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Rural Electrification Corp
CMP: Rs197 TP: Rs310 BuyBSE SENSEX S& P CNX
17,847 5,349
Stock performance (1 year)
Shareholding pattern % (Mar-11)
Y/E March 2011 2012E 2013E
NII (Rs b) 33.1 38.6 45.4
OP (Rs b) 34.8 39.6 46.6
NP (Rs b) 25.7 29.3 34.5
EPS (Rs) 26.0 29.7 34.9
EPS Gr. (%) 28.1 14.2 17.7
P/E (x) 7.6 6.6 5.6
BV/Sh. (Rs) 129.4 149.1 172.3
P/BV (x) 1.5 1.3 1.1
RoE (%) 21.5 21.3 21.7
RoA (%) 3.4 3.2 3.1
Domestic
Inst, 4,5
Others,
7.8
Foreign,
20.8
Promoter
66.8
Business outlook healthy; SEB losses an overhangSuperior return ratios, attractive valuations
Expect strong loan growth of 22% over FY11-13E due to a healthy demand
environment, however, NIMs may come off peaks.
Rising SEB losses are driving up REC's risk quotient, given its high exposure
to T&D. However the government's thrust on power sector reforms,
protection through an escrow mechanism and SEB initiatives to ease the
strain on cash flows provide some comfort.
The REC stock price has corrected 50% from its peak. We believe current
valuations are attractive at 1.1x FY13E BV. Buy with a target price of Rs310
(1.8x FY13 BV).
Incremental lending opportunity of more than Rs8t over FY12-17
The government has made high allocations to the power sector in its Eleventh and
Twelfth Five Year Plans. During the Twelfth Plan the power sector fund requirement
will be Rs11t: Rs5t for gencos (~100GW to be added), Rs2.4t for the transmission
segment and Rs3.7t for distribution. In FY12 (the last year of Eleventh Plan), ~20GW
is likely to be added, leading to fund requirement of Rs1t. Thus, total fund requirement
over FY12-17 will be Rs12t. Assuming debt equity of 70:30, this translates into a
massive opportunity of over Rs8t for lending agencies. We expect REC to post 22%
CAGR in its loan book to Rs1.2t by FY13.
Government thrust on reforms, SEB focus to cut losses augur well
The T&D segment (51%) comprises the bulk of the loan book and with state discoms
largely cash negative against cash positive gencos, the overhang on asset quality is
relatively high. However, interactions with industry participants suggest it is unlikely
that SEBs will default, as state governments would bail out ailing SEBs. Reluctance
to procure, particularly costly short term (ST) power, tariff hikes and timely receipt of
subsidies would ease the strain on cash flow for SEBs.
NIMs to contract, but would still be healthy at over 4%
REC's NIMs have improved significantly from 3.6% in FY08 to 4.4% in FY11 due to apositive asset-liability mix (ALM) and decline in wholesale rates. A rising proportion of
external commercial borrowings (ECB), due to the IFC status, also helped to sustain
healthy margins. However, with lower room to raise ECB (under the automatic route)
going ahead, and rising interest rates, we believe NIMs could diminish further in the
coming quarters. We expect spreads and NIMs to come off from their highs of 3.3%
and 4.5% in FY11 to 3% and 4.2% in FY12 respectively.
Valuations attractive; reiterate Buy
We expect REC to post 16% earnings CAGR over FY11-13, with NII growth of 17%.
While we expect RoA to decline by ~30bp to ~3.1% over FY11-FY13 owing to a
compression in NIMs, RoE would remain strong at 21-22% due to improving leverage
(CAR at 19% at the end of March 2011). We reiterate Buy with a target price of Rs310
(1.8x FY13 BV).
Bloomberg RECL IN
Equity Shares (m) 987.5
52-Week Range (Rs) 410/210
1,6,12 Rel.Perf.(%) -6/-34/-36
M.Cap. (Rs b) 194.5
M.Cap. (US$ b) 4.3
25 May 2011
Update | Sector: Banking & Finance
Alpesh Mehta ([email protected]) + 9122 3982 5415
Sohail Halai ([email protected])+ 9122 3982 5430
180
240
300
360
420
May-10 Sep-10 Jan-11 May-11
Rural Electric. Corp.Sensex - Rebased
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Rural Electrification Corp
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Government thrust on reforms, SEB initiatives to cutlosses augur well for asset qualityHigher share of T&D segment an overhang
The T&D segment (51%) comprises the bulk of the loan book. With state discoms largely cashnegative against cash positive gencos, the overhang on asset quality is relatively high.
