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UBS Investment Research
Rural Electrification
Attractive valuation outweighs concerns
„ Concern 1: growth slows in FY11
We now expect REC’s disbursals to remain flat in FY11, compared with our
previous 10% growth estimate, due largely to delays in the transmission &
distribution segment (where REC has 51% exposure). With flat disbursement, loan
growth is likely to be 21% in FY11 against our previous estimate of 25% growth.
However, strong loan approvals in FY08-10 should ensure a healthy pipeline,
which we expect to be disbursed over FY12-13, thereby providing some comfort
on growth. We maintain our 24% loan growth estimate for FY12.
„ Concern 2: tight liquidity to impact NIMs
We expect REC’s NIMs to normalise over the next four quarters from the current
4.4%, as incremental spreads will be lower. However, given the high duration of
liabilities, the decline should be gradual rather than immediate. Additional funding
options in the form of external commercial borrowing, and infrastructure bonds
could help arrest the steep increase in funds. We forecast a 15bp decline in NIM in
FY12.
„ Concern 3: SEB financial health could lead to asset-quality risk
The weakening financials of state utilities (key borrowers) has often been cited as a
concern for REC; however, given the implicit backing of state governments and
the escrow mechanisms in place, we think credit losses from this exposure are
unlikely.
„ Valuation: lower estimates and PT on lower growth; maintain Buy
We lower our EPS estimates 4%/9% for FY11/12 to Rs24.4/28.4 on our lower
growth estimate for FY11 and lower NIM estimate for FY12; consequently we
lower our price target from Rs415 to Rs350 (2.4x FY12E book). We base our price
target on a residual income model, assuming a discount rate of 13.5%, terminal
ROE of 13.5%; and terminal growth of 5%.
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