Securities

o Proposing distribution sub-licensees / franchisees (aimed at partial/complete privatisation, especially for discoms unable to reform/meet proposed criteria); o Streamlining and simplifying selection of members of commissions, improving transparency and independence in decision making. If the bill is passed in the Parliament even with some minor changes, it will be a landmark reform as it will improve viability of the entire sector. The proposed amendments have the potential to revive demand by: o Reducing unscheduled power cuts by discoms due to their inability to pay for power procurement, o Revive capex cycle especially in distribution, o Comfort investors in the sector whose confidence was shaken by Andhra renewables PPA cancellation issue last year, o Provide aggrieved parties a definitive recourse, and uphold contract sanctity.  National Tariff Policy (NTP) to be approved in the next few months: The MoP had been working on the since the past one year, but has been facing objections to some of the proposals from the states, mainly on the higher say which the Centre will have after the amendments. However, due to the stress emerging from Covid- 19 pandemic, state discoms are now facing increased liquidity issues (lack of availability of funds at viable rates), giving GoI an upper hand in negotiations. We expect this to be approved by the Union Cabinet in the next few months. Following reforms are expected in the tariff policy: o Consumer Rights - Discom inefficiencies not to burden consumers - Standards of Service and associated penalties for Discoms - Discoms to ensure adequate power; load-shedding to be penalised o Promote Industry - Progressive reduction in cross subsidies - Time bound grant of open access - Generation and transmission project developers be selected competitively o Sustainability of Sector - No regulatory assets - Timely payment of gencos - DBT for subsidy; smart prepaid meters o Metering - All government departments to have prepaid meters installed - All urban areas to have smart meters - All meters should be digital and can be remotely disconnected in case of non-payments.

Power Finance Corporation, September 15, 2020 ICICI Securities

 Growth opportunity is significant - National Infrastructure pipeline outlines Rs25trn capex for the period FY20-25 - Power is one of the most capex-intensive sectors, where planning needs to be done at least 4-5 years in advance to cater to the projected demand. It is, therefore, imperative that the capex cycle be revived. The NIP chalks out a comprehensive plan, outlining in detail the capex in the sector between FY20 and FY25. o Of the total estimated capex of Rs111trn by FY25, power sector comprises 22.5% at Rs25trn. o This is a 41% jump from the Rs17.7trn capex done in the sector between FY13- FY19. o Of the Rs25trn outlined, conventional generation, distribution and transmission comprise Rs3.3trn, Rs3.2trn and Rs3trn, respectively while, separately, state expenditure (all segments) includes Rs4.6trn and renewables Rs9.3trn. o From FY13 to FY19, India’s infrastructure investment has been an estimated Rs57tn (5.7% of India’s nominal GDP of Rs989trn) during the period. Chart 21: Capex in the power sector at 20-40% of infra investments

Power sector investment (Rs tn) As share in total infrastructure investment (%)

3.5 44% 50% 41% 3.0 34% 35% 40% 2.5 32% 27% 2.0 30% 20% 1.5 20% 1.0 10% 0.5 2.3 2.5 2.5 2.7 3.2 2.6 1.9 0.0 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19E

Source: NIP, I-Sec research

Chart 22: Power capex of Rs25tn estimated over FY20-FY25

Generation Distribution Transmission States Renewable Energy Atomic energy

Source: NIP, I-Sec research

Power Finance Corporation, September 15, 2020 ICICI Securities

 Improved visibility on 10-15% balance sheet growth – Over the past three years, PFC has grown the balance sheet by 12% CAGR touching the base of Rs3.5trn. Growth was primarily led by renewables, refinancing demand and regular capex in state utilities. PFC will play an integral role in driving the comprehensive capex plan chalked out by NIP. Also, special discom package will boost the disbursement trend as we expect Rs900bn to be disbursed in FY21 cumulatively by PFC and REC. This will only pep-up their normalised disbursement run-rate of Rs600-700bn. We are building in loan growth of 10-15% for PFC over FY20-22E. Although India is moving towards faster adoption of renewables, we believe its capacity addition in the next three years should be reduced and made more back ended. This will address the lingering concerns of reduced thermal PLFs as well as reduce the stress on discoms, who are finding it difficult to comply with the increasing RPOs. During this period, i.e. up to FY24, focus should be more on investments strengthening distribution and transmission segments. Chart 23: Consistently supporting power sector with >10% portfolio growth

