Bernstein has initiated coverage on Power Finance Corporation Ltd. and REC Ltd. with 'outperform', citing over 20% upside for both the companies.
The brokerage views both of these stocks as leveraged power sector plays, despite the associated risks. It has set a target price of Rs 620 and Rs 653 for PFC and REC, respectively, given the healthy valuation, under-estimated capex cycle, and lower default risk.
Modest Valuations
Shares of PFC and REC have jumped between 2.24 and 3.85 times, respectively, in the past 12 months, leading to a market capitalisation of both companies exceeding Rs 1.4 lakh crore.
Despite this surge, the current valuations of the companies stand between 8 and 10 times their earnings, the brokerage said.
Additionally, both companies have better return-on-equity and growth ratios compared to their other power peers, Bernstein said.
Power Capex Cycle
Investors are also underestimating the duration and intensity of the current capex cycle, Bernstein said. In the next six years, the brokerage anticipates adding over 300 gigawatts of power generation.
Bernstein also believed that power demand will continue to surprise and that the intensity of the current capex cycle could be at least double of what it was in the previous year.
Lower Risk Of Bad Loans
The risk of non-performing assets is also much lower in the current cycle, as around 70% of PFC and REC lending is to government entities and 30% to private renewables.
While the risk associated with private lending has historically been higher, renewable loans have a significantly lower default rate due to factors such as:
Short execution cycle of one to two years versus five years for thermal projects.
Projects being backed by power purchase agreements.
No fuel risk.
Better receivables since the majority of contracts are bidded out by the central government
Provisional Write Backs
The brokerage also thinks that provision reversals will help the companies in fiscal 2025.
Provisions are essentially funds the company sets aside to cover anticipated losses on specific assets. At the time of entry, provisions are recorded as liabilities on the balance sheet and as expenses on the income statement, thus reducing the company's net income.
When provisions are reversed, it reduces the liability amount on the balance sheet and increases the company's net income in the respective period.
The benefits of the write-backs were evident in REC's fiscal 2024 performance, as there was a provision write-back of Rs 13,584 crore. The company's management plans to become a zero-NPA company by fiscal 2025. It hasn't added any new NPAs in the last eight quarters.
The company expects to resolve two Maharashtra projects in fiscal 2025, the management told NDTV Profit. They also state that the company expects write-backs worth Rs 1,500–2,000 crore in the current financial year.
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