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RURAL ELECTRIFICATION CORPORATION
Margins sustained; disbursement growth modest
Rural Electrification Corporation (REC) reported PAT growth of 40% Y-o-Y (7% Q-o-
Q), to INR 6.64 bn in Q3FY11, ahead of our estimate, as the company reported
robust margins in an otherwise rising wholesale funding costs environment. Key
highlights for the quarter were: (1) Modest pace of disbursements, as anticipated
(flat Y-o-Y); (2) higher NIMs, at 4.6%, up 17bps Q-o-Q; 3) NII growth of 36% Y-o-Y
to INR 8.5 bn, including INR 310 mn of prematured repayment penalty; 4) MTM forex
gain of INR 26 mn on unhedged forex borrowings of USD 200 mn; and 5) sustained
NPLs near zero levels.
Modest pace of disbursements, as anticipated
As highlighted in our previous update on the company (refer REC- Visit note –
‘Modest pace of disbursements; margins to sustain’, dated December 21, 2010),
momentum in disbursements continued to be modest - flat Y-o-Y at INR 60 bn,
ending 9mFY11 with a muted 7% growth. Consequently, loan growth moderated
to 21% (from 30% in FY10 and 26% in H1FY11). Trend in sanctions was also not
encouraging – flat Y-o-Y and Q-o-Q, at INR 106 bn, ending 9mFY11 with growth
of 4%. We revised our disbursement growth estimate for REC in December to
18% for FY11-12 (from 27% earlier) and our loan growth estimate to 23% CAGR
over FY10-12 (27% earlier). We maintain this stance as of now.
Margins up 17bps Q-o-Q; to come off going forward
NIMs in Q3FY11 came in at a robust 4.56%, up 17 bps Q-o-Q, as margins in
Q2FY11 were depressed due to INR 347 mn upfront fee on account of ECB raised
in September. In an otherwise rising wholesale cost environment, REC has been
able to sustain cost of funds at ~7.8%, as it is adequately capitalising on its IFC
status by resorting to ECBs. It plans to raise another USD 250 mn of ECBs,
having raised USD 900 mn for the fiscal. Also, it has floated INR 10 bn of
infrastructure bonds (issue closes on March 31, 2011) to meet the overall
borrowing requirement of ~INR 250 bn for this fiscal. We believe rising interest
rate environment will adversely impact its margins, going forward (albeit
marginally). We build in margins of 4.2-4.3% for FY12-13E.
Outlook and valuations: Positive; maintain ‘BUY’
In light of the modest pace of disbursements in FY11 and increasing competition,
we expect loan growth to moderate to 23% CAGR over FY10-12E. Unutilised
sanctions of above INR 1 tn will, however, continue to provide support. On the
back of visible growth outlook and relatively stable margins, we expect 20%
earning CAGR and average RoE of 20% over FY11-12E. The stock is currently
trading at 1.6x FY12E book and 8.5x FY12E earnings. We maintain ‘BUY/Sector
Outperformer’ recommendation/rating on the stock.
Other highlights
• The company charged INR 15 mn to P&L on account of wage revision w.e.f. January
01, 2007. It made a final payout of INR 382 mn against provisions of INR 366 mn as
on September 30, 2010.
Company Description
Rural Electrification Corporation (REC), incorporated in 1969, is a leading public
institution primarily involved in the financing of T&D and generation projects across
India. It was established by GoI for the purpose of developing the T&D infrastructure in
rural India and currently acts as a nodal agency for RGGVY, a GoI initiative for rural
electrification. Over the last decade, the company has diversified into urban areas and it
plays a strategic role in GoI plan to improve the transmission and distribution
infrastructure of India. REC, along with Power Finance Corporation (PFC), is the nodal
agency for APDRP, a GoI initiative to improve the financial viability of state power
utilities. Loans to T&D projects constituted ~52% to the total loan book as on December
31, 2010.