However, our interactions with industry participants suggest it is unlikely that SEBs would
default on their loan obligations as state governments would bail out ailing SEBs. Reluctance
to procure, particularly costly short term (ST) power, tariff hikes and timely receipt of subsidies
would ease the strain on cash flow for SEBs. Further, state government guarantees and an
escrow mechanism offer strong protection. We are not building-in default on loans for REC.
SEBs dominate REC loan book; escrow cover ensures smooth recovery
REC was formed with the objective of meeting financing needs of the power segment.
The primary focus was to provide funds to meet capex requirements for transmission and
distribution (T&D). State and central utilities comprise 83% and 7% of REC's loan book
respectively and more than half the loan book is devoted to funding T&D ventures. Despite
their weak financial position (SEBs' overall losses doubled over FY04-09 to US$9b), SEBs
have met their repayment obligations on time. This is reflected in REC's asset quality
ratios. We believe the asset quality of loans to SEBs is likely to be stable, given the
government's continued thrust on power sector reforms, REC's recourse to SEB collections
through an escrow mechanism and SEB initiatives to ease the strain on cash flows. 80-
82% of the loans given to state and central utilities are covered under the escrow mechanism.
1.7
2.4
0.8
0.1
0.0
0.0
0.8
1.9
0.6
0.0
0.0
0.0
FY06 FY07 FY08 FY09 FY10 FY11
GNPA (%) NNPA (%)Private
10%
State
83%
Central PSUs
7%
Asset quality impeccable (%) but high exposure to SEBs causes concern
State-wise loan book exposure - as on FY10 (%) State-wise disbursement exposure - as on FY10 (%)
MP
2%
WB
7%Punjab
7%Haryana
7%
UP
8%
TN
11%Raj
12%
AP12%
Others
20%
Maha
14%
MP
2%
Punjab
5%AP
7%WB
8%
Haryana
12%UP
12%
Maha
18%
Others
12%
TN
15%
Raj
9%
Source: Company/MOSL
State and central utilities
comprise 90% of the loan
book; of this 80-82% are
under escrow cover
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The cash losses (revenue and subsidy realised basis) of four SEBs: Tamil Nadu, Rajasthan,
Uttar Pradesh and Madhya Pradesh account for 90% of the total loss (based on FY09
data). REC's exposure to these states comprised ~35% of the loan book as at the end of
FY11.
Government focus on reforms
Schemes such as Accelerated Power Development and Reform Program (APDRP) and
National Electricity Fund (NEF), which offer grants/subsidies to improve the financial health
of SEBs and reduce distribution losses, are steps in the right direction.
The Prime Ministers Office (PMO) appointed a high level committee headed by Mr VK
Shunglu to review SEB financials, particularly in relation to losses incurred and projected
distribution losses over April 2010-March 2017. The committee is likely to give its
recommendations/suggestions on:
Required electricity tariffs, including the role of state governments, state tariff regulatorand SEBs/SDCs in periodic tariff revisions, after having examined the geographical
and spatial compulsions and determining their operational impact.
Organizational and managerial structure, manpower employed and future requirements
to achieve financial viability in distribution of power by 2017.
Fall in merchant power rates, tariff hikes, government initiatives positivefor SEBs
Our interactions with industry participants suggest it is unlikely that SEBs would default
on their loan obligations as state governments would bail out ailing SEBs. Inadequate tariff
hikes to cover higher costs have been the mainly responsible for the SEBs' weakeningfinances. Besides, subsidy realized has been lower than subsidies the SEBs booked, straining
their cash flows.
The following developments provide comfort on SEB finances:
Tariff hike, timely receipt of subsidies to enable improved cash flow:No/inadequate
tariff revision in response to cost increases is a key reason for the deteriorating financial
health of state discoms (specifically in UP, Rajasthan and Tamil Nadu). The situation is
changing, with several states now considering tariff hikes. Rajasthan recently affected a
tariff increase of ~20% and Tamil Nadu raised rates for the first time in seven years.
