Inside Out Swotlight: Is Power Finance Corporation a re-rating candidate?

The viability of the power sector is improving as a result of the reforms implemented by the Ministry of Power, the state governments as well as distribution companies.

The demand for power is shooting through the roof. The sector will need to make more investments if it has to meet this growing demand by expanding capacity. Goes without saying, investments will only come if the sector remains viable

The result is evident. The Power Ministry noted a marked reduction in aggregate technical and commercial losses of distribution companies in financial year 2022. The AT&C losses is a combination of energy loss (technical loss, theft and billing inefficiencies) and commercial loss (payment default and collection inefficiency). For financial year 2022, the AT&C losses declined to 17 percent from 22 percent in September 2021.

Prudential norms for PFC and REC have been revised by the power ministry. The revised norms state that discoms cannot avail of financing from both the companies unless they draw up an action plan to reduce the losses within a specified timeframe and also get their respective state government's to commit to the same.

An additional borrowing window has also been provided by the 15th Finance Commission to the states provided they take steps to reduce the losses of their discoms.

In June this year, the Power Ministry also issued late payment surcharge rules which state that unless discoms promptly pay for the power drawn from the interstate transmission system, their access to the power exchange will be cut off. Of course, while putting these measures in place, the ministry worked with the discoms to provide the necessary finances under the Revamped Distribution Sector Scheme (RDSS) to undertake the loss reduction measures.

The implementation of the electricity rules this year has not only ensured that the outstanding dues are liquidated but also ensured that current dues are paid in time. This is ensuring financial discipline in discoms.

As of the September quarter, PFC's gross loan assets stood at close to Rs 4 lakh crore while disbursements are over Rs 22 lakh crore in the first half of the current financial year.

Generation and distribution companies form close to 90 percent of its loan book. Majority of the lending is done to government entities.

Improving asset quality has been one of the highlights for PFC, reflecting its successful resolution efforts. The company's net NPA is now at the lowest level in six years, mainly due to the resolution of two stressed assets - South East Up Transmission Co. and Jhabua Power Ltd., in the previous quarter.

Apart from the valuation comfort, PFC also provides a solid dividend payout, which has ranged between Rs 9-12 over the last few years.

With an eye on financial year 2024, the street is hopeful of 8 percent loan growth, driven by the infrastructure financing opportunity, a pick-up in the capex cycle and greater credit demand by the generation companies. The EBITDA margin may bottom out even in a rising interest rate scenario as asset repricing happens every three years.

A significant provision buffer would mean lower credit costs and with stress already recognised in the private sector, slippages are also likely to be on the lower side.

Among the key risks include the capital allocation overhang due to the PSU-label.