Investment Theme
Over the Eleventh and Twelfth Five Year plans (FY07-17), India targets to add ~170 GW,
creating huge investment opportunities across the power value chain. According to our
research on the power sector, this capacity addition target entails an investment of
~USD 400 bn, assuming INR 50 mn/MW generation and an equal amount in T&D. High
growth, long-term visibility and sustainable returns, coupled with demand-supply gap
(~12% peak deficit) and rising energy consumption, make the sector an attractive
investment option. REC, being a specialised power financier, plays a strategic role in
GoI’s ongoing financing plans for development of the power sector. It disbursed INR 422
bn of loans for power projects in the Tenth Plan (FY02-07), accounting for 16-18% of the
debt requirement in the power sector. Superior domain knowledge, financing expertise
and government support will enable it to leverage emerging financing opportunities in
the power sector over Eleventh and Twelfth plans (FY07-17) as well. According to the
estimates of Working Group of Power, REC is expected to disburse at least INR 592 bn in
the Eleventh Plan (against the expected disbursement of INR 812 bn for PFC). We
believe REC will be able to fund 15-20% of its total funding requirement in the Eleventh
Plan. We, thus, expect its loan book to grow at 23% CAGR over FY10-12E delivering a
ROAE of ~20% over FY11-12.
Key Risks
• REC’s growth depends on its ability to remain effectively competitive in the power
financing space and to pass the higher cost of funds to customers. Also, benefits
under Section 54EC are being curtailed continuously and there are uncertainties
surrounding the level of benefits REC will receive from these instruments, going
forward.
• REC’s gross NPAs are at near zero levels. Any major slippage or ineffective
recoveries can raise NPAs significantly, adversely affecting profitability and growth.
• REC is subject to risk arising from asset-liability mismatch as majority of its loans
are long-term in nature due to wholesale financing of large power projects, whereas
its borrowings are relatively for shorter term.
• REC’s ability to borrow from banks may be restricted with the limit on exposure of a
bank in infrastructure finance companies at 25% of bank’s capital funds (tier I+tier
II).
• REC is exposed to project-specific and general risks inherent to the power sector.
Any delay in the power sector projects due to lack of fuel supplies, supply of key
equipment or delay in getting environment clearances can adversely affect the
profitability of power projects, increasing the company’s NPAs.
• There have been qualifications by auditors with respect to internal control and audit
system; these do not have any quantifiable impact as of now, but could impact
REC’s business in the long term.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
RURAL ELECTRIFICATION CORPORATION
Margins sustained; disbursement growth modest
Rural Electrification Corporation (REC) reported PAT growth of 40% Y-o-Y (7% Q-o-
Q), to INR 6.64 bn in Q3FY11, ahead of our estimate, as the company reported
robust margins in an otherwise rising wholesale funding costs environment. Key
highlights for the quarter were: (1) Modest pace of disbursements, as anticipated
(flat Y-o-Y); (2) higher NIMs, at 4.6%, up 17bps Q-o-Q; 3) NII growth of 36% Y-o-Y
to INR 8.5 bn, including INR 310 mn of prematured repayment penalty; 4) MTM forex
gain of INR 26 mn on unhedged forex borrowings of USD 200 mn; and 5) sustained
NPLs near zero levels.
Modest pace of disbursements, as anticipated
As highlighted in our previous update on the company (refer REC- Visit note –
‘Modest pace of disbursements; margins to sustain’, dated December 21, 2010),
momentum in disbursements continued to be modest - flat Y-o-Y at INR 60 bn,
ending 9mFY11 with a muted 7% growth. Consequently, loan growth moderated
to 21% (from 30% in FY10 and 26% in H1FY11). Trend in sanctions was also not
encouraging – flat Y-o-Y and Q-o-Q, at INR 106 bn, ending 9mFY11 with growth
of 4%. We revised our disbursement growth estimate for REC in December to
18% for FY11-12 (from 27% earlier) and our loan growth estimate to 23% CAGR
over FY10-12 (27% earlier). We maintain this stance as of now.
Margins up 17bps Q-o-Q; to come off going forward
NIMs in Q3FY11 came in at a robust 4.56%, up 17 bps Q-o-Q, as margins in
Q2FY11 were depressed due to INR 347 mn upfront fee on account of ECB raised
in September. In an otherwise rising wholesale cost environment, REC has been
able to sustain cost of funds at ~7.8%, as it is adequately capitalising on its IFC
status by resorting to ECBs. It plans to raise another USD 250 mn of ECBs,
having raised USD 900 mn for the fiscal. Also, it has floated INR 10 bn of
infrastructure bonds (issue closes on March 31, 2011) to meet the overall
borrowing requirement of ~INR 250 bn for this fiscal. We believe rising interest
rate environment will adversely impact its margins, going forward (albeit
marginally). We build in margins of 4.2-4.3% for FY12-13E.
