PFC, REC may benefit from enhanced 54 EC bonds attraction after real estate tax shift: Bernstein

If demand for 54 EC bonds bonds rises, it could potentially lower borrowing costs for PFC and REC, thereby improving their spreads and return on equity (ROE), Bernstein said.

The Indian government has recently reduced capital gains tax on real estate sales, but has simultaneously eliminated indexation benefits. This change is expected to lead to an increase in tax outflow for real estate investment gains, depending on the sale price and inflation, according to Bernstein.

To mitigate this increased tax burden, investors have two primary options: reinvest the capital from the asset sale into another real estate property or invest in special government 54 EC bonds.

The 54 EC bonds, which can only be issued by specific government-backed entities such as Power Finance Corporation (PFC), REC Ltd, National Highways Authority of India (NHAI), and Indian Railway Finance Corporation (IRFC), currently offer a coupon rate of 5.25 percent with a five-year duration.

This rate is lower compared to the average cost of funds for PFC at 7.4 percent and REC at 7.1 percent. If demand for these bonds rises, it could potentially lower borrowing costs for these two lenders, thereby improving their spreads and return on equity (ROE), Bernstein said.

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The international brokerage had initiated coverage on both PFC and REC stocks with an 'outperform' rating and target prices of Rs 653 and Rs 620 respectively. It views both of these stocks as leveraged power sector plays, despite the associated risks.

In its note, Bernstein highlighted that REC and PFC, long overlooked by investors, now boast market capitalisations between $15 billion and $20 billion, with trading volumes nearing $125 million.

Despite this, both stocks trade at relatively low trailing price-to-earnings ratios of 8 to 10 times, it said, adding that three types of investors think about these two stocks: those who are enthusiastic about REC and PFC, those who question their relevance, and those who are unaware of these stocks.

At 12:00 noon on July 25, REC and PFC shares were trading marginally higher at Rs 606.80 and Rs 525.15 apiece, respectively, on the National Stock Exchange (NSE). In the last one year, both stocks have zoomed 251 percent and 175 percent respectively, beating benchmark Nifty's returns of 23 percent during this period.

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