rec - most

8/6/2019 REC - MoST

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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

8/6/2019 REC - MoST

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25 May 2011 2

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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25 May 2011 3

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)


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25 May 2011 4

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


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.

8/6/2019 REC - MoST

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25 May 2011 5

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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25 May 2011 6

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


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


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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25 May 2011 7

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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25 May 2011 8

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


Banks and

FIs

16%

Taxable

Bonds

57%

Capital gains

bonds

16%

Foreign

11%

40 3346 43

3218 16

60 6754 57

6882 84


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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25 May 2011 9

Control on cost of funds leads to healthy spreads (%) Margins to stay robust (%)


... 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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25 May 2011 10

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


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


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

8/6/2019 REC - MoST

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25 May 2011 11

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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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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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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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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