Outlook and valuations: Positive; maintain ‘BUY’
In light of the modest pace of disbursements in FY11 and increasing competition,
we expect loan growth to moderate to 23% CAGR over FY10-12E. Unutilised
sanctions of above INR 1 tn will, however, continue to provide support. On the
back of visible growth outlook and relatively stable margins, we expect 20%
earning CAGR and average RoE of 20% over FY11-12E. The stock is currently
trading at 1.6x FY12E book and 8.5x FY12E earnings. We maintain ‘BUY/Sector
Outperformer’ recommendation/rating on the stock.
Other highlights
• The company charged INR 15 mn to P&L on account of wage revision w.e.f. January
01, 2007. It made a final payout of INR 382 mn against provisions of INR 366 mn as
on September 30, 2010.
Company Description
Rural Electrification Corporation (REC), incorporated in 1969, is a leading public
institution primarily involved in the financing of T&D and generation projects across
India. It was established by GoI for the purpose of developing the T&D infrastructure in
rural India and currently acts as a nodal agency for RGGVY, a GoI initiative for rural
electrification. Over the last decade, the company has diversified into urban areas and it
plays a strategic role in GoI plan to improve the transmission and distribution
infrastructure of India. REC, along with Power Finance Corporation (PFC), is the nodal
agency for APDRP, a GoI initiative to improve the financial viability of state power
utilities. Loans to T&D projects constituted ~52% to the total loan book as on December
31, 2010.
Investment Theme
Over the Eleventh and Twelfth Five Year plans (FY07-17), India targets to add ~170 GW,
creating huge investment opportunities across the power value chain. According to our
research on the power sector, this capacity addition target entails an investment of
~USD 400 bn, assuming INR 50 mn/MW generation and an equal amount in T&D. High
growth, long-term visibility and sustainable returns, coupled with demand-supply gap
(~12% peak deficit) and rising energy consumption, make the sector an attractive
investment option. REC, being a specialised power financier, plays a strategic role in
GoI’s ongoing financing plans for development of the power sector. It disbursed INR 422
bn of loans for power projects in the Tenth Plan (FY02-07), accounting for 16-18% of the
debt requirement in the power sector. Superior domain knowledge, financing expertise
and government support will enable it to leverage emerging financing opportunities in
the power sector over Eleventh and Twelfth plans (FY07-17) as well. According to the
estimates of Working Group of Power, REC is expected to disburse at least INR 592 bn in
the Eleventh Plan (against the expected disbursement of INR 812 bn for PFC). We
believe REC will be able to fund 15-20% of its total funding requirement in the Eleventh
Plan. We, thus, expect its loan book to grow at 23% CAGR over FY10-12E delivering a
ROAE of ~20% over FY11-12.
Key Risks
• REC’s growth depends on its ability to remain effectively competitive in the power
financing space and to pass the higher cost of funds to customers. Also, benefits
under Section 54EC are being curtailed continuously and there are uncertainties
surrounding the level of benefits REC will receive from these instruments, going
forward.
• REC’s gross NPAs are at near zero levels. Any major slippage or ineffective
recoveries can raise NPAs significantly, adversely affecting profitability and growth.
• REC is subject to risk arising from asset-liability mismatch as majority of its loans
are long-term in nature due to wholesale financing of large power projects, whereas
its borrowings are relatively for shorter term.
• REC’s ability to borrow from banks may be restricted with the limit on exposure of a
bank in infrastructure finance companies at 25% of bank’s capital funds (tier I+tier
II).
• REC is exposed to project-specific and general risks inherent to the power sector.
Any delay in the power sector projects due to lack of fuel supplies, supply of key
equipment or delay in getting environment clearances can adversely affect the
profitability of power projects, increasing the company’s NPAs.
• There have been qualifications by auditors with respect to internal control and audit
system; these do not have any quantifiable impact as of now, but could impact
REC’s business in the long term.
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