SEBs cash losses (revenue, subsidy realized
basis)
State Rs b Proportion (%)
Tamil Nadu 66.4 23.4
Uttar Pradesh 71.7 25.2
Madhya Oradesh 44.3 15.6
Rajasthan 73.3 25.8
Maharashtra 26.3 9.3
Top 5 states 281.9 99.3
All states combined 284.0 100.0 13 6 1
95
297
128
165
184
2006-07 2007-08 2008-09
Subsidy booked Subsidy realised
Recent tariff hikes in some
states
State Avg hike (%) W.e f
UP 13.2 Apr-10
MP 10.66 Jun-10
Rajasthan 20 Apr-11
TN Rs0.3- Aug-10
1.1/ unit
AP 10 to13 Apr-11
Subsidies have been inadequately paid
(Rs b)
Source: Company/MOSL
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SEBs lower power purchases: SEBs have begun to cut power purchases to minimize
losses. In FY11, power demand was up just 4.4% against demand growth of ~7% in
FY10. Better than expected monsoons and economic recovery is expected to fuel power
demand growth. However, SEBs have been reluctant to buy power, particularly costly
short-term power. The ST power trading market has contracted and ST power rates havedeclined. This would help to reduce SEB losses, as ST power purchases account for 18%
of SEB power procurement.
Our estimates do
not build in defaults
on loans for REC
Absolute demand for ST power has slowed (BU) Trading market size down; bodes well for SEBs
Source: Company/MOSL
66
60
67
65 6
8
66 6
87373
69
64
69 7
0
65
76
7
5
75
71
707
1
68
74
64
717
6
70
Jan-0
9
Mar-09
May-0
9
Jul-09
Sep-0
9
Nov-0
9
Jan-1
0
Mar-10
May-1
0
Jul-10
Sep-1
0
Nov-1
0
Jan-1
1
0
10
20
30
40
Jan-0
9
Mar-09
May-0
9
Jul-09
Sep-0
9
Nov-0
9
Jan-1
0
Mar-10
May-1
0
Jul-10
Sep-1
0
Nov-1
0
Jan-1
10
4
8
12
16
Trading mkt size (Rs B) (LHS)Trdg as a % of generation (RHS)Wtd. Avg. Price (Rs/unit) (LHS)
Long-term measures top sustain SEB health key to earnings/valuations
While in the near term, developments are positive for SEBs, long-term sustainable solutions
are a key for the sector. Until concrete reforms to improve the health of SEBs are
implemented, the risk of bad debt/payment defaults will reflect in the earnings/valuations
of power finance companies.
In our estimates, we have not built-in default on loans for PFC (and REC), as state
government guarantees and the escrow mechanism provide strong protection. However,
SEBs' weak financial health could trigger restructuring of loans or require states to pay
additional subsidies. Lower SEB purchases could impact power generators' profitability.
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Incremental lending opportunity of Rs8t+ over FY12-17REC well positioned to leverage the opportunity
Recognizing the power sector's importance in India's economic growth, the government
has made high allocations to it in its Eleventh and Twelfth Plans. In the Twelfth Plan the power
sector will require Rs11t: Rs5t for gencos (~100GW to be added), Rs2.4t for transmission and
Rs3.7t for distribution. In FY12 (the last year of the Eleventh Plan), ~20GW is likely to be added,
leading to requirement of Rs1t. Thus, total fund requirement over FY12-17 is Rs12t. Assuming
debt equity of 70:30, this translates into an Rs8t+ opportunity for lending agencies. We expect
REC to post 17% CAGR in loan disbursals over FY11-13 and consequently 22% CAGR in its loan
book to Rs1.2t by FY13.
Equivalent investment opportunity in generation, T&D segments gives RECan edge
The government aims to add power generation capacity of 78,700MW during the Eleventh
Plan and 100,000MW during the Twelfth Plan (compared with 21,180MW added in theTenth Plan). Government (central and state) power utilities are likely to account for ~86%
of the additions. While Eleventh Plan capacity addition is likely to be lower than budgeted
it will still be more than 100% achieved in the Tenth Plan.
Planned power capacity additions
Under 12th
Existing March 11 Under 11th Five Year Plan Five Year
MW Central State Private Central State Private Plan
Thermal 40,747 52,187 19,891 24,800 23,301 11,552 74,000
Nuclear 4,780 - - 3,380.0 - - 3,400
Hydro 8,885 27,257 1,425 8,654 3,482 3,491 20,000
Renewable energy sources - 3,009 15,446 2,500
Source: RHP
India's power transmission and distribution (T&D) infrastructure has failed to keep pace
with generation capacity. Our interactions with experts/companies suggest the ratio of
investments in generation and investments in T&D should ideally be 1:1 for India. However,
investments in T&D lag investments in generation capacity. Deficiencies plague the T&D
system, leading to high losses and low reliability. However, the government's initiatives
like R-APDRP, NEF, Electricity Act, privatisation of distribution companies and DRUM
are steps in right direction to cut T&D losses, which will accelerate investment in the
T&D segment.
