Beyond countryside

India's huge power deficit and its position as a country that has one of the lowest per capita power consumption of 600 units (world average of 2,500 units) has led the government to pursue policies to attract public and private investments into the Indian power sector.

The 11th plan (fiscal 2008-2012) envisages a total investment of Rs 8.38 lakh crore in the entire value chain of generation (Rs 4.11 lakh crore), transmission (Rs 1.4 lakh crore) and distribution (Rs 2.87 lakh crore). This also means huge demand for funds for setting up projects and hence, benefits for sector specific specialised financing organisations like Power Finance Corporation (PFC) and Rural Electrification Corporation (REC).

While the former is listed since a year, the 40-year old mini-ratna, REC plans to raise roughly Rs 1,400-1,640 crore offering 15.6 crore equity shares in the price band of Rs 90-105 each. Half of the shares on offer are being sold by the government and the balance a fresh issue of shares by REC. Hence, REC will receive only Rs 700-820 crore from the total funds raised. Post-issue, public holding will be 18.2 per cent.

With Emaar MGF and Wockhardt hospitals forced to withdraw their IPOs due to market conditions, a disappointing post-listing performance of Reliance Power, a 35 per cent decline in stock price of its closest peer, PFC in the last three months, what response does REC hope to get?

Expanding boundaries

REC holds a key position in government's plans and policies. For example, the company is a nodal agency for implementation and supervision of the Rajiv Gandhi Grameen Vidyutikaran Yojna scheme introduced in 2005. The expected disbursement in the 11th plan under the scheme is expected to be Rs 40,000 crore-eight times that of cumulative disbursement of Rs 5,000 crore in 10th plan.

This translates into an opportunity for REC, even as 90 per cent of the amount is in the form of government grants, as the rest is funded by the company. The company also lends under various other schemes like Accelerated Power Development and Reform Programme (APDRP) and Accelerated Generation and Supply Program. In the 11th plan, about Rs 50,000 crore is earmarked under APDRP.

Beyond that, there is huge scope for business expansion in future. The company is now open to financing even generation projects unlike its initial concentration on transmission and distribution projects. The share of generation in total outstanding loans has gone up from 6.55 per cent in FY05 to 27 per cent in H1FY08.

Further, unlike its traditional set up of developing power infrastructure in rural areas, it is open to projects across the country. It is also open to consortium lending and working with the private sector.

Some hurdles

On the lending front, about 96 per cent of the outstanding loans as on H1FY08 were to public sector companies, which due to non-payments or delays is a major risk as this could lead to higher NPAs. Secondly, the company's growth prospects are highly dependent on government policies. This again poses a huge business risk, given the past record of delays.

Currently, the company has been able to lend at a competitive rate, primarily due to the benefit of borrowings under tax-free 54EC capital gains tax exemption bonds, which was the single largest source of funds (43 per cent in H1FY08).

For example, the company's cost of funds and yield on advances were lower at 6.55 per cent and 9.93 per cent, respectively as compared with its closest peer, PFC, at 8 per cent and 10 per cent, respectively, as on September 2007. In the event of the government withdrawing the section 54EC benefit in future, the company's margins would be impacted substantially. 
 

PEER COMPARISON
Rs crore	PFC	REC
Asset size (FY07)	45,537	36,078.74
CAGR (%)#	20	24.9
Loan book (FY07)	46,032	30,279.17
CAGR (%)#	20.68	23.78
NIM (%)	3.8*	3.76
Operating profit (FY07)	1,511	1,130.81
CAGR (%)#	2.52	2.47
RONW (%)(FY07)	10.98	21.08
P/BV (x)
FY08E	2.3	1.3-1.5
FY09E	2	1.0-1.2
* Q2FY08  # Between FY03 and FY07

Financials

REC's financials are slightly better than its peer, PFC on most parameters. (see table: peer comparison) However, the company lags behind PFC in terms of quality of assets. As on September 30, 2007, PFC had gross non-performing assets (NPAs) of 0.1 per cent, much lower than 0.9 per cent in case of REC. This should change as the company enhances its share of generation projects (including private ones).

While core revenues and profitability have been fluctuating, in the near-term the outlook is healthy. In H1FY08, net interest income jumped 63.3 per cent to Rs 596.3 crore, while operating and net profit increased at a faster rate of about 80 per cent each, to Rs 781.5 crore and Rs 522.9 crore, respectively. 
 

FINANCIALS
Rs crore	FY07	H1FY08	% chg
Net Interest Income	936.20	596.31	63.28
Operating profit	1130.81	781.50	80.46
Net profit	775.03	522.87	81.08

Investment rationale

At Rs 90-105, REC trades at 1.03-1.2 times its estimated FY09 book value. Its closest peer, Power Finance corporation's trades at around 2 times, which is also reasonable compared to its size (loan book is 1.5 times of REC), quality of assets and margins of about 3.8 per cent.

However, analysts are also positive about the REC and expect a decent appreciation as it is already priced at a discount to PFC. Crisil has assigned a rating of 3 out of 5 indicating average fundamentals.

Thus, being a PSU and given the high visibility for the company's operations makes the issue a safe haven to park money for the long term. Investors looking for a consistent and steadily growing company may opt for REC.

Issue opens: February 19, 2008
Issue closes: February 22, 2008