 With credit cost of sub-1%, RoE still in high teens – Even after building in the worst case assuming further 15% stress on unimpaired private book, 5% on renewables and shoring up provisioning coverage to 70%, the knock is capped below 3% of the loan book and 15% of the net worth. In fact annual operating profit is more than sufficient to absorb this impact driving home the point that erosion of net worth argument is unwarranted.  Dividend payout of 30-40% almost certain – Visibility on potential earnings power and sustenance of RoEs upwards of 14% only reaffirm certainty on dividend payout capability. PFC is a consistent dividend paying entity (except in the year of merger) and as a policy, is required to shell out dividend equivalent to 30% of earnings or 5% of net worth, whichever is higher. Based on our estimates, dividend yield of ~10% at the current juncture is attractive (especially for dividend yield funds).

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 24: Consistent track record of high dividend payout

DPS (Rs) Dividend Payout (%) - RHS

16.0 70 13.9 14.0 60 12.0 50 9.5 10.0 9.0 9.1 7.8 40 8.0 7.0 6.0 30 6.0 5.0 5.0 20 4.0 2.0 10 - - FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source: Company

Power Finance Corporation, September 15, 2020 ICICI Securities

Rewarding investment case at alluring valuations

 Myths have weighed on valuations: Myths highlighted above coupled with deterioration in private sector asset quality have weighed on PFC’s valuations below book over the past 2-3 years. Chart 25: Trading at steep discount though networth erosion is unwarranted

1Yr Fwd PABV Avg -1SD +1SD -2SD +2SD

3.5 3.0 2.5 2.0

(x) 1.5 1.0 0.5 - -0.5 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18 Sep-19

Source: Bloomberg, I-Sec Research

Chart 26: PFC has underperformed financial index by ~20% over past 3 years

PFC BANKNIFTY

140 120 100 80 60 40 20 0 Jul-18 Jul-19 Jul-20 Jan-18 Jan-19 Jan-20 Mar-18 Mar-19 Mar-20 Nov-17 Nov-18 Nov-19 Sep-17 Sep-18 Sep-19 Sep-20 May-18 May-19 May-20

Source: Bloomberg

 Downside risk to further asset quality deterioration is limited and would be more than offset by resolution in advanced stages. We expect stage-3 assets (net of recoveries) to remain in the range of 7.25-7.5%. Shoring up the coverage to 65% gradually leads to a credit cost of 80bps each for FY21 as well as FY22.  PFC’s earning delivery has been consistent QoQ at Rs13-16bn and RoEs upwards of 15%. We concede that incremental business at a lower spread (Atmanirbhar package loans), downward repricing of advances (revised lending rates after almost 18 months in September 2020) would drag NIMs below 3%. However, lower competitive intensity and benefit of funding cost would also arrest the downside below 2.5%.

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 27: Despite power sector stress, consistently delivering superior RoEs

RoA (%) RoE (%) 25.0% 21.3% 20.2% 20.1% 20.0% 20.0% 19.7% 18.0% 20.0% 18.0% 17.3% 16.2% 14.6% 14.4% 14.2%

15.0% 12.8% 12.1%

10.0% 3.2% 3.1% 3.0% 2.9%

5.0% 2.8% 2.8% 2.6% 2.5% 2.4% 2.4% 2.3% 1.9% 1.8% 1.7% 1.6%

0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20 FY 17 FY FY21E FY22E Source: Company, I-Sec Research

 We expect disbursements to pick up momentum from an average of Rs670bn over the past four years, supported by special discom package and comprehensive capex plan chalked out by NIC. Visibility on it sustaining balance sheet growth of 10-15% is high at this juncture. Chart 28: Comfortable CAR and liquidity to participate in upcoming growth…

Tier I ratio Tier II ratio 24.0% 20.1% 20.3% 20.3% 19.3% 19.3% 20.0% 17.2% 17.2% 17.6% 17.1% 17.1% 17.0% 15.7% 16.3% 16.0%

12.0%

8.0% 18.6% 17.1% 17.0% 16.5% 16.5% 16.5% 16.4% 16.2% 15.4% 15.0% 14.0% 12.5% 4.0% 11.7%

