Rural Electrification - Loan growth and margins surprise:: Macquarie Research,

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Rural Electrification
Loan growth and margins surprise
Event
 REC 1Q12 results were mixed with PAT of Rs6.6bn vs our expectation of
Rs6.5bn. Loan growth and margins were robust even as a loan asset slipped
into NPL this quarter. Management held a conference call post its 1Q12
results. We maintain our Outperform with a TP of Rs290 (Rs 309 earlier). Our
TP values the company at 1.8x FY13 ABVPS for ~18.5% sustainable ROE.
Impact
 Loan growth and margins tracking ahead of our expectations. Both loan
growth and margins have been ahead of our estimates.
Loans grew by 23% YoY vs our 20% expectations. Generation loans
again are the main drivers with 31% YoY growth and now make up 43%
of loan book. New sanctions at Rs220bn were strong and management is
looking to grow loans by a minimum of ~22% vs our 20% estimate for
FY12E.
NIMs were flat QoQ at 4.34% vs our expectations of 20bp drop. 2Q
margins should be under pressure, as cost of funds remains high at
~9.5%. However, 2H should benefit from nearly US$1.5bn of forex
borrowings. All-inclusive cost of such borrowings including hedging is
6.9%- a 260bp funding advantage.
 Asset quality- management sees improvement in SEB situation. This
quarter, REC’s exposure in a hydro power project slipped into NPL.
Management believes the exposure, the Shree Maheshwar hydro project,
will be restructured and it will recover its loan with a small haircut. They
have provided 10% for the exposure.
In case of Tamil Nadu state utilities, REC expects a governmentguaranteed
bond issuance followed by a tariff increase to improve the
financial situation. It sees little possibility of the utilities defaulting.
Nevertheless we have introduced a 15-25 bp credit costs in our P&L
estimates for FY12-14E to take into account possible NPLs/
restructurings given challenges facing sector.
Earnings and target price revision
 We have reduced our EPS by 4-7% for FY12 to 14E, mainly driven by P&L
provisioning we have introduced. Our TP reduces by 6% to Rs290 on lower
P/BVPS multiple.
Price catalyst
 12-month price target: Rs290.00 based on a Gordon growth model.
 Catalyst: Improvement in the macro environment.
Action and recommendation
 The return ratios for the business remain attractive. Given its cheap
valuations, we maintain OP.