Thermal capacity addition
will remain high;
however, environmental
clearances and fuel linkages
are an issue
The power sector will require Rs21.3t during the Eleventh Plan (Rs 10.3t) and Twelfth Plan (Rs 11t), (%)
Source: RHP
11th plan 12th plan
Transmission, 14 Generation, 59
Distribution, 28
Transmission, 22Generation, 45
Distribution, 34
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Underlying growth remains strong; banks close to hitting exposure limits
Benefiting from strong underlying demand, REC posted 24% CAGR in loans over FY05-
11 (v/s 22% by PFC). Bank credit to the power sector was 38% CAGR over FY05-11.
However, with some banks approaching the lending limit approved by their respective
boards for the infrastructure segment, growth in bank loans to this segment will be in lineor marginally above the industry average. This coupled with grant of IFC status (enabling
higher exposure to a single/group of borrowers) would provide better growth opportunity
for niche NBFCs like REC.
REC well placed to benefit from strong demand
REC, with a mix of loans in the generation (42%) and T&D (51%) segments, is well
placed to leverage the strong investment opportunities across the power value chain. On
an incremental basis, with higher demand for loans in the generation segment, REC reported
higher loan growth of 44% YoY in this segment at the end of FY11. As capacity addition
in the T&D segment lags the capex in the generation segment, growth was lower at 14%YoY.
Following the high capacity addition in the generation segment over the past two years,
we expect demand for loans in the T&D segment to pick up from FY12. This, coupled
with strong demand for loans in the generation segment would ensure continued strong
growth for REC. Outstanding sanctions of Rs1.5t offer good visibility for business growth.
We expect REC's loan book to post ~22% CAGR over FY11-13.
Sanctions and disbursements (Rs b) Slowdown in T&D keeps FY11 disbursement growth low
Loan book composition segment wise (%) Robust demand to boost 22% CAGR in loans over FY11-13
Source: Company/MOSL
163188
286
468 454
664
74 75107
130172
211245
407
FY05 FY06 FY07 FY08 FY09 FY10 FY11
Sanctions Disbursements
217 253321
393
665
821
1,008
1,223
514
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E
Loan CAGR 24%
Over FY05-11
Loan CAGR 22%
Over FY11-13E
6.4 12.2
22.8 25.735.5 36.1 42.3
71.7 61.256.9
62.156.0 55.3
51.1
21.9 26.6 20.312.2 8.5 8.7 6.5
FY05 FY06 FY07 FY08 FY09 FY10 FY11
Generation T&D Others
15.8 20.7
40.0 33.345.8 39.5
47.9
50.8 37.1
44.6 54.542.4
42.639.4
33.442.1
15.4 12.2 11.9 17.9 12.7
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Generation T&D Others
REC well placed to leverage
the investment opportunity
in the power sector
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In February 2010, the Reserve Bank of India created a new classification, infrastructure
financing company (IFC), to address hurdles such as exposure norms and access to low-
cost funding, that NBFCs, specializing in infrastructure finance, face. IFCs enjoy relaxed
exposure caps and access to retail deposits and ECBs, enabling them to cut borrowing
costs and diversify their funding mix.
Benefits of being classified as an IFC
Relaxed exposure norms (25% and 40% of owned funds to single and a single group
of borrowers, respectively, against 15% and 25%, earlier);
Increased limit for banks to lend 20% to an IFC against 15% of capital funds to a
single borrower;
Risk weights on loans granted to IFC linked to their credit rating;
Easier access to ECBs IFCs can raise up to 50% of their net worth through the
automatic route;
Allowed to issue tax-free bonds (long tenure bonds at attractive cost) but restricted to
25% of the incremental infrastructure investments made by the issuer during a financial
year.
Other companies that have been awarded IFC status include IDFC, REC, L&T Infrastructure
Finance, PTC Finance, IFCI and Infrastructure Leasing and Financial Services.
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NIMs to contract; but would still be healthy at 4%+Rising rates and lower room to raise ECB would lead to spread compression
NIMs of REC have improved significantly from 3.6% in FY08 to 4.4% in FY11 due to a positive
asset-liability mix (ALM) and a sharp decline in wholesale rates. Further rising proportion of
external commercial borrowings (ECB)-due to infrastructure financing company (IFC) status
also helped improved margins. However with lower room to raise ECB (under automatic
route) and rising interest rates, we believe that NIMs have peaked and could come off in the
coming quarters. We expect spreads and NIMs to come off from their highs of 3.3% / 4.5% in
FY11 to 3%/ 4.2% by FY12 respectively.