0.0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY 17 FY18 FY19 FY20

Source: Company, I-Sec Research

Table 5: …Despite REC acquisition knocking down 400bps of Tier-1 Pre-REC Post-REC % Q3FY19 Q4FY19 CAR 18.95% 17.09% - Tier I 15.95% 11.73% - Tier II 3.00% 5.36%

Networth (Rs mn) 4,09,320 4,32,820 Networth post knocking-off investment in REC (Rs mn) 3,31,102 Suborinated bonds raised during REC acquisition (Rs mn) 54,120

Implied RWA (Rs mn) 25,66,270 27,37,603

Purchase price (Rs mn) 1,45,000 Source: Company, I-Sec Research

Power Finance Corporation, September 15, 2020 ICICI Securities

 PFC owns 52% in REC. Dividend certainty will be more with PFC (finally dividend has to flow to government through PFC’s earnings), though upstreaming of dividend from subsidiaries would aid its payout capability. One of the key concerns post PFC acquiring government’s 52% stake, is the possibility of merger of both the entities as that was the set out roadmap. However, we have seen debt market being not so positive (reflected in spreads of over G-sec yield) about this development. That said, it has its own constraints with respect to borrower exposure limit in raising funds as well as concentration of exposures in a single entity. Given it has its own strategic role to play (as a nodal agent for for UMPP, rural electrification etc), merger approach would not be very synergistic.  Valuations more attractive on consolidated book – PFC is currently trading at 0.5x trailing. Despite its ability to deliver >3% of annual operating profits (to assets), street is anticipating huge erosion to net worth that seems unwarranted. Even after building in the worst case assuming further 15% stress on unimpaired private book, 5% on renewables and shoring up provisioning coverage to 70%, the knock is capped below 3% of the loan book and 15% of the net worth. Also, to draw your attention, consolidated book value (after adjusting purchase price of REC’s stake) will still be boosted by >20% over standalone. Chart 29: Consolidated book value per share (Rs) (FY20)

250

70 240 55 220

186 190 171

160

130

100 Std book (FY20) Accretion from Post REC's stake Purchase price Consolidated REC's stake book (FY20)

Source: Company, I-Sec Research

 With visibility on potential earnings power and sustenance of RoEs upwards of 14%, certainty on dividend payout capability is high. Based on our estimates, dividend yield of ~10% at the current juncture is attractive (especially for dividend yield funds).  Given balance sheet expansion of >10%, steady state RoE profile of >14%, dividend yields of ~10%, more than offsetting slower than anticipated stress resolution and weakening health of utilities, we assign fair multiple of 0.75 FY22E book to PFC. These translate to fair value for PFC at Rs151. Initiate coverage on the stock with ‘BUY’.

Power Finance Corporation, September 15, 2020 ICICI Securities

Annexure

Table 6: All India discom P/L (Rs bn) Particulars FY14 FY15 FY16 FY17 FY18 FY19 Total income on subsidy booked basis 3,928 4,496 4,826 5,376 5,971 6,736 EBITDA (179) (12) (21) 237 404 200 PAT (680) (546) (633) (338) (295) (496) Source: Company, I-Sec research

Table 7: All India discom – trend of key parameters Particulars FY14 FY15 FY16 FY17 FY18 FY19 Energy sold (MU) 698,169 753,436 789,512 820,244 891,109 957,509 Total debt (Rs bn) 3,651 4,038 4,220 4,170 4,545 4,785 Accumulated losses (Rs bn) -3,063 -3,586 -4,139 -4,118 -4,408 -4,887 AT&C loss (%) 22.16 25.21 23.44 23.5 22.33 22.01 ARR-ACS gap on subsidy booked (excl reg. income & UDAY grant) (Rs/kWh) 0.72 0.52 0.59 0.68 0.63 0.77 Source: Company, I-Sec research

Table 8: All India discom P/L on per unit of energy sold basis (Rs/kWh) Particulars FY14 FY15 FY16 FY17 FY18 FY19 Total Revenue on subsidy received basis 5.63 5.97 6.11 6.55 6.70 7.03 EBITDA (0.26) (0.02) (0.03) 0.29 0.45 0.21 PAT (0.97) (0.72) (0.80) (0.41) (0.33) (0.52) Source: Company, I-Sec research

