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  Rural Electrification Corp (REC) reported a PAT of INR7.7bn as against our expectation of
 

Rural Electrification Corp (REC) reported a PAT of INR7.7bn as against our expectation of INR7.9bn (growth of 16% YoY and 24% QoQ). This includes INR866mn in forex MTM writeback. Key highlights are: 1) INR2.23bn of exposure to Konaseema project classified as NPL; provisioning hit of INR240mn and interest income reversal of INR250mn, 2) Employee costs more than double YoY/QoQ as it provided for additional incentives for the period FY10 11, 3) NIMs came off 13bps to 4.34% mainly due to income reversal, 4) Disbursement growth moderated to 10% due to weak December month and 5) interim dividend of INR5 per share; dividend payout to be maintained near 30% (implying final dividend of ~INR3.0 per share). At current valuations of 1.2x FY13E book and 6.1x FY13E earnings, the risk–reward is favourable. We maintain ‘BUY’ with TP of INR240.

EDELWEISS 4D RATINGS

 

Absolute Rating

 

BUY

Rating Relative to Sector

 

Outperformer

Risk Rating Relative to Sector Medium

Sector Relative to Market

 

Equalweight

 

MARKET DATA (R: RURL.BO, B: RECL IN)

CMP

: INR 198

Target Price

: INR 240

52week range (INR)

 

: 289 / 144

Share in issue (mn)

 

: 987.5

M cap (INR bn/USD mn)

 

: 195 / 3,904

 

Avg. Daily Vol.BSE/NSE(‘000) : 2,941.6

 

NIMs sustained; stayed away from banks borrowing

   

SHARE HOLDING PATTERN (%)

 

Borrowing was skewed in favour of bonds/debentures where the incremental cost was 9.6%. It has further raised USD100mn in ECB in Q3FY12 (over and above USD300mn in H1FY12). With banks having aggressively raised base rates in Q2FY12, REC has completely stayed away from bank borrowings since past three quarters (proportion has come off from 16% in FY11 to 7% in Q3FY12). The increase in blended cost of funds was capped at 11bps to 8.4% whereas yields came off 6bps due to interest reversal. Consequently, NIMs came off 13bps QoQ to 4.34% in line with expectation. Management indicated that in FY12E, INR120bn of assets and INR90bn of liabilities will come up for repricing. We are building in margins of 4.1% 4.3% for FY12 14E.

Others

Promoters* 43.2% FIIs 27.1%
Promoters*
43.2%
FIIs
27.1%

27.2%

MFs, FIs & Banks

 
 

* Promoters pledged shares (% of share in issue)

2.5%

:

NIL

 

Outlook and valuations: Positive developments at SEBs; ‘BUY’

   

REC has underperformed broader markets by 20% over the past one year, led by concerns surrounding the power sector. However, some positive developments have taken place for SEBs recently (tariff hikes, government support etc). Banks are reluctant to provide further funds to ailing discoms and restructuring is inevitable for working capital loans. However, REC’s lower share in working capital finance and limited dependence on private projects offer comfort. Led by 17% CAGR in loan assets and relatively stable NIMs, we expect 13% earnings CAGR and average ROEs of 20% over FY12 14E. The stock is trading at 1.2x FY13E book and 6.1x FY13E earnings. We maintain ‘BUY/Sector Outperformer’ recommendation/rating on the stock.

PRICE PERFORMANCE (%)

 
 

Stock

Nifty

EW Banks and Financial Services Index

1

month

22.9

7.0

12.8

3

months

3.6

(0.1)

 

0.2

12 months

(33.7)

(11.4)

 

(9.5)

Kunal Shah

+91 22 4040 7579 kunal.shah@edelcap.com

 

Financials

 

Nilesh Parikh

Year to March

Q3FY12 Q3FY11 Growth (%) Q2FY12 Growth (%)

FY11

FY12E FY13E

+91 22 4063 5470 nilesh.parikh@edelcap.com

 

Net int. inc. (INR mn) 10,917 8,480

28.7

8,241

32.5

33,808 39,337 45,916

PAT (INR mn)

7,694

6,641

15.9

6,229

23.5

25,066 28,143 31,935

Suruchi Chaudhary

 

Diluted EPS (INR)

7.8

6.7

15.9

6.3

23.5

25.4

28.5

32.3

+91 22 6623 3316 suruchi.chaudhary@edelcap.com

 

BV per share (INR)

 

130

148

170

Price/ Earnings (x)

 

7.8

6.9

6.1

January 25, 2012

 

Price/ Book (x)

 

1.5

1.3

1.2

 
   

Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.

 
Edelweiss Securities Limited

Edelweiss Securities Limited

 

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Banking and Financial Services

Banking and Financial Services
Banking and Financial Services Asset quality slips on Konaseema gas based project The company has classified

Asset quality slips on Konaseema gas based project

The company has classified INR2.23bn of exposure to Konaseema gas based project as NPL on which it made a provisioning of INR240mn while there was an interest income reversal of INR250mn. Gross NPLs now stand at 0.52% and with provisioning coverage of 14%, net NPAs stand at 0.45%.

Disbursement growth moderates; some short term funding in Q3FY12

While the disbursement momentum picked up post Q2FY12, December month saw a muted offtake as disbursement growth moderated to 6% YoY to INR63bn. Disbursements include INR11.5bn of short term loans primarily provided to Rajasthan, Haryana, UP, Punjab state utilities against government guarantee and based on conditionalities of tariff hikes, AT&C loss reduction etc. Loan book sustained 25% YoY growth to INR950bn. More disappointing has been the decline in sanctions to merely INR88bn (compared to a run rate of INR160bn 175bn). While sanctions picked up in the generation segment, T&D segment (including RGGVY) saw lower sanctions. We are building in a disbursement growth of 10% over FY1214 and expect the loan book to post 17% CAGR to INR1.4tn.

