REC-- 2QFY11 – Steady business growth; Buy :: Anand Rathi

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Rural Electrification Corporation
2QFY11 – Steady business growth; Buy

 Steady business growth continues. REC reported 25% yoy rise
in net profit, led by strong loan growth and largely stable margins.
We retain a Buy as we expect the strong business growth, superior
margins and negligible credit cost to sustain high RoA and RoE,
of over 3.3% and 23% respectively.
 Loans up 26%. The loan book grew 26% yoy, and 5.4% qoq, to
Rs729bn. Disbursements were flat yoy. Quarterly sanctions were
down 36% yoy, to Rs104bn. (In 1QFY11, REC had sanctioned
projects worth Rs229bn.) A sanction pipeline of over Rs1trn
would drive the 28% CAGR in loans over FY10-13e.
 Spreads and NIM dropped marginally. Cost of funds (adjusted
for one-time arrangement fees on ECB) rose 20bp qoq, to 8%,
owing to increased wholesale funding costs. Lending yields were
up slightly (9bp qoq) to 11.2%. The spread declined 11bp to 3.1%.
NIM stood at 4.4% vs. 4.6% in 1QFY11. We have assumed a 10%
drop in spreads/margins in FY11e (from FY10).
 Return ratio to be strong. We expect REC to record an earnings
CAGR of 26% over FY10-13e on the back of strong loan growth
and stable margins. This would lead to high RoA and RoE, of
more than 3.3% and 23% respectively, over FY10-13e.
 Valuation. At our target price, REC would trade at 3.3x FY11e
and 2.8x FY12e PBV respectively. Risks: Slowdown in power
sector investment, regulatory changes and poor health of SEBs.