Well matched asset liability profile
REC's sustained efforts to strengthen its asset-liability profile have cushioned it against
interest rate risks. REC's loans are primarily long-term in nature, as power generation and
T&D projects have long gestation. The average tenure of loans as at the end of FY11 was
~8 years. ~80% of the assets have an interest reset clause of three years.
On the liability front, bonds accounts for 73% of the borrowed funds rest being sourced
from banks and foreign currency loan. Eligibility to issue low-cost (capital gains tax exempt)
bonds have enabled REC to maintain relatively lower cost of funds compared with
institutions like IDFC and PFC. While borrowing through this mode is likely to decline
(outstanding mix of 16%) it would still be meaningful, giving REC a cost advantage over
its peers. The average duration of its liability book was 6.5 years as at the end of FY11.
Diversified borrowing profile (%) Proportion of 54EC bonds still meaningful
Source: Company/MOSL
Banks and
FIs
16%
Taxable
Bonds
57%
Capital gains
bonds
16%
Foreign
11%
40 3346 43
3218 16
60 6754 57
6882 84
FY05 FY06 FY07 FY08 FY09 FY10 FY11
54EC Bonds Others
Diversified borrowing mix cushioning cost of funds...
Being a government-owned company, REC enjoys the highest credit rating and has been
able to raise funds in both domestic and international markets at favorable rates. IFC
status has further improved the company's borrowing profile, as it can raise ECBs under
the automatic route as well as issue retail infrastructure bonds at lower rate. The widened
base to raise resources would enable REC to keep in check the overall cost of funds.
At the end of March 2011, the proportion of foreign currency loans was 11% (vs 7% in
3QFY11) for REC v/s 5% for PFC and 4% for IDFC.
Assets worth Rs129b are due for repricing in FY12, while on the liability side the amount
is Rs96.6b, indicating well managed asset-liability profile.
The average duration of its
assets as at the end of FY11
was ~8 years
REC's higher mix of ECBs
gives it a cost advantage
while the average
duration of its liabilities
was 6.5 years
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Control on cost of funds leads to healthy spreads (%) Margins to stay robust (%)
Source: Company/MOSL
... however limit on ECBs, rising rates to put pressure on spreads
Diversified funding sources and a healthy ALM profile have enabled REC to maintain
superior spreads/NIMs. However, less room to raise ECBs (through the automatic route)
and rising interest rates will put pressure on the cost of funds. Going forward, sustenance
of margins will be dependent on REC's ability to raise ECBs and low interest cost 54EC
bonds as lending rates would be competitively driven. We believe NIMs have peaked out
and could come off in coming quarters. We expect spreads and NIMs to come off their
highs of 3.3% and 4.5% in FY11 to 3% and 4.2% by FY12 respectively.
IFC status allows REC to raise upto US$500m a year through the automatic routesubject to the aggregate outstanding ECBs not exceeding 50% of owned funds. At the
end of FY11 the proportion of foreign borrowings increased to 59%. This would require
REC to take prior approval from RBI to access incremental ECBs. The management
doesn't expect hindrance in raising foreign currency resources. It has sought RBI
approval to raise an additional US$750m.
10.910.9
10.59.69.69.2
11.411.411.8
8.5
8.47.67.7
7.3
6.16.46.2
7.1
3.6
4.7
3.03.2
3.13.2
2.9
3.03.3
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12E
FY13E
Yield on funds Cost of funds Spreads 5.2
3.2 3.33.7
4.04.3 4.5 4.2 4.1
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12E
FY13E
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Valuations attractive; reiterate BuyLoan growth of 22% CAGR to drive 16% earnings CAGR
With the demand environment likely to be healthy, we expect loan growth to be strong at
22% CAGR over FY11-13. NIMs are likely to come off their peaks (due to rising rates
and less room to raise ECBs through the automatic route), but would still remain strong at
over 4%. 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. However the government's thrust
on power sector reforms, recourse to SEB collections through an escrow mechanism and
SEB initiatives to ease the strain on cash flows provide comfort.
We expect REC to post 16% earnings CAGR over FY11-13, with NII rising 17%. While
we expect RoA to fall by ~30bp over FY11-13 due to a compression in NIMs, RoE would
stay strong at 21-22% due to improving leverage (CAR at 19% at the end of March
2011).
