REC Buy for long term

Rural Electrification: Powered to grow

Sarath Chelluri / Mumbai April 6, 2009, 0:30 IST

Large funding needs of the power sector and stable margins will help REC grow its income at a healthy pace.

The humongous investments required towards improving the country’s power infrastructure as well as the growing needs is translating into opportunities for many companies. And, one of them is Rural Electrification Corporation (REC), which is into funding power projects. REC has grown beyond its original mandate to fund state electricity boards for electrification of villages.

It has been increasingly financing projects in the power generation space, which will see huge capacity additions during the eleventh five-year plan (FYP). To feed the growing appetite for funds, REC is targeting a loan disbursement of Rs one lakh crore in this plan period. Apart from higher business volumes, its ability to sustain margins will ensure healthy growth for the next couple of years.

Robust business growth

It roughly takes Rs 4 crore to set up a megawatt of power generation capacity and half of that towards allied transmission & distribution (T&D) infrastructure. Thus, to install the targeted power generation capacity of 79,000 mw and T&D infrastructure in the eleventh FYP, investments worth Rs five lakh crore will be required.

 

HEALTHY PROSPECTS

in Rs crore FY08 FY09E FY10E

Total income 1,305 1,746 2,073

Net profit 860 1,171 1,348

EPS 10.02 13.64 15.70

P/E (x) 9.64 7.08 6.15

P/BV (x) 1.54 1.37 1.19

E: analyst estimates

This in turn, will see REC’s loan book (Rs 52,000 crore currently) grow by 23-24 per cent for a couple of years at least. For now, the management expects the loan-book to touch Rs 64,000 crore in FY10 on the back of faster growth in disbursements; these were up 27 per cent to Rs 16,500 crore in FY09 and are expected to rise 45 per cent to Rs 24,000 crore in FY10.

Category-wise, the share of T&D segment in total loan book has been contracting at the cost of the generation segment. The share of latter has been consistently rising from 22 per cent in Q1 FY08 to 32 per cent, of late. This has been driven by higher sanctions towards generation projects; the share of generation (in total sanctions) has averaged around 60 per cent in the last 7-8 quarters.

Going ahead, higher disbursements to the generation segment will see its share of loan book inch up further to around 37-39 per cent in FY10 and thus, it will provide a balance to REC’s asset profile.

About 94 per cent of lending to central and state electricity boards, either secured by escrow or mortgage is a positive (especially during current conditions), as it ensures better recovery and timely settlement of loans. However, with increasing participation of private players, their share is seen rising to 15 per cent over next three years.

Spreads & margins

REC has largely been able to maintain spreads of around 3 per cent and net interest margins (NIMs) of over 3 per cent in the last four years. Even in the last six quarters prior to Q3FY09, when the share of funds raised through tax-free capital gains bonds (interest rate of around 6 per cent vis-a-vis 9.5-10 per cent for funds raised through banks and taxable bonds) route declined from 45 per cent in Q1FY08 to 38 per cent in Q2FY09, REC was largely able to sustain spreads and NIMs. This reflects its ability to pass on increased costs to its customers.

In Q3 FY09 though, the spreads as well as NIMs came under some pressure (see chart), thanks to the extra-ordinary environment of tight liquidity and high interest rates. However, going ahead, REC is expected to sustain spreads at around 2.75-3 per cent and NIMs at 3.8-4 per cent, which is considered healthy.

This will be partly supported by the resetting of loans given to customers worth Rs 7,800 crore in FY10, at current interest rates. Additionally, plans to raise $500 million through foreign loans (ECBs) and a line of credit of $1 billion from Chinese banks should also support margins (interest rate of about 6.5-8 per cent).

Besides, banks also find it convenient (due to lower risk weights requirements) to lend to companies like REC at lower rates. Thus, expect spreads and NIMs to sustain at the present levels in FY10, at least.

Investment rationale

A high asset portfolio (net NPAs at 0.04 per cent) provides significant comfort. And, since most of REC’s customers are government owned entities, the chances of its loans turning bad are limited. Hence, expect NPA levels to remain low.

The rapid growth in loan book and healthy margins would ensure that net profits grow by 25 per cent in FY10. The proposal to reduce risk-weights on loans backed by government-guarantee by a fifth will also shore up REC’s capital adequacy ratio (CAR), as 35 per cent of its loan book is government-guaranteed.

Thus, expect the CAR to rise by 150-250 basis points from 13.5 per cent currently. Being a nodal agency for Rajiv Gandhi Grameen Vidyutikaran Yojana, REC earns a commission of Rs 60 crore annually, which contributes 5 per cent to profits and ensures steady fee income.

On the flip side, the slowing economic growth since mid-FY09 and high interest rates had resulted in a slowdown in sanctions growth for REC in Q3. This however, is seen as a temporary blip. Also, a majority of power projects planned in 11th FYP are being set up by public sector undertakings like NTPC, and over 75 per cent of the planned capacity addition is on track for timely completion.

Notably, projects for 12th FYP are already being taken up. All these indicate that demand for funds will remain strong, and thus, good growth prospects for REC in the long run. At Rs 96, the stock can deliver 18 per cent returns in a year’s time.

Source  : business standard 6th April 09