Can the proposed PFC-REC merger revive their stocks?

Following this, the boards of PFC and REC quickly approved the merger in principle on 6 February. Interestingly, this prompted profit-booking, with PFC stock down about 1% since then. REC investors have been sceptical right off the bat, with the stock correcting almost 3% since the Budget.

The mixed sentiment follows an about 40% correction in both stocks from their peaks in July 2024. Could a merger finally breathe fresh life into these struggling stocks? Let’s dive in.

Scale and synergy

REC is already a wholly owned subsidiary of PFC, since PFC had acquired more than 50% of the government’s holding back in 2019. The merger will result in a single entity, removing the parent-subsidiary relationship. This would remove the holding-company discount, resulting in an immediate earnings upgrade for the consolidated business.

Over the medium to long term, the enhanced scale from a combined loan book of ₹11.5 trillion would result in higher operating leverage. Some reports suggest greater scope for funding larger and more complex projects with improved pricing power.

On the cost side, PFC and REC have similar borrowing mixes, with more than 40% exposure to term loans and foreign currency borrowing. The combined scale of borrowing is likely to add to their heft at the negotiating table, lowering their lower costs of funds – another potential avenue for improved profitability post-merger.

They have similar loan mixes as well, tilted towards transmission and distribution, and have both dived headfirst into renewable energy. Their client profiles are similar as well, with 75-85% exposure to government-owned entities. This has led to frequent competition for projects. As this cannibalization is done away with and duplicate overheads are eliminated, synergistic benefits should follow.

Promising potential

There are undeniable industry tailwinds, including the government’s push for data centres, logistics, and maritime, which make the merger rather well-timed. In addition to claiming a fifth of India’s power financing market, PFC is also India’s largest renewable-energy financier, with the sector accounting for 16% of its loan book.

Similarly, as the government’s trusted arm for rural electrification, REC has availed the benefits of several government schemes including but not limited to the solar rooftop program, Revamped Distribution Sector Scheme (RDSS), and Pradhan Mantri Sahaj Bijli Har Ghar Yojana.

The consolidated entity will be at the forefront of capitalizing on India’s power sector and clean-energy goals. India’s per-capita electricity consumption is expected to triple by 2047, which, according to the power secretary, will increase the country’s power financing needs by more than ₹40 trillion over the next seven years. If PFC and REC manage to hold on to their market shares, it will lay the path for almost 14% compound annual credit growth between 2025 and 2032.

Poised for growth

It’s important to note that industry potential does not necessarily translate into company growth. Both PFC and REC were previously weighed down by massive bad loans, which restricted their ability to double down on growth. Over the years, however, both have cleaned up their acts.

PFC’s asset quality significantly improved in the first nine months of FY26, with net credit impaired asset ratios at 1.64% and 0.26%, respectively during 9MFY26, down 104 basis points (Bps) and 50 bps from a year earlier. REC, which has had relatively superior asset quality, also reduced its gross and net credit-impaired assets from 7.24% and 3.79% in FY19 to 0.88% and 0.2%, respectively.

This opens up room for further credit growth even as their provision coverage ratios offer comfort on profitability. REC has a provision coverage ratio of 77%, up from 48% in FY19. PFC has provisioned for 84% of its stage-3 assets, limiting the possibility of immediate shocks to profitability from any deterioration in asset quality.

Unclear merger mechanics

The share-swap ratio for the merger, which has not been announced yet, will drive the dynamics of the immediate arbitrage opportunity. Experts expect REC to be merged into PFC, and based on REC’s response to the merger, investors appear to be pricing in an undervaluation of REC. According to a report by UBS, 8 shares of PFC are likely to be offered against every 9 shares of REC.

There are also concerns around the government holding. If the merger goes through at current prices, the government’s stake in the merged entity would fall to 42%, lower than the 51% required to categorize it as a government company. Sure, buybacks or capital infusion by the government could solve for this, but clarity is still awaited.

Other causes for concern

This is not the first time that a merger of PFC and REC is being considered. In fact, when PFC acquired a majority stake in REC, the idea was to eventually merge the entities, given their similar business profiles and synergistic opportunities. But this very same overlap got in the way. Given the similar customer bases of PFC and REC, the merged entity would breach the 25% regulatory cap placed on exposure to a single project. If this pushes the consolidated business to wind down exposures, growth prospects would be severely affected.

Also, asset quality and repayment concerns persist. Given that 75% of PFC’s and 85% of REC’s customers are government-owned entities such as utility companies, delays in repayments are all but a given. Also, provisions cover barely 1% of PFC’s stage 1 and 2 assets – loans overdue for up to 90 days. If these loans go belly up, they will hit PFC’s profitability in the absence of adequate provisioning.

Synergistic benefits may also be limited, given the already high operating efficiencies. General PSU-related bureaucracy could also hinder integration after the merger.

Bottom line

Despite massive industry tailwinds and improved asset quality, which pave the way for growth, uncertainty looms. The merger ratios are yet to be announced and the regulatory implications cast a shadow as well.

Valuations have turned more palatable following recent corrections. Both PFC and REC are trading below their FY28 book value estimates, leaving room for appreciation, provided growth and return on equity remain high and bad assets remain stable. Execution will be key, and near-term volatility cannot be ruled out as nuances emerge.

Ananya Roy is the founder of Credibull Capital, a Sebi-registered investment adviser. X: @ananyaroycfa

Disclosure: The author does not hold shares of the companies discussed. The views expressed are for informational purposes only and should not be considered investment advice. Readers are encouraged to conduct their own research and consult a financial professional before making any investment decisions.