Company Background

• Rural Electrification Corporation Limited (REC) was incorporated in 1969 for the purpose of developing the power infrastructure in rural areas.
• REC acts as a public financial institution in the Indian power infrastructure sector which is engaged in the financing and promotion of transmission, distribution and generation projects throughout India. Since FY03, Government of India (GOI) permitted to finance all segments of the power sector, including generation, throughout the country.
• REC provides loan assistance to State Electricity Boards(SEBs)/State Power Utilities for investments in rural electrification schemes through its Corporate Office located at New Delhi and 17 field units (Project Offices), which are located in most of the States.
• The company hold the highest long-term borrowing domestic credit rating from each of CRISIL Limited, ICRA Limited, Fitch and CARE Limited.
• REC loan sanctions and loan disbursements have grown at a CAGR of 25.71% and 23.23%, respectively, between FY05 and FY09.
• Post issue Promoters & Promoter’s group shareholding will reduce to 66.79% from existing 81.82%.

Objective of Issue

• Enlarging the capital base to meet future capital requirements arising out of growth in business due to the growth of the Indian economy and the Indian power sector, and for other general corporate purposes. As the Indian economy continues to grow, the country’s power requirements and need for power infrastructure are expected to grow substantially as well.

 Strength

REC a beneficiary of buoyancy in the power sector
The power Sector is expected to see generation capacity addition of 80GW during FY08-12. This, along with transmission and distribution, will entail investment of Rs 10,300 bn. REC is dedicated to power-sector financing and enjoys strong relationships with Central and state government utilities, which account for 94% of its loan book. With over 78% of the total investment pipeline expected from government utilities, REC would be a major beneficiary of the buoyancy in the power sector.

REC will continue to have an edge in power financing
Banks have limitations in lending to SEBs because of SEBs' poor financial health and the asset-liability mismatch that lending to such borrowers would create. Power generation financing inherently has a long gestation period, which may extend to over 20 years. Bankers would be unwilling to lend beyond five to ten years as this could lead to an acute asset-liability mismatch and liquidity problems for banks. As a result, REC will continue to have an edge in power financing.

REC's strong Loan Assets.
Company’s loan assets have grown at a CAGR of 24.07% from Rs. 2,16,844 mn in Fiscal 2005 to Rs. 5,13,814 mn in Fiscal. These will subsequently convert into disbursements. REC loan sanctions and loan disbursements have grown at a CAGR of 25.71% and 23.23%, respectively, between Fiscal 2005 and Fiscal 2009.

Strong earnings growth visibility
Being a government-promoted AAA rated organization, REC's borrowing cost is the lowest among peers as it enjoys lower funding cost due to bonds under Sec 54EC of the Income Tax Act. Under section 54EC of the Income-tax Act, the Central Government notifies that the bonds for an amount of Rupees four thousand five hundred cr (redeemable after three years) to be issued by REC. It is expected that FY09-12E disbursement would grow at a CAGR of 25% and loan book CAGR of 27% translating into PAT CAGR of 23%. With this REC could report RoA of over 2.5% and RoE of more than 23% over FY09-12E.

REC changing business mix in favor of generation projects
While REC's exposure has historically been in favor of the T&D segment as compared with PFC, it is changing its profile in favor of generation projects as well. Sanctions and disbursement trends indicate that generation projects occupy a higher share in its incremental business.

Escrow mechanism ensures REC's recoveries
Most of the loans to SEBs are backed by default escrow accounts as a credit enhancement mechanism. Under this mechanism, certain predetermined amounts from the payments received by SEBs from their respective customers are deposited in an escrow account pursuant to a tripartite escrow agreement between REC, the SEBs and an escrow agent.(the bank). The deposited amount is available to the SEBs except in case of a default due to non-payment of dues. In such cases, the escrow agent makes the default amount available to PFC/REC on demand. Thus, while balance sheets of SEBs are in bad shape, REC and PFC lend based on the security of the cash flows from the operations of the utilities. PFC and REC have enjoyed over 98% recovery from SEBs during past four to five years

Rising cost of fund is matter of concern
The GoI has not provided any direct funding since 2001, similarly, the GoI has not allowed to issue SLR bonds since Fiscal 1999, tax-free bonds since Fiscal 2002 and infrastructure bonds since Fiscal 2006. In addition, since January 2007 the GoI has limited the amount of bonds that an individual investor can utilize to offset capital gains to Rs. 5 mn, which has reduced the amount of bonds that company have been able to offer for subsequent periods. Consequently, company is increasingly reliant on funding from the debt capital markets and commercial borrowings. As a result of these Company’s cost of funds has risen from 6.25% for FY06 to 7.52% for the six months ended September 30, 2009.

Delays in power project execution
India's track record of executing power projects has been dismal till the Tenth Five-Year Plan. If this persists going forward, REC's loan sanctions will not translate into disbursements, adversely impacting growth in loan book and earnings.

Poor track record of state utilities
A significant proportion of REC's loan book is exposed to state utilities, which have a poor financial track record. As on September 30, 2009, company had aggregate loans outstanding to state sector borrowers of Rs. 485,547 mn, which constituted 83.87% of the total loans outstanding.

Financials

• Income from Operation of REC registered a CAGR growth of 22% from FY05 to FY09.
• Company is maintaining its OPM of around 40% and NPM of around 30% from last 5 years.
• For the quarter ended September 2009 REC reported 38% rise in Income from Operations stood at Rs 1,532.44 crore.
• For the half year ended September 2009 REC reported 42% rise in Income from Operations stood at Rs 2981.79 crore.
• Going forward with annualize PAT company’s Post issue EPS will be 19.45 which looks quite impressive.
  

  Rs in Crore

  Particulars 2008 2009 2010E 2011E  Income from operations  3,380.46 4,754.93 6,088.97 7,489.43  Interest and other Charges  2,054.06 2,887.35 3,608.11 4,493.66 Net Financing Income 1,326.40 1,867.58 2,480.85 2,995.77 % Change 0.00 40.80 32.84 20.76  Other income 159.25 162.68 174.74 178.00 Net Total Income 1,485.66 2,030.26 2,655.60 3,173.77 % Change 0.00 36.66 30.80 19.51  Establishment Exp (Staff costs) 92.30 87.22 106.71 131.07  Administrative expenses  17.88 22.69 21.20 25.46 Other Exp. 9.12 9.80 21.05 18.72 Operating Income before Prov. 1,366.37 1,910.54 2,506.64 2,998.52 Provisions 41.38 4.79 6.27 7.50 % of Operating Income 3.03 0.25 0.25 0.25 PBT 1,324.99 1,905.76 2,500.37 2,991.02 Tax 359.71 529.48 694.60 830.91 % of PBT 27.15 27.78 27.78 27.78 PAT 965.28 1,376.28 1,805.77 2,160.12

Peer Analysis      

Valuation

Company has set a floor price of Rs. 203. Based on annualized PAT of Six month ended 30th Sept 2009 stock is trading at a PE of 10.79x for FY10 and forward PE of 9.28x for FY11E which looks quite fair for long term (12 months) prospective.