Powering ahead

Big ticket power investments should ensure that REC grows its loan book rapidly in the future.

As part of the government’s disinvestment programme, Rural Electrification Corporation (REC) would be one of the first public sector companies to tap the primary market. The follow-on offer, comprising 15 per cent fresh equity and five per cent offer for sale by the government, would fetch around Rs 3,750 crore at the two-week average price of Rs 220. The management expects to file its draft prospectus by mid-December and hopes to hit the market by the end of the fiscal. A major part of the proceeds (about Rs 2,800 crore) would be going to the company coffers, which would help it to finance the growing needs of the power sector. While over 60,000 MW of power generating capacity is expected to be added in the current five-year plan (2008-2012), which has already been generating increased business volumes for financiers like REC (it proposes to disburse a lakh crore in this period), the target of 100,000 MW for the next five-year plan (2012-2017) indicates that volume growth should remain robust. Apart from higher business volumes, REC’s ability to sustain margins will ensure robust profit growth for the next couple of years.

Robust demand
A sum of rupees 10 lakh crore is expected to be invested in the power sector in the eleventh Five-year Plan. Around three-fourth of investments are set to be made by government related utilities. With most of them being the mainstay of REC’s customer profile, expect the company to lend a reasonably large portion in the future also. REC had sanctioned loans worth Rs 1.2 lakh crore in the last three years. Besides, participation of the private players in the power projects is on the way-up, and is also throwing up opportunities for the company. In view of this, REC expects to increase lending to private sector power projects from 6 per cent to 15 per cent in the next three years.

The deceleration in the economic growth in the second half of 2008-09, saw sanctions slowing. As things improved from there-on, REC had started to lend more. In the first half of 2009-10, the company sanctioned loans equivalent to almost 80 per cent of total loans it sanctioned in the entire 2008-09. Little wonder, REC has been able to report strong growth in revenues in the first half, while profits have grown faster thanks to the company’s ability to curb operating expenses.

Going ahead, the management expects to sanction loans worth Rs 50,000 crore in 2009-10. Disbursements are set to increase in line; it grew at 27 per cent in the last three years, and the company expects to sustain 25-27 per cent growth on an average for the next two years.

REC's had primarily been a financier to the transmission and distribution (T&D) segments in the past; it is changing its profile towards generation projects gradually. This is evident in the way the share of generation segment has moved up in the recent years, up from 22 per cent in Q1 FY08 to 38 per cent as of Q2 FY10. The change in asset mix towards the generation segment gives a balance to REC’s asset profile; however, the management feels that this proportion would increase up-to 50 per cent in the next two years.

Margins stable
REC had consistently been able to maintain spreads of around 3 per cent. In the recent quarter also, the spreads were 3.35 per cent as REC benefited from lower funding costs. REC has access to capital gains tax exemption bonds (issued under Section 54EC) that are been sourced at lower rates (interest rate of 6.25 per cent) compared to relatively more expensive sources like banks. However, in spite of the declining share of these bonds in total borrowings (as REC borrowed more from other sources), the company has been able to maintain spreads.

However, going ahead, things may be a bit different. In 2007, the share of low-cost 54EC bonds was 46 per cent and subsequently it reduced to 32 per cent in 2008-09. It further fell to 22 per cent in Q2 FY10, as REC retired some bonds issued earlier. While this figure could further reduce to 10-15 per cent in 2010-11, with loans (given to customers) worth Rs 7,800 crore and Rs 12,000 crore expected to be reset (at higher yields) in 2009-10 and 2010-11, respectively, it should offset the pressure on spreads in the medium-term. Going ahead, REC’s management feels confident of sustaining spreads in the region of 2.75-3 per cent on a regular basis.

STEADY GROWTH
in Rs crore	FY09	H1 FY10	% Chg	FY10E
Net interest income	1,768	1,167	39	2,380
Operating income	2,036	1,317	40	2,533
Net profit	1,272	966	71	1,793
EPS (Rs)	14.8	-	-	20.9
P/E (x)	15.9	-	-	11.3
P/BV (x)	2.8	-	-	2.4
E: analyst estimates; % change is y-o-y

Conclusion
While a majority of REC’s lending is to central and state electricity boards, it is either secured by escrow or mortgage ensuring better recovery and timely settlement of loans. Thus, asset quality, which had remained intact with net non performing assets at 0.04 per cent as on Q2 FY10, should remain healthy.

Initiatives to link risk weight to credit rating as well as separate categorisation of NBFCs engaged in infrastructure lending would provide easier access to funds to companies like REC.

Going ahead, with demand expected to remain robust and margins likely to stay healthy, expect REC’s loan book and net profit to grow at 25 per cent annually in the next two years. At Rs 232, the stock is trading at 2.4 times its 2009-10 book (pre-offer), and can be considered on dips.