Rural Electrification Corp: Buy

Fresh investments can be considered in the stock of Rural Electrification Corporation (REC), a navratna public sector undertaking, which finances all the segments across the power value chain.

Secured advances with a high asset quality (net non-performing assets of almost zero) coupled with sustainable spreads are the key positives for REC when compared to most finance companies. Even after gaining more than 165 per cent this year, the company's stock is trading at a modest 12 times its estimated FY10 earnings (assuming 15 per cent equity expansion post-offer) and at 1.6 times its estimated book value.

A power sector debt funding requirement of more than Rs 15 lakh crore over the Eleventh and Twelfth Plans is the major growth driver for REC. Its proposed follow-on public offer will augment the capital base, enabling balance sheet expansion.

The Reserve Bank of India's recent policy change which pegs bank's risk weights to the borrowers credit rating, will also favour the company given its AAA rating. The profits of REC rose 70 per cent in the first half of this fiscal, helped by loan book and disbursements growth of 32 per cent and 22 per cent respectively. This bettered overall bank credit growth of 20 per cent. Improvement of spreads from 3.34 per cent to 3.47 per cent, helped by better yields and lower costs, also aided the company's net profit growth.

We expect the loan growth to continue at robust pace on the back of the wide Rs 1,50,000-crore gap between sanctions and disbursements. The margins may get some support as the proportion of private sector borrowers trends up.

At current market prices, the follow-on offer may raise Rs 2,600 crore, given the proposed offer size. This will increase its net worth by 32 per cent and bring down the debt-equity ratio from 6.3 to 4.8, reducing the risk to its credit rating. Increase in costs due to reduced reliance on tax-free bonds, may be compensated by the fall in borrowing costs from banks.

Delays in power projects leading to late disbursement and rescheduling of loan repayments, are the biggest risks for the company. Asset-liability mismatch arising out of lower maturity deposits and high duration loans is also a potential risk. Increase in interest rates later in the year may put pressure on margins as the company predominantly has fixed-rate loans, with three- or 10-year reset.

M.V.S Santosh Kumar

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