Table 9: Capex over FY20-FY25 estimated to be >40% higher Category (Rs bn) FY20 FY21 FY22 FY23 FY24 FY25 Total Generation 301 538 638 635 650 507 3,268 Distribution 211 420 442 600 700 857 3,230 Transmission 549 539 507 515 515 415 3,041 Total 1,061 1,497 1,587 1,750 1,865 1,779 9,539 States 581 758 630 485 387 331 4,565 Renewable Energy 305 1,510 1,440 1,700 2,170 2,170 9,295 Atomic energy 116 215 283 331 327 283 1,555 Overall total 2,063 3,980 3,941 4,266 4,749 4,563 24,954 Source: NIP, I-Sec research

Power Finance Corporation, September 15, 2020 ICICI Securities

Chart 30: PFC’s group Structure

Power Finance Corporation

Associates Subsidiaries Joint Venture

24.97%

Ultra Mega Power PFC REC Ltd EESL Project (100%) Consulting (52.63%) (47.15%)

Source: Company

Chart 31: PFC’s top 10 borrowers

Top 10 borrower concentration

9.0 7.9 8.0 7.3 7.0 6.0 4.9 4.7 5.0 3.6 4.0 3.0 2.8 (Rs mn) (Rs 2.7 2.7 3.0 2.5 2.0 1.0 0.0 Borrower 1 Borrower 2 Borrower 3 Borrower 4 Borrower 5 Borrower 6 Borrower 7 Borrower 8 Borrower 9 Borrower Borrower 10 Borrower

Source: Company

Power Finance Corporation, September 15, 2020 ICICI Securities

Financial summary

Table 10: Profit and loss statement (Rs mn, year ending March 31) FY18 FY19 FY20 FY21E FY22E Interest income 2,64,747 2,87,961 3,22,301 3,43,346 3,77,532 Interest expended 1,72,256 1,93,860 2,15,589 2,32,025 2,59,176 Net interest income 92,491 94,101 1,06,712 1,11,321 1,18,356 Non interest income 1,499 1,490 1,230 2,434 2,714 Income from operations 93,990 95,591 1,07,941 1,13,755 1,21,069 Other income 3,233 1,763 13,003 12,012 13,343 Net revenues 97,222 97,355 1,20,944 1,25,768 1,34,413 Operating expenses 3,828 4,016 3,969 4,405 4,923 - Employee exp 3,560 3,888 3,799 4,240 4,749 - Depreciation /amortisation 64 61 91 82 87 - Other opex 205 67 79 83 87 Preprovision profit 93,394 93,338 1,16,975 1,21,363 1,29,490 Provisions 8,153 (8,715) 9,912 29,133 32,366 - Loan loss provisions 5,608 (8,715) 9,912 29,133 32,366 PBT 85,241 1,02,053 1,07,063 92,230 97,124 Taxes 25,302 29,765 33,160 23,242 24,475 PAT 59,938 72,288 73,903 68,988 72,649 Extraordinaries (1,386) (2,759) (17,352) 3,569 1,141 Reported PAT 58,552 69,529 56,551 72,557 73,789 Basic number of shares (mn) 2,640 2,640 2,640 2,640 2,640 Basic EPS (INR) 22.2 26.3 21.4 27.5 28.0 Diluted number of shares (mn) 2,640 2,640 2,640 2,640 2,640 Diluted EPS (INR) 22.2 26.3 21.4 27.5 27.9 DPS (INR) 7.8 - 9.5 8.9 9.7 Dividend payout (%) 42.1 - 49.0 32.4 34.8 Source: Company data, I-Sec research

Table 11: Balance sheet (Rs mn, year ending March 31) FY18 FY19 FY20 FY21E FY22E Liabilities Equity capital 26,401 26,401 26,401 26,401 26,401 Reserves & surplus 3,44,862 3,76,774 4,14,511 4,58,433 5,01,393 Net worth 3,71,263 4,03,175 4,40,911 4,84,833 5,27,793 Reserve for doubtful debts 33,830 37,402 25,142 21,227 20,671 Secured Loans 3,31,030 9,53,630 11,79,690 13,41,361 14,72,073 Unsecured loans 19,64,354 19,30,646 18,54,832 20,06,481 22,69,887 Deferred tax liability 3,009 -40,607 -29,521 -15,625 -12,711 Interest subsidy fund from government 1,160 0 0 0 0 Total liabilities 27,04,646 32,84,246 34,71,053 38,38,277 42,77,713 Assets Loans 27,28,122 30,32,104 33,41,126 37,11,236 41,52,307 Investments 23,364 1,65,862 1,64,733 1,64,733 1,64,733 Current assets 1,12,518 2,09,801 81,812 75,663 77,839 Current liabilities 1,66,493 1,31,501 1,31,705 1,28,695 1,32,762 Net current assets -53,974 78,300 -49,893 -53,032 -54,923 Fixed assets (net block) 648 283 675 641 602 Foreign currency transaltion difference 6,486 7,697 14,412 14,700 14,994 Total assets 27,04,646 32,84,246 34,71,053 38,38,277 42,77,713 Balance sheet ratios (%) Loan growth 13.6 11.1 10.2 11.1 11.9 Borrowings growth 13.3 25.7 5.2 10.3 11.8 EA growth 12.7 21.4 5.7 10.6 11.5 Gross NPA ratio 9.6 9.4 8.1 7.5 7.3 Net NPA ratio 7.4 4.6 3.8 3.1 2.7 Provision coverage 22.9 51.5 52.9 60.0 65.0 Source: Company data, I-Sec research

