At first, it was a relief rally, because reports that REC would be the one using its cash to acquire PFC came unfounded. But now, relief seems to have turned into exuberance.
The corporation will continue as a public sector entity, and its borrowing costs will be similar. Analysts are ruling out much synergy with no major benefits accruing in operating costs. Besides, while REC could merge with PFC in the long run, that may not garner much benefit. “We see limited cost synergies, though some benefits on lending yields should accrue," noted Deutsche Equities India Pvt. Ltd in a note to clients.
If anything, investors need to worry if PFC’s inferior profitability rubs off on REC. In December 2018, its net interest margin was 4.3%, compared to 3.4% for PFC.
While both corporations are into financing power projects, their business segments are different. REC largely finances transmission and distribution, PFC funds generation. After the acquisition, therefore, analysts aver that lending priorities could see a change, and adversely affect REC’s margins.
Another worry for investors is that the high dividend payouts could now be behind.
REC had recently declared an interim dividend of ₹11 a share. With this, its dividend yield for FY19 is 8.5% at current market prices. Analysts reckon that as it will cease to be a subsidiary of the government, the corporation is likely to reduce its dividend payouts to shore up its lending business.
Its business has been doing well lately with an increase in the loan book. The December 2018 quarter registered 15.3% growth year-on-year. Stress has been lower. Net non-performing assets (NPAs) contracted to 4%, down from the September 2018 quarter. Some of the old stress in the book is being resolved through the bankruptcy process. Besides, the net interest margin improved in the December quarter.
Still, the stock’s recent performance has raised its valuation profile. REC’s price-to-book-value is up to 0.83 times from 0.6 times. Gains accruing to shareholders from the synergies have already been priced in. What remains now is how fast the lending business can expand in the new structure.