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Rural Electrification Corporation Ltd
SEB losses remain an overhang
We initiate coverage on Rural Electrification Corporation (REC) with a SELL
rating and a target price of Rs 230 (1.6x BV and 8x EPS on FY12E). While the
demand environment is likely to remain healthy, we expect loan growth to
moderate from historical levels due to the high base. NIMs too are likely to
come off from peaks, though higher ECB borrowings and tax-free bonds would
provide some support. On the asset front, rising SEB losses are driving up the
risk quotient, more so for REC given its higher exposure to the T&D segment.
We note that REC remains vulnerable to any shift in investment outlook related
to the power sector due to its single-product profile and concentrated exposure
to a few utilities.
We expect the stock to remain an underperformer as its valuation premium to
better placed PSU banks is whittled down. Improvement in SEB health (due to
lower AT&C losses or tariff hikes) would be a key risk to our call.
Loan book likely to grow at 22% CAGR: REC has an outstanding sanction book of
Rs 1.6tn. Disbursals could remain strong in FY12 as investments are likely to pick
up in the last fiscal of the 11th five year plan. We are currently building in a
16.4% CAGR in disbursals over FY11-FY13 (adjusted for RGGVY). Loan growth
is likely to moderate to a 22% CAGR over FY11-FY13 from the historical level of
25% over FY06-FY11 as high base effect kicks in.
Asset quality healthy for now but a key risk: Asset quality has been pristine thus far
with GNPA at almost negligible levels. However, the risk on asset quality is rising
given concentrated exposure to a few SEBs which are seeing a deterioration in
financial health. Moreover, we foresee higher risks in the T&D segment (~52% of
REC―s loans) as opposed to generation projects. The rising proportion of private
sector loans would also increase the company―s risk profile going forward. We
model loan loss provisions of ~10bps through FY13 as we expect REC to prepare a
war-chest in the wake of rising SEB losses.
NIMs have largely peaked: NIMs are likely to decline from 4.5% levels in
9MFY11 due to the sharp rise in wholesale rates. However, better access to ECBs
(due to IFC–NBFC status) and tax-free bonds coupled with a favourable assetliability
profile should help limit NIMs compression to ~40bps through FY13.
Initiate with SELL: We expect a 15% earnings CAGR for REC through FY13, with
NII rising 17% during this period. Valuations have corrected in the wake of
apprehensions over the impact of rising rates on loan growth and spreads, as well
as concerns surrounding SEB health. Though any major defaults from SEBs are
unlikely, given the potential state government support, we believe that current
valuations at 1.7x FY12 BV and 9x FY12E earnings remain expensive in the
backdrop of rising SEB losses and high T&D exposure.