Heightened concerns over SEB losses, an expected slowdown in loan growth (due to
environment clearance issues) and the impact of rising rates on spreads led to a ~50%
correction in the stock price from its peak. We believe current valuations are attractive at
1.1x FY13E BV. We reiterate our Buy recommendation with a target price of Rs310
(1.8x FY13E BV)
Strong return ratios to drive valuations (%) One- year forward P/BV
Source: Company/MOSL
Dupont analysis for REC
DuPont Analysis FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E
Net Interest Income 2.1 2.3 2.6 3.4 3.8 4.3 4.4 4.2 4.1
Other Operating Income 2.7 0.5 0.3 0.0 0.2 0.2 0.2 0.2 0.2
Other Income 0.5 0.7 0.6 0.4 0.4 0.3 0.3 0.2 0.1
Total Income 5.3 3.5 3.5 3.9 4.4 4.7 4.9 4.6 4.4
Operating expenses 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2
Operating profits 5.0 3.2 3.2 3.6 4.2 4.4 4.6 4.3 4.2
Provisions 0.0 0.0 0.1 0.1 0.0 0.0 0.0 0.0 0.0
PBT 5.0 3.2 3.2 3.5 4.1 4.4 4.6 4.3 4.2
Taxation 1.2 0.7 1.1 1.2 1.4 1.1 1.2 1.1 1.1
RoA (incl DTL) 3.8 2.5 2.1 2.3 2.7 3.4 3.4 3.2 3.1Leverage (x) 5.9 6.4 7.7 8.0 8.0 6.9 6.3 6.7 7.1
RoE (incl DTL) 22.2 16.0 15.9 18.4 22.0 23.2 21.5 21.3 21.7
Source: Company/MOSL
22
.2
15
.7 17
.12
1.2
22
.0
21
.5
21
.3
21
.7
17
.4
3.13.23.43.4
2.7
2.32.1
2.5
3.8
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12E
FY13E
RoE RoA
1.31.6
2.6
0.50.2
1.0
1.7
2.5
3.2
Mar-08 Nov-08 Jul-09 Feb-10 Oct-10 May-11
P/B (x) Avg(x) Peak(x) Min(x)
Healthy business outlook,
superior return ratios makes
REC an attractive buy
Expect 16% earnings CAGR;
built in ~30bp contraction
in margins in FY12
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Highlights of 4QFY11 resultsOperating performance in line; usiness growth robust
Business growth remained strong: Sanctions for 4QFY11 grew ~6x YoY to Rs226b
(on a lower base) and disbursements grew 39% YoY to Rs83b. On a sequential basis,disbursements were up 38%. In FY11, sanctions grew 46% and disbursements grew
16%. Disbursements in the generation segment grew 42% YoY (up 63% QoQ) to ~Rs36b.
Disbursements to the T&D segment grew 24% YoY (up 56% QoQ) to Rs39.4b. Loan
book (ex-interest accrued) growth was strong at ~24% YoY and 7.4% QoQ.
Increased reliance on ECBs: Outstanding borrowings at the end of 4QFY11 were
Rs700b. Of the outstanding borrowings, taxable bonds issued by REC constitute ~57%
followed by 54EC bonds at ~16%. The proportion of ECB borrowing increased to ~11%
(7% at the end of 3QFY11 and 3.7% at the end of 4QFY10).
Spreads decline QoQ: NII grew 17% YoY (flat QoQ) to Rs8.5b. Reported margins
declined 22bp QoQ to 4.34%. Reported spreads declined 24bp QoQ to 3.2%. In FY11
spreads were higher at 3.36%.
Other highlights: In 4QFY11 other operating income declined 46% QoQ to Rs303m.
However, adjusting for Rs310m, being pre-payment premium booked in 3QFY11, other
operating income grew 19.5% QoQ. Foreign exchange gains were Rs559m against Rs26m
in 3QFY11. Of the total foreign borrowings, ~42% is unhedged.
