Power investment beneficiary; high margins, strong asset growth ahead
Rural Electrification Corp (REC) is India’s leading infrastructure finance company
with a focus on the power segment. We estimate a 27% asset CAGR in FY10-13E
on robust growth in power industry investment. UBS’s India infrastructure
research team forecasts US$186bn investment in the power segment in the next
five years, with 30% funded by IFCs. REC’s margins are among the highest in the
sector at 4%+ on the diversified and inexpensive funding options available due to
regulatory and government support.
One of the lowest cost models in the industry
Due to its 100% wholesale model, REC’s operating cost-to-assets ratio is among
the lowest in the industry at 0.3% of assets, which is more or less covered by non
interest income, also at 0.3% of assets. With state and central government utilities
making up the bulk of borrowers, credit costs have historically remained low.
NIMs flow directly to PBT leading to ROA of 3% and ROE of 22% FY11-12E.
Key risks: financial position of state utilities, lumpiness of NPA
A key concern is the deteriorating financial position of state electricity boards,
which are the major borrowers (86% of loan book). Escrow mechanisms and
government guarantees are risk mitigant; we believe growing investment in the
power sector will necessitate government impetus on structural reforms.
Valuation: strong beneficiary of power investments
We initiate coverage of REC with a Buy rating and PT of Rs475. We estimate an
EPS CAGR of 20% in 2011-12. We base our PT on a residual income model
assuming a discount rate of 13.0%, terminal ROE of 13.0%; and terminal growth
of 5%. At our PT, the stock would trade at 3.2x FY12E P/BV and 15.0x FY12E
PE. REC is one of our preferred picks in the NBFC segment.
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