Power Finance Corporation Limited : Rare profit making PSU?

thanks so much. your feedback is very helpful.

I agree on most of the thoughts presented by Anupam and Smallcapvaluefind . I wish to document my views (by slightly being devil’s advocate)

  • As far as asset quality is concerned, we can make some educated guess here. In the FY ending March 2017, PFC moved from Prudential Norms of MOP to the prudential norms of the RBI. Those norms required aggressive recognition of NPAs and make provisions accordingly. The resulting net NPAs shot up as a result from 2.55% to 10.55%. All of these were state owned projects and were servicing debt regularly.
  • If we go through concall transcripts step-by-step since the change in norms we learn that these NPAs got reversed. As I write this, the latest June 2020 quarter presentation shows that net NPAs have since then come down to 3.41% and NPAs in state owned project/companies is NIL. So maybe all of government loans either got restructured or were standardized.
  • However, net NPAs have increased if we take RBI norms out of the picture.
  • 70% of their book is under moratorium which gets over at the end of August. So we need to keep a close watch on what happens to these account. Since more than 80% of their loans are towards government sector we can make an educated guess as done in above scenario that these accounts will be gradually standardized or restructured if they face stress (which they will in my view)
  • Government has also announced Rs. 90,000 crore package for the Discoms to infuse liquidity into the sector and it will be trough PFC and REC. Rs. 30k crores is sanctioned and Rs. 8.5k crore is already disbursed. All these loans are to be secured with state government guarantee. So it adds to the relief post-moratorium period.

Growth and Profitability:

  • Despite the average ROE since last 3 years of 16% they have not compounded book value by that amount because they pay more dividend and build loan book through borrowing. So debt is significant part of their balance sheet. Also, due to sovereign guarantee they get easy access to leverage.
  • There are many moving parts into the profitability of the company. Consider for example Rs. 5000 crore forex loss in FY Ending March 2020. 5000 Crores!! On a net profit of Rs. 9400 crores!! I am puzzled at what they are doing with their hedging policy. I checked but there was no explanation anywhere. I also found no institutional investor raising this question in the latest concall transcripts. May be, it is a normal thing for them. God knows.

Investment Thesis:

  • PSUs are notorious for their bad capital allocation skills. A good capital allocator focuses on building a good balance sheet compounding well through years. It is not the case here, going by their debt level. So investment in the company is only on the basis of price bargain to book value plus for their regular dividends.
  • Since some PSU stocks are beaten down and overlooked by the retail investors for whatever reason. I thought to take this contrarian bet. Will start exiting once market value merges with business value. (I am more of Philip Fisher type investor but I have invested in to practice and learn Graham style investing also).

Risks:

  • Price stays unmoved for too long (> 3 years) or gets beaten down due to external factors.
  • Asset quality reduces drastically post-moratorium lifting period.
  • Government stake changes.
  • It also has large institutional holding. Also need to keep an eye if institutional investors start selling this stock. No harm in tracking their positions.
  • Squeeze in liquidity in power sector.

Disc: I hold. Not a SEBI registered advisor.

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@Nikhil_Udhani

  1. On the capital allocation point, the Banking/NBFC business is by design a highly leveraged business and if they do not use leverage there is no business model. The CRAR for PFC ranges between 17 & 18% and is broadly in line – may note the following:

    • CRAR Norm (NBFCs) – 15%
    • CRAR of NBFCs (March 2020) – 19.6%
    • In the Q4FY20 concall, PFC mentioned that there has been a reduction of 40 bps in CRAR because of regulatory change: The key reason for depressed CRAR is the recent change introduced by RBI on 13th March, 2020, for exclusion of any net unrealized gains on fair valuation of financial instruments from calculation of own funds under CRAR, whereas all such net losses should be considered. For FY 19-20 after including net fair valuation gains, the CRAR would have been up by around 40 bps.
  2. Restructuring is not available to financial sector entities, central and state government as well as local bodies. So, if there are problems, they will come to the surface earlier. The long term solution is privatization of DISCOMs and is the unsolved portion in Power sector. Hope some worthwhile reforms are pushed by state governments at this time of adversity.

  3. Forex Loss – my understanding is that it is more of an Accounting loss and not cash loss. PFC has 74% of the FC loan hedged with 5 years residual maturity.

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Yeah, I understood that. My point was that people take bottom line as an input for the stock price (voting machine). No matter what the intrinsic value. Too many moving parts in net profit is a built-in characteristic of the business. I was only concerned whether it will take too long a time for value to be discovered.

I agree. I was just pointing out at low plough back ratio. For example they reported a Net Profit in FY 2019-20 of Rs. 9400 Crores if we take out dividends and profit for non controlling entities only Rs. 2200 crores were transferred to book. Which is of course the function of high dividend payout policy. If they want they can use this money. But then in this case, we all know what dividends mean to us… dont we?? :grinning:

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Financial results declared
YOY Revenue up 15%
Net Profit up 65%

What are the inherent risks in this stock?