Disbursements pick up, led by the generation segment Loan book growth remains strong
Increased reliance on foreign borrowing Spreads decline; remain better than peers
27
48
44
36
55
60
60
46
55
60
83
53
1839
01
2835
1416
35
0
52
93
1QFY09
2QFY09
3QFY09
4QFY09
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
3QFY11
4QFY11
Disbursements (Rs b) YoY Gr (%)
409
437
492
514
548
587
636
665
698
735
821
765
222426
293028
2525
32333133
1QFY09
2QFY09
3QFY09
4QFY09
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
3QFY11
4QFY11
Loan Book (Rs b) YoY Gr (%)
16
57
16
17171918212231323538
41
5956565553524141413628
1718181918192021212327
1179888786333
1QFY09
1HFY09
9MFY09
FY09
1QFY10
1HFY10
9MFY10
FY10
1QFY11
1HFY11
9MFY11
FY11
54EC Bonds Taxable bonds Banks and FIs Other
11.011.211.211.111.211.011.011.111.8
10.710.610.1
7.8 7.8 8.0 7.8 7.87.77.77.68.6
7.87.26.7
3.23.43.23.43.43.33.43.53.22.93.43.3
1QFY09
2QFY09
3QFY09
4QFY09
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
3QFY11
4QFY11
Yield on loans Cost of funds Spread
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Rural Electrification Corp
25 May 2011 12
Comparative Analysis
REC PFC
FY11 FY12E FY13E FY11 FY12E FY13E
Disbursement (Rs b) 245.2 285.6 335.6 341.2 409.5 491.3
Disbursement Growth (%) 16.0 16.5 17.5 32.2 20.0 20.0
Loan (Rs b) 821.3 1,008.4 1,223.0 995.7 1,225.9 1,496.6Loan Growth (%) 23.6 22.8 21.3 24.7 23.1 22.1
PAT (Rs b) 25.7 29.3 34.5 26.2 30.8 36.7
PAT Growth (%) 28.4 14.0 17.7 11.1 17.4 19.5
Spreads (%) 3.31 3.02 2.92 2.60 2.22 2.07
Margins (%) 4.45 4.22 4.07 3.86 3.68 3.59
RoA (%) 3.42 3.19 3.08 2.91 2.74 2.68
RoE (%) 21.5 21.3 21.7 18.4 16.8 16.4
D/E Ratio (x) 5.5 5.9 6.2 5.6 4.8 5.4
Book Value (Rs) 129.4 149.1 172.3 135.0 160.1 179.8
EPS (Rs) 26.0 29.7 34.9 22.8 23.3 27.8
P/E (x) 7.6 6.6 5.6 8.8 8.6 7.2
P/BV (x) 1.5 1.3 1.1 1.5 1.3 1.1
PFC FY12 and FY13 nos are after considering the dilution Source: Company/MOSL
Key risks to our call
Delays in power project execution:Indias track record of executing power projects
has been dismal. If this persists, RECs loan sanctions will not translate into
disbursements, adversely impacting growth in loan book and earnings.
Drop in power rates to impact private players: SEBs have become reluctant to
buy costly short term power, which in turn could impact the profitability of power
projects.
Poor track record of state utilities, no standard provisions by REC: REC hashigh exposure to state utilities, which have a poor financial track record. While efforts
are being made to improve SEB financials, we believe it would take time for the
benefits to show up.
Concentration risk, no buffer to absorb defaults:REC has concentrated exposure
on central and state utilities. The RBI recently asked NBFCs to provide standard
asset provisions of ~25bp; however, this was not applicable to PFC/REC, as these are
government-owned institutions. This exemption has kept profitability high. However,
we believe no buffer to absorb defaults would increase volatility in earnings in case of
deterioration in asset quality.
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Rural Electrification Corp
25 May 2011 13
Financials and Valuation
Income Statement (Rs Million)
Y/E March 2008 2009 2010 2011 2012E 2013E
Interest on Loans 33,605 46,649 64,309 81,088 104,308 127,351
Interest Exp and Other Charges 20,637 28,873 38,961 48,001 65,729 81,933Net Financing Income 12,969 17,776 25,348 33,087 38,579 45,418
Change (%) 60.4 37.1 42.6 30.5 16.6 17.7
