Market participants keenly watch brokerage upgrades or downgrades, which often signal changing market dynamics. Stocks are also quick to react to brokers’ reports, and if the report is optimistic, it acts as a booster shot for the company.
As such, two PSU stocks, Rural Electrification Corporation (REC) and Power Finance Corporation (PFC), have been upgraded by two global brokerage giants, UBS and CLSA. This shows growing optimism in the company, hinting at improving fundamentals and potential upside, making these stocks worth watching.
Let’s break down what’s driving the optimism.
#1 Power Finance Corporation
PFC is a non-banking financial company owned by the Government of India. It has the highly coveted Maharatna status and is India’s highest profit-making NBFC.
The company provides credit to power sector companies and funds projects in power generation, transmission, distribution, and renewable energy. Its customers include electrical equipment manufacturers, and central and state power utility companies.
The company’s share price has seen a big re-rating over the last five years owing to its strong financial performance.
Its total income grew at a CAGR of 9.8% to ₹460 billion in FY24, while profit rose 15.6% to ₹143 billion.
This robust growth was fuelled by strong loan disbursements, which grew at a CAGR of 8.9% during this FY20-FY24 to ₹4.8 trillion in FY24, led by strong power financing demand. The loan book comprises 81% of loans from the government sector and 19% from the private sector.
On the asset-quality front, its net non-performing assets (NNPA) have declined to 0.85% from 3.8% in FY20. Improvements in power distribution companies ‘ financial position and the increasing share of loans secured by government guarantees helped PFC reduce its NPAs.
Now, let us discuss why these brokers are bullish on PFC.
UBS expects PFC to be a major beneficiary of India’s energy transition financing theme. It said India aims to achieve 50% of installed capacity from renewables by FY30, with a total non-fossil fuel capacity of 500 GW.
This requires an estimated total power-related capex CAGR of 11% during FY24-30 to ₹5 trillion annually from the current ₹3 trillion. Most of the capex will go into upgrading transmission, distribution, and renewable energy.
Its recent loan book growth has been a robust 12% CAGR over the last three years. This growth was driven by government schemes, renewable energy, rising power demand, and infrastructure financing disbursements.
Now, 15% of PFC’s loan book comes from renewable energy and infrastructure financing, up from 8% in FY19. Due to increased spending on renewable energy, this is expected to grow to 26% by FY27, helping PFC grow its loan book at a CAGR of 13%.
To sustain loan growth, CLSA says 59% of the loans sanctioned in the last 33 months are yet to be disbursed. This gives PFAs a solid pipeline to support double-digit to mid-teens loan growth in FY26-27.
The company’s asset quality is also expected to remain strong, with an increase in the share of state-guaranteed loans (41% in FY24 vs 10% in FY17). To this end, it also expects write-backs of legacy assets over the following two years.
PFC trades at a price-to-book (P/B) ratio of 1.2, a 70% premium to its 10-year median P/B of 0.7. However, relative to its peers, it is one of the cheapest NBFCs, and UBS says there is more headroom for re-rating.
As per UBS, the current valuation does not consider the base case of 13% loan growth, stable net interest margins, credit costs, and a strong return on equity (ROE) of 18-20%.
UBS has a target of ₹670 per share, 72% higher than its current market price (CMP) of ₹390, while CLSA has a target of ₹525, 35% higher than CMP.
#2 Rural Electrification Corporation
REC is a leading Maharatna central public sector enterprise and one of India’s largest NBFCs. It initially started as a lender to state power utilities for rural electrification, but its scope has expanded to the broader power sector.
The company provides long-term project loans to the state, central, and private companies. On the other hand, short-term/medium-term loans are given to power utilities to meet their working capital requirements.
The company also offers non-fund-based products, including a letter of undertaking in lieu of a bank guarantee. And now, it has further broadened its portfolio to fund the infrastructure and logistics sector.
In terms of financials, REC’s total income has grown at a CAGR of 9.8% to ₹472 billion over the last five years, while profit has grown by an impressive 23.5% to ₹140 billion. This growth was driven by loan book growth of 9.6% CAGR to ₹5.1 trillion during this period.
REC’s asset quality remains strong, with net NPA at 0.86% in Q4FY24, down from 1.24% in Q2FY23. The company has not reported new NPAs during the last nine quarters ending Q4FY24. CLSA says that the company maintains strict control over project approvals and agreements, which helps it maintain strong asset quality.
UBS believes REC’s attractive growth story aligns with the government’s vision of power transition and infrastructure capex. It says diversifying into infrastructure financing bodes well for the company, as the segment is three times larger than power financing.
This growth opportunity will allow REC to nearly double its loan book from ₹5 trillion in FY24 to ₹10 trillion in FY30E. Moreover, like PFC, REC is also expected to benefit from resolving its legacy assets, which will help the company maintain growth momentum for the next two years.
As a result, REC’s return on assets is expected to remain strong at 2.5% during FY25-FY29E (2.8% in FY24) and RoE at 18-20%. As per CLSA, REC’s best-in-class loan growth, RoE, and dividend yield set it apart from peers in the sector.
Regarding valuations, it sees further upside potential, given its 20% RoE, despite a significant re-rating to 1.5 P/B from 0.6 in February 2023. UBS has assigned a price of ₹720, 71% higher than the CMP.
Looking ahead, REC’s plans are closely aligned with India’s push towards clean energy sources. In keeping with the philosophy, REC aims to grow its green lending 8-fold to ₹3 trillion by 2030 from the current ₹390 billion in FY24.
The company is confident of sustaining growth in disbursements and asset quality. It aims to increase private sector exposure to 30% by 2030, primarily through renewable energy projects.
Conclusion
Power demand in India is growing, driven by demand from data centers, increasing electrification, and urbanization. Notably, India’s per capita energy consumption is also lower than the global average, which leaves room for growth.
However, India lacks power infrastructure, requiring massive investments of ₹42 trillion to meet the demand, which is expected to grow at a CAGR of over 7% in the coming years.
PFC and RECs both remain dominant power financiers, with robust loan growth, strong asset quality, robust earnings growth, and a strong track record, making them well-positioned to capitalize on this opportunity.
Disclaimer
Note: We have relied on data from www.Screener.in throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.
The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educative purposes only.
About the Author: Madhvendra has been deeply immersed in the equity markets for over seven years, combining his passion for investing with his expertise in financial writing. With a knack for simplifying complex concepts, he enjoys sharing his honest perspectives on startups, listed Indian companies, and macroeconomic trends.
A dedicated reader and storyteller, Madhvendra thrives on uncovering insights that inspire his audience to deepen their understanding of the financial world.
Disclosure: The writer and his dependents do not hold the stocks discussed in this article.
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