  1. It gives consistent dividend. Current dividend Rs.10 gives 7.2 percent yield and dividend is growing. Dividend payout is just 25%. So, don’t see any risk in dividend be decreased.
  2. Loan book has grown 7x over last 10 years. Tremondoes growth indeed. Profit has also grown 3-4x which is really good too. The share price is the only constant!!

Now, I assume a dividend of Rs.15-17 by 2025. And even at a 8% dividend yield it translates to Rs. 180-200 per share. A return of roughly 15% per year (dividend + stock).

The market is in almost a bubble. (The tech ipos like Zomato, paytm, PolicyBazaar and even Nykaa are definitely a bubble)… so what am I missing here?
What is the risk in this stock? Except yeah it doesn’t move. I don’t really consider this a risk… because it is at a stage where it will not move by pe but by dividend yield instead!! And if its dividend it has to move.

The only issue is how to know hdfc/hul? There are many other big companies that actually failed.
Plus most of the really good companies didn’t give huge profits due to profit growth alone but due to pe expansion too!!!

Like hul pe increased from 20 to 80!! SRF pe from 3 to 60!! and so on. If they grow 30 times 5 times is coming from actual profit growth and 6 times from pe expansion!!
Even asian paints 2010 to 2020 it increased 16 times. 4 times due to growth and 4.due to pe expansion (20 to 80!!)

Say 10 years from now pe of this expands modestly to 12. That would be 4 times growth in itself!!

One major reason for underperformance is, LIC has offloaded 2.02 percent stake in PFC through open market transactions. Reduced to 5.06 percent against 7.09.

Is there any way to verify whether PFC is paying any tax on the dividend received from REC. It receives like 1500 Crore from REC and if it pays 20-30% tax on it that comes out to be 300-450 cr.

There are certain conditions to be satisfied so that it is considered that the dividend was passed on and is not taxed which should be true. Just not sure PFC is doing that considering its a government company and govt companies are generally not pro minority-shareholders.

My understanding is that the dividend received from REC is passed on as PFC dividend and therefore only the end recipient has to pay tax on the same. Not sure though!

Any thoughts on this?

At what valuation will PGCIL buy REC from PFC if it happens. Will it be on book value or Market Value. It would be a big loss for PFC if its market value.

That’s true - however, to my mind, the bigger issue is market not giving any valuation to the company. Unable to understand why market is giving a multiple of 2 to this Company.

Snapshot of the fundamentals:

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Another good set of results from PFC with Conso EPS growing to ~Rs 15.

Net NPA is just 1.31% now! Ofcourse, this news also would not matter and stock would continue its struggle.

Disclosure: Invested and puzzled with the performance

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Any idea why the stock has suddenly shot up?

Haven’t been able to figure this out yet. However, I did notice that media channels have been recommending PFC/REC lately

Could this be retail buying? :thinking:

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This is a classic dilemma of an investor, if a stock appears cheap, then we distrust it, instead of jumping in and scooping it up.

Since you posted, the PSUs have become beloved of the market. There is a change from the financials that you have posted.

Compounded Profit Growth
10 Years: 16%
5 Years: 44%
3 Years: 12%
TTM: 8%
Stock Price CAGR
10 Years: 4%
5 Years: 2%
3 Years: 5%
1 Year: 15%
Return on Equity
10 Years: 18%
5 Years: 20%
3 Years: 19%
Last Year: 21%

To me it looks attractive, especially seen in the context of the rally in the Rail PSUs. To me, it looks better, particularly as it is not tied to the coat-tails of one overbearing client.

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While for me, PFC forms substantial part of my portfolio and have been invested for 3 years, the stock is still extremely cheap and one can invest at these levels.

The irony is if just long term profit growth,ROE chart is shown without naming the company- add to that honest management - the valuation at which stock is quoting is unthinkable.

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i m wondering, looking at almost all psu stocks rallying up… and all are good dividend payers… and there were discussions in changing of capital gains tax during budget … few weeks back… and if its related to dividend tax etc… hmmm and known resources are accumulating all div psu stocks… just speculating :slight_smile:

And this is a growth area. Indian power requirement is forecast to grow

“India expects annual electricity demand to grow at an average of 7.2% over five years ending March 2027, a draft government plan showed, nearly double the growth rate of over 4% seen during the five years to March 2022”

An expanding economy, population, urbanisation and industrialisation mean that India sees the largest increase in energy demand of any country, across all of our scenarios to 2040

I think till the discoms are reformed there will always be a discount.

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but thats old news right… first line ("India expects… " ) is Sep 2022, and the outlook analysis is of 2021 … but stock is jumping only last few sessions…

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