Ignore IREDA IPO, Choose PFC/ REC Instead
PFC and REC offer better risk-reward than the ongoing IPO of IREDA
A few days back I shared on LinkedIn about my successful investment in PFC and REC around a year back. At the time of investment, the thesis was good dividend yield + optionality from power sector revival. In the last year, both PFC and REC have surprised the street both with their growth as well as profitability. Street took no time to notice and both the stocks are up around 3x in the last one year (adj. for Bonus for PFC).
The IPO from IREDA (Indian Renewable Energy Development Agency) seems to have come at an opportune time when its peers PFC and REC are at their lifetime highs and there is a lot of market interest in anything that has 'renewable' in its name.
I took a closer look at the financials and the valuations at which IREDA IPO is offered. I could not find one reason to justify why I should invest in IREDA at the cost of PFC/ REC or make a fresh allocation to it. Before getting to the reasons, a bit on the business model.
The business model of PFC, REC, and IREDA is to finance power projects in India. There is a need for these specialized NBFCs owing to the fact that power projects are long gestation projects (10-15 years) and banks due to their asset-liability balance are of limited capacity to fund these projects. While PFC and REC fund the power sector across the value chain, IREDA focuses only on the renewable side and majorly on generation.
Moving on, below are the reasons why I think PFC/REC continues to make a lot of sense at CMP Vs subscribing to IREDA IPO:
Sovereign-backed loan book proportion: PFC and REC loan book put together is tilted heavily towards Gov of India-backed institutions at 80-90% of the loan book while for IREDA, the loan book is private sector heavy at 77% since most renewable projects are currently been undertaken by the private sector
Diversification: IREDA loan book is 100% renewable based generation assets which makes it susceptible to risks pertaining to one sub-segment of the power sector. PFC/ REC both plan to grow very aggressively in the renewable space while keeping its share at around 20-25% in the next 5 years. This means that with PFC/ REC, one can have decent exposure to the renewable sector growth while also benefiting from the entire power sector revival theme.
Infrastructure as an additional growth area: Recently, Gov has allowed PFC and REC to participate actively in infrastructure-related activities which was not allowed earlier. This makes PFC/REC a beneficiary of a big infrastructure theme in addition to the already attractive and reviving power sector. In the case of IREDA, there is no such additional lever to loan book growth.
PFC/REC represents the overall revival that is taking in the power sector. PFC/REC are the nodal agencies for the implementation of the RDSS scheme which is aimed at cleaning the DISCOMS. There are transmission-related schemes also which would further benefit PFC/REC. These schemes and benefits will not benefit IREDA in any major way.
PFC and REC are majorly provided for the stressed assets which are currently getting resolved and these are throwing provisions write-backs leading to superior profitability. This lever will at least be there till FY26. IREDA doesn't have any such lever available to it.
The only counterpoint I can think of is growth which in the case of IREDA is much higher than PFC/REC. I would say that PFC and REC both are placed in a very good position to deliver high teen growth in their loan book which would be similar to or better than IREDA (note that in the 1H, IREDA's loan book is flat while PFC and REC have grown by 6-9%.
Conclusive Thoughts:
With all of the above, in terms of valuations, IREDA IPO is offered at similar valuations at which PFC/REC are currently trading. In the chart below, I have shown my base case estimates for all the three NBFCs.
PFC and REC individually are 10x the size of the IREDA’s loan book. For 10x the loan book size of IREDA, better profitability, more growth prospects, and a more diversified loan book, and most importantly at similar valuations; PFC and REC make much more sense than IREDA at current valuations.