Power Finance Corporation, September 15, 2020 ICICI Securities

Table 12: Growth metrics (%, year ending March 31) FY18 FY19 FY20 FY21E FY22E Net interest income (9.9) 1.7 13.4 4.3 6.3 Net revenues growth (7.5) 0.1 24.2 4.0 6.9 Opex growth 2.6 4.9 (1.2) 11.0 11.8 PPP growth (7.9) (0.1) 25.3 3.8 6.7 PAT growth 185.5 20.6 2.2 (6.7) 5.3 Source: Company data, I-Sec research

Table 13: Operating ratios (%, year ending March 31) FY18 FY19 FY20 FY21E FY22E Yield on assets 10.4 9.6 9.54 9.40 9.30 Cost of funds 8.0 7.5 7.28 7.27 7.31 Spread 2.4 2.1 2.3 2.1 2.0 Net interest margins 3.6 3.1 3.16 3.05 2.92 Cost-income 3.9 4.1 3.3 3.5 3.7 Tax rate 29.7 29.2 31.0 25.2 25.2 Source: Company data, I-Sec research

Table 14: Sanctions and disbursements (Rs mn, year ending March 31) FY18 FY19 FY20 FY21E FY22E Sanctions 11,88,700 13,07,570 14,38,327 15,82,160 17,40,376 Disbursements 6,78,560 6,76,780 6,79,970 7,81,966 8,60,162 Disbursements to sanction ratio (%) 57.1 51.8 47.3 49.4 49.4 Disbursements growth (%) 1.7 (0.3) 0.5 15.0 10.0 Sanctions growth (%) 14.7 10.0 10.0 10.0 10.0 Sanctions (INR mn) 11,88,700 13,07,570 14,38,327 15,82,160 17,40,376 Source: Company data, I-Sec research

Table 15: RoE decomposition (%, year ending March 31) FY18 FY19 FY20 FY21E FY22E Net interest income/assets 3.6 3.1 3.2 3.0 2.9 Non interest income/assets 0.2 0.1 0.4 0.4 0.4 Net revenues/Assets 3.8 3.3 3.6 3.4 3.3 Operating expense/Assets 0.2 0.1 0.1 0.1 0.1 Provisions/Assets 0.3 (0.3) 0.3 0.8 0.8 Taxes/Assets 1.0 1.0 1.0 0.6 0.6 Total costs/Assets 1.5 0.8 1.4 1.6 1.5 ROA 2.3 2.4 2.2 1.9 1.8 Equity/Assets 15.0 13.9 13.1 12.9 12.6 ROAE 15.7 17.4 16.7 14.6 14.2 Source: Company data, I-Sec research

Table 16: Valuation metrics (year ending March 31) FY18 FY19 FY20 FY21E FY22E Diluted EPS (Rs)* 22.2 26.3 21.4 27.5 27.9 EPS growth (%) 175.4 18.7 (18.7) 28.3 1.7 Book value per share (Rs) 151.0 164.0 171.1 186.1 202.1 Adjusted book value per share (Rs)* 92.5 123.2 133.8 153.0 170.7 Diluted P/E (x) 4.1 3.5 4.3 3.3 3.3 Price/ BV (x) 0.6 0.6 0.5 0.5 0.5 Price/ Adj. BV (x) 1.0 0.7 0.7 0.6 0.5 Dividend yield (%) 8.5 0.0 10.3 9.7 10.6 Source: Company data, I-Sec research

