PFC-REC merger targets scale, but sector growth and swap ratio key: Experts

Mutual fund ownership in both stocks has seen only moderate trimming in recent quarters, suggesting portfolio rebalancing rather than a loss of conviction.

• PFC and REC boards approve merger, forming a major power sector financier
• Swap ratio and valuation outcomes will be key for equity market impact
• Government stake may fall below 51%, posing execution challenges

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Market experts believe the proposed merger of Power Finance Corporation (PFC) and REC is aimed at building scale in power-sector financing. However, they note that the move alone is unlikely to impact valuations unless sector growth visibility improves and merger mechanics, including the share swap ratio, are clarified, as the intricacies of the merger remain "complex".

The boards of the two state-owned lenders on February 6 approved the merger in principle, following the Union Budget announcement on restructuring PFC and REC. The combined entity is expected to have a loan book of around Rs 11.5 lakh crore, positioning it among the largest specialised financiers for India’s power sector. Currently, REC is a fully-owned subsidiary of PFC. PFC acquired 52.63% of the government's holding in REC Limited (REC) for Rs 14,500 crore in March 2019.

The PFC stock has gained around 9 percent since Jan 31, while REC has fallen around 1.3 percent.

Ownership structure poses execution challenges

Analysts at Emkay Global noted that a merger at prevailing share prices would reduce the government’s stake in the merged entity to about 42%, below the 51% threshold required for a ‘government company’ under the Companies Act, 2013.

This would necessitate alternative routes such as large-scale buybacks, capital infusion, or amendments to the law, each with its own constraints and potential to extend timelines.

“Irrespective of the route taken to merge the two companies, their business fundamentals do not change,” Emkay said, adding that both lenders remain closely linked to power sector capital expenditure, particularly lending to state-owned utilities, with limited scope for efficiency gains given already lean cost structures.

Investment thesis unchanged; swap ratio key

From an investor perspective, Emkay said the merger does not materially alter the core investment case for either stock. “The investment case for both remains similar,” the brokerage said, adding that “the scheme of merger-led eventual share swap ratio will provide any arbitrage opportunity.”

Market participants said the swap ratio is likely to be the most closely watched variable. While no formal proposal has been disclosed, Akshay Chinchalkar, Head of Market Strategy at The Wealth Company pointed to early market expectations. “Some estimate that for every nine shares of REC, investors may receive around eight shares of PFC,” he said, but added that these are currently only indicative estimates.

“The final swap ratio will be determined by independent valuers and will also require regulatory approval,” Chichalkar added, noted that valuation outcomes hinge on the structure eventually adopted.

Valuations compressed despite stable fundamentals

Valuations of both stocks have corrected sharply from earlier peaks, even as balance sheets and asset quality remain stable. PFC’s one-year forward price-to-earnings multiple peaked at 12.4 times on July 11, 2024, and currently trades at around 7.32 times. REC’s one-year forward PE has declined from a peak of 9.6 times to about 5.3 times.

Both stocks are trading below their estimated FY28 book value, with return on equity projected in the mid-teens, while offering dividend yields of roughly 5%. Broker sentiment remains positive, with both PFC and REC carrying 12 ‘buy’ ratings each, one ‘hold’, and no ‘sell’ recommendations.

Scale, cost of funds may drive longer-term rerating

Some experts believe consolidation could address valuation issues over time, particularly for PFC. “For investors, the move is expected to remove the holding company discount of PFC along with better earnings growth, potentially leading to a market re-rating,” said Vijay Gour of Mirae Asset Sharekhan.

Gour said the strategic rationale lies in scale and balance-sheet strength. “A larger and more powerful entity is required to finance higher ticket-size and more complex projects,” he said, adding that a stronger balance sheet could lower the cost of funds and support profitability over the medium term.

Chinchalkar echoed this view, saying markets typically reward scale. “Instead of competing with each other, the combined entity would benefit from improved pricing power and potentially stronger margins,” he said, adding that “a reduction in government ownership is generally interpreted as greater operational freedom.”

Mutual fund holdings show mild trimming, not exits

Mutual fund ownership in both stocks has seen only moderate trimming in recent quarters, suggesting portfolio rebalancing rather than a loss of conviction. In PFC, mutual funds held 10.09% of equity as of the December 2025 quarter, down from 10.58% in September 2025 and 11.57% a year earlier. In REC, mutual fund holdings stood at 9.18% in December 2025, compared with 9.41% in the previous quarter and around 9.66% in mid-2025.