A robust track record, healthy outlook and reasonable pricing make REC’s offer attractive.
After NTPC’s prestigious issue, it is the turn of Rural Electrification Corporation (REC), another navratna status company to hit the markets with a follow-on public offer (FPO). The Rs 3,500 crore offer is expected not only to fill up government coffers (Rs 870 crore), about three-fourth of the proceeds (Rs 2,615 crore) are going towards shoring up REC’s capital base for its future capital requirements as well. With major investments planned to develop power infrastructure in the country, state-run power financiers like REC would be in demand to lend more. During the eleventh five-year plan, the company already announced to disburse around a lakh crore and is on the way to meeting its target. Besides, it is transforming its lending landscape to become a diversified power financier branching beyond its original mandate to fund state electricity boards for electrification of villages. In the recent years, it has forayed majorly into financing of power generation, a segment that is seeing major capacity additions. The loan book for generation has increased from 23 per cent in 2006-2007 to about 38 per cent in the first half of 2009-10 with share of generation (in total sanctions) averaging around 50-60 per cent in this period.
Healthy demand outlook
As per planning commission, to sustain a GDP growth of 8-9 per cent, India would require additional capacity of about 70,000 MW by 2012 and another 165,000 MW by 2017. Overall, a total of about $450 billion worth of investments is estimated to be required in the eleventh and twelfth Five-year Plan, if these capacities and allied infrastructure are to be set up. REC’s main customers are government owned utilities (around 90 per cent). But, with private sector making increased foray into power space, it should see the company increase lending to this segment in the future. REC expects the share of the private sector in total advances rise from 6 per cent of advances to 15 per cent in the next three years.
Robust demand for funds was visible for the most part of the last three years. Nevertheless, second half of 2008-09 saw sanctions slowing owing to the deceleration in the economic growth. Things, however, have improved from there-on. In the first nine months of 2009-10, the company has already sanctioned loans of around Rs 42,000 crore, which is more than what it sanctioned for the entire 2008-09. The trend also indicates that REC is on the way to achieve its target of Rs 50,000 crore in sanctions for 2009-10.
The change in asset mix towards the generation segment gives a balance to REC’s asset profile; with higher disbursements, this proportion would increase up to 50 per cent in the next two years. Overall, for 2009-10, expect the loan book to grow to Rs 65,000-66,000 crore, an increase of 27-30 per cent compared to 2008-09.
| ROBUST SHOW | |||||
| in Rs crore | FY09 | 9M FY10 | % chg | FY10E | FY11E |
| Total Income | 4,757 | 4,716 | 40.4 | 6,300 | 7,950 |
| Operating profit | 1920.00 | 1896.00 | 40.30 | 2,530 | 3,100 |
| Net profit | 1272.00 | 1440.00 | 62.90 | 1,915 | 2,300 |
| P/E (x) @ Rs 203 | 13.70 | 10.5 | 8.7 | ||
| P/BV (x) @ Rs 203 | 2.50 | 1.8 | 1.5 | ||
| E: Analysts' estimates | |||||
Sound financials
Apart from higher business volumes, sound financials have been a hallmark of its performance in the last three years. Total income and net profit grew at an average rate of over 30 per cent annually in this period. Notably, REC has largely been able to maintain spreads of around 3 per cent and net interest margins of over 3 per cent in this period, which explains its robust financial performance. Also, its performance is commendable given that the share of capital gains tax exemption bonds (issued under Section 54EC; these are sourced at lower rates as compared to funds taken from banks) in total liabilities has fallen to about 20 per cent currently, as compared to 43 per cent in 2007-08. Here, access to funds from the multilateral agencies has also helped in maintaining the spreads.
Going ahead, with loans worth Rs 12,000 crore expected to be reset in 2010-11, it should aid spreads in the medium-term. While margins in the first half of 2009-10 stood at 4.5 per cent, expect REC to maintain them in the region of 3.5 -4 per cent on a regular basis, going ahead.
Conclusion
The recent directive to recognise NBFCs engaged in infrastructure lending as a separate category would provide easier access to funds to companies like REC. Since most of the lending to central and state electricity boards is either secured by escrow or mortgage, it ensures better recovery. Thus, REC’s asset quality has remained intact with net non performing assets at 0.04 per cent as of December 2009. With demand expected to remain robust, expect REC’s loan book to grow on an average at 22-24 per cent annually in the next two years. The rapid growth in loan book and healthy margins would ensure net profits grow by 20-25 per cent in 2010-11. Besides, REC earns a commission of Rs 60 crore annually, which contributes 5 per cent to profits as a nodal agency for Rajiv Gandhi Grameen Vidyutikaran Yojana.
At the floor price of Rs 203, the stock is trading at 1.5 times its estimated 2010-11 book value. While valuations are largely similar to comparable peers like PFC, which is trading at 1.9 times its estimated 2010-11 book, REC has been growing at a faster pace. RECs financials and increasingly diversified asset book also provide comfort. Investors with a long-term perspective can subscribe the FPO.