Note: FY18 financial statements are as per I-GAAP; FY19-FY22E financials are as per Ind-AS

Power Finance Corporation, September 15, 2020 ICICI Securities

Index of tables and charts

Tables Table 1: Outstanding portfolio of PFC: Distribution, ST loans and others at <25% of the book ...... 7 Table 2: Account by account analysis of PFC’s stressed private sector exposure suggest ~50% haircut in the base case (Rs mn) ...... 10 Table 3: PFC/REC scheme – status so far (data till 8th Sep’20) ...... 14 Table 4: PFC/REC scheme – loan applications status (data till 8th Sep’20) ...... 14 Table 5: …Despite REC acquisition knocking down 400bps of Tier-1 ...... 20 Table 6: All India discom P/L (Rs bn) ...... 22 Table 7: All India discom – trend of key parameters ...... 22 Table 8: All India discom P/L on per unit of energy sold basis (Rs/kWh) ...... 22 Table 9: Capex over FY20-FY25 estimated to be >40% higher ...... 22 Table 10: Profit and loss statement ...... 24 Table 11: Balance sheet ...... 24 Table 12: Growth metrics ...... 25 Table 13: Operating ratios ...... 25 Table 14: Sanctions and disbursements ...... 25 Table 15: RoE decomposition ...... 25 Table 16: Valuation metrics ...... 25

Charts Chart 1: Myths we want to debunk ...... 3 Chart 2: Reality and Certainty to pay heed to ...... 3 Chart 3: Power financiers funding 35-45% capex of the power sector ...... 4 Chart 4: Power capex of Rs25tn estimated over FY20-FY25 ...... 4 Chart 5: PFC to consistently support power sector with >10% portfolio growth ...... 4 Chart 6: Yields have remained sticky; lower funding cost supports NIMs ...... 5 Chart 7: Despite power sector stress, consistently delivering superior RoEs ...... 5 Chart 8: Consistent track record of high dividend payout ...... 5 Chart 9: Banks averse to power sector lending; PFC actively supporting ...... 6 Chart 10: Power financiers funding 35-45% capex of the power sector ...... 6 Chart 11: Cumulative disbursements of PFC over past 5 years; ST loans at 15% ...... 7 Chart 12: AT&C losses consistently improving post UDAY (%) ...... 8 Chart 13: ARR-ACS (Rs/kWh) gap has improved too ...... 8 Chart 14: DISCOM losses were contained post UDAY ...... 8 Chart 15: ~45% of private sector exposure already stressed with 55% coverage ...... 9 Chart 16: PFC’s state-wise exposure ...... 11 Chart 17: Yields have remained sticky; lower funding cost supports NIMs ...... 12 Chart 18: Assets and liabilities skewed towards longer term maturity...... 12 Chart 19: Forex translation losses make earnings volatile ...... 13 Chart 20: Forex borrowings >5 years maturity not hedged; 26% of <5 years forex exposure is unhedged ...... 13 Chart 21: Capex in the power sector at 20-40% of infra investments ...... 16 Chart 22: Power capex of Rs25tn estimated over FY20-FY25 ...... 16 Chart 23: Consistently supporting power sector with >10% portfolio growth ...... 17 Chart 24: Consistent track record of high dividend payout ...... 18 Chart 25: Trading at steep discount though networth erosion is unwarranted ...... 19 Chart 26: PFC has underperformed financial index by ~20% over past 3 years ...... 19 Chart 27: Despite power sector stress, consistently delivering superior RoEs ...... 20 Chart 28: Comfortable CAR and liquidity to participate in upcoming growth… ...... 20 Chart 29: Consolidated book value per share (Rs) (FY20) ...... 21 Chart 30: PFC’s group Structure ...... 23 Chart 31: PFC’s top 10 borrowers ...... 23

Power Finance Corporation, September 15, 2020 ICICI Securities

ICICI Securities has received an investment banking mandate for disinvestment in REC Ltd. This update is prepared on the basis of publicly available information.

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New I-Sec investment ratings (all ratings based on absolute return; All ratings and target price refers to 12-month performance horizon, unless mentioned otherwise) BUY: >15% return; ADD: 5% to 15% return; HOLD: Negative 5% to Positive 5% return; REDUCE: Negative 5% to Negative 15% return; SELL: < negative 15% return

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