Other Operating Income 177 922 1,189 1,481 1,810 2,166
Other Income 1,594 1,741 1,578 2,384 1,592 1,652
Net Income 14,740 20,439 28,115 36,951 41,981 49,236
Change (%) 32.6 38.7 37.6 31.4 13.6 17.3
Employee Cost 923 872 1,171 1,275 1,402 1,542
Administrative Exp 182 224 277 369 406 446
Other Operating Exp. 105 112 172 539 564 604
Operating Income 13,530 19,231 26,495 34,768 39,609 46,643
Change (%) 32.1 42.1 37.8 31.2 13.9 17.8
Total Provisions 400 34 2 2 20 50
% to Operating Income 3.0 0.2 0.0 0.0 0.1 0.1
PBT 13,130 19,197 26,493 34,766 39,589 46,593
Prior Period Adjustments -6 4 -1 0 0 0
PBT(post prior period adj) 13,124 19,201 26,492 34,766 39,589 46,593
Tax (Incl Deferred tax) 4,523 6,480 6,478 9,067 10,293 12,114
Tax Rate (%) 34.4 33.8 24.5 26.1 26.0 26.0
PAT 8,601 12,721 20,014 25,699 29,296 34,479
Change (%) 30.3 47.9 57.3 28.4 14.0 17.7
Proposed Dividend 2,576 3,864 6,032 7,406 8,393 9,875
Balance Sheet
Y/E March 2008 2009 2010 2011 2012E 2013ECapital 8,587 8,587 9,875 9,875 9,875 9,875
Reserves & Surplus 53,261 62,881 100,855 117,884 137,360 160,285
Net Worth 61,848 71,468 110,730 127,758 147,234 170,160
Borrowings 342,828 449,360 559,482 700,038 864,206 1,057,924
Change (%) 13.2 31.1 24.5 25.1 23.5 22.4
Total Liabilities 404,676 520,827 670,212 827,797 1,011,440 1,228,084
Investments 11,474 10,049 9,099 8,124 8,531 8,957
Change (%) -3.9 -12.4 -9.5 -10.7 5.0 5.0
Loans 393,165 513,814 664,526 821,321 1,008,408 1,223,034
Change (%) 22.5 30.7 29.3 23.6 22.8 21.3
Net Fixed Assets 779 809 899 880 891 901
Net Current assets -742 -3,845 -4,312 -2,528 -6,389 -4,807
Total Assets 404,676 520,827 670,212 827,797 1,011,440 1,228,084
E: MOSL Estimates
Strong loan growth
would lead to 17% NII
CAGR over FY11-13E
We expect 16% earnings
CAGR over FY11-13E
Strong pipeline of
loans to result in healthy
loan growth
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Rural Electrification Corp
25 May 2011 14
Financials and Valuation
Ratios
Y/E March 2008 2009 2010 2011 2012E 2013E
Spreads Analysis (%)
Avg. Yield - on Financing Portfolio 9.4 10.3 10.9 10.9 11.4 11.4Avg Cost of Funds 6.4 7.3 7.7 7.6 8.4 8.5
Interest Spread 3.1 3.0 3.2 3.3 3.0 2.9
Net Interest Margin 3.6 3.9 4.3 4.5 4.2 4.1
Profitability Ratios (%)
RoE 17.1 21.2 22.0 21.5 21.3 21.7
RoA 2.5 3.1 3.4 3.42 3.19 3.08
Efficiency Ratios (%)
Int. Expended/Int.Earned 61.4 61.9 60.6 59.2 63.0 64.3
Other operating Inc./Net Income 1.2 4.5 4.2 4.0 4.3 4.4
Other Income/Net Income 10.8 8.5 5.6 6.5 3.8 3.4
Op. Exps./Net Income 8.2 5.9 5.8 5.9 5.7 5.3
Empl. Cost/Op. Exps. 76.3 72.2 72.3 58.4 59.1 59.5
Asset-Liability Profile (%)
Loans/Borrowings Ratio 114.7 114.3 118.8 117.3 116.7 115.6
Invest./Borrowings Ratio 3.3 2.2 1.6 1.2 1.0 0.8
Net NPAs to Adv. 0.6 0.0 0.0 0.0 0.0 0.0
Debt/Equity Ratio 5.5 6.3 5.1 5.5 5.9 6.2
Valuations
2008 2009 2010 2011 2012E 2013E
Book Value (Rs) 72.0 83.2 112.1 129.4 149.1 172.3BV Growth (%) 18.3 15.6 34.7 15.4 15.2 15.6
Price-BV (x) 2.7 2.4 1.8 1.5 1.3 1.1
OPS (Rs) 15.8 22.4 26.8 35.2 40.1 47.2
OPS Growth (%) 86.3 42.1 19.8 31.2 13.9 17.8
Price-OP (x) 12.5 8.8 7.3 5.6 4.9 4.2
EPS (Rs) 10.9 16.4 20.3 26.0 29.7 34.9
EPS Growth (%) 9.8 50.6 23.3 28.1 14.2 17.7
Price-Earnings (x) 18.0 12.0 9.7 7.6 6.6 5.6
Dividend 3.0 4.5 6.5 7.5 8.5 10.0
Dividend Yield (%) 1.5 2.3 3.3 3.8 4.3 5.1
E: MOSL Estimates
Modeled in ~30bp spread
compression in FY12
Available at an attractive
valuation of 1.1x FY13E BV
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