Other highlights

REC had hedged USD500mn of forex borrowings in September 2011 to minimise the impact of MTM losses. Now the unhedged position stands at a mere USD250mn (compared to USD970mn in FY11).

Employee cost has jumped significantly up to INR680mn (up 137% YoY and 125% QoQ) as the company provided an extra incentive of 66% to employees for FY10 11 (now following a similar salary structure like PFC).

Chart 1: Sanctions dip in T&D segment

200 160 120 80 40 0 Generation T&D Short term (INR bn) Q409 Q110 Q210
200
160
120
80
40
0
Generation
T&D
Short term
(INR bn)
Q409
Q110
Q210
Q310
Q410
Q111
Q211
Q311
Q411
Q112
Q212
Q312
Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Chart 2: Disbursement growth momentum moderates

Chart 2: Disbursement growth momentum moderates

45 36 27 18 9 0 Generation T&D Short term (INR bn) Q409 Q110 Q210
45
36
27
18
9
0
Generation
T&D
Short term
(INR bn)
Q409
Q110
Q210
Q310
Q410
Q111
Q211
Q311
Q411
Q112
Q212
Q312

Source: Company

2

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Rural Electrification Corporation

Rural Electrification Corporation

Chart 3: Stayed away from bank borrowings completely

Chart 4: Borrowings skew in favor of forex and bonds

100.0 100.0 80.0 80.0 60.0 60.0 40.0 40.0 20.0 20.0 0.0 0.0 Capital gains Taxable
100.0
100.0
80.0
80.0
60.0
60.0
40.0
40.0
20.0
20.0
0.0
0.0
Capital gains
Taxable bonds
Banks, Fis, etc.
Capital gains
Taxable bonds
Banks, FIs, CP,etc
Foreign
Foreign
CP
(%)
Q409
Q110
Q210
Q310
Q410
Q111
Q211
Q311
Q411
Q112
Q212
Q312
(%)
Q409
Q110
Q210
Q310
Q410
Q111
Q211
Q311
Q411
Q112
Q212
Q312
Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Chart 5: NIMs sustained due to
Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Chart 5: NIMs sustained due to

Chart 5: NIMs sustained due to commendable liability management

13.0

5.0

11.4

11.4 4.6

4.6

9.8

4.2

(%)

(%)

8.2

3.8

6.6

3.4

5.0

3.0

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Yield on advances

Yield on advances

 
Yield on advances   Cost of funds   NIMs

Cost of funds

 

NIMs

Chart 6: Asset quality slips (Konaseema project classified as NPL)

 

0.9

100.0

0.7

0.7 80.0

80.0

0.5

60.0

(%)

(%)

0.4

40.0

0.2

20.0

0.0

0.0

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Gross NPA   Net NPA   Provision coverage (RHS)

Gross NPA

 
Gross NPA   Net NPA   Provision coverage (RHS)

Net NPA

 

Provision coverage (RHS)

Source: Company

3

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Banking and Financial Services

Banking and Financial Services

Financial snapshot

(INR mn)

Year to March

Q3FY12

Q3FY11

% Change

Q2FY12

% Change

FY11

FY12E

FY13E

Interest income

26,500

20,860

27.0

25,145

5.4

82,318

101,189

120,237

Interest exp

15,583

12,380

25.9

16,904

(7.8)

48,510

61,852

74,321

Net income from ops

10,917

8,480

28.7

8,241

32.5

33,808

39,337

45,916

Net operating income

136

564

(75.9)

176

(22.8)

1,481

1,681

1,683

Other income

354

357

(0.8)

379

(6.5)

300

330

363

Net revenues

11,407

9,401

21.3

8,796

29.7

35,589

41,348

47,962

Staff costs

680

287

137.1

302

124.8

1,275

1,635

2,191

Other expenses

92

92

(0.1)

145

(36.5)

369

503

564

Depreciation

7

8

(6.5)

9

(17.2)

30

35

35

Pre prov op profit (ppop)

10,629

9,015

17.9

8,341

27.4

33,915

39,174

45,172

Provisions

241

2

1,276

2,129

Profit before tax

10,388

9,015

15.2

8,341

24.5

33,913

37,898

43,043

Tax

2,693

2,374

13.5

2,112

27.5

8,847

9,755

11,109

PAT

7,694

6,641

15.9

6,229

23.5

25,066

28,143

31,935

Diluted EPS (INR)

7.8

6.7

15.9

6.3

23.5

25.4

28.5

32.3

Cost to income (%)

6.8

4.1

5.2

4.7

5.3

5.8

Tax Rate

25.9

26.3

25.3

26.1

25.7

25.8

Price/ Book (x)

1.5

1.3

1.2

Price/ Earnings

7.8

6.9

6.1

 

4

Edelweiss Securities Limited

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Rural Electrification Corporation

Rural Electrification Corporation
Rural Electrification Corporation Company Description Rural Electrification Corporation (REC), incorporated in

Company Description

Rural Electrification Corporation (REC), incorporated in 1969, is a leading public institution primarily involved in the financing of T&D and generation projects across India. It was established by GoI for the purpose of developing the T&D infrastructure in rural India and currently acts as a nodal agency for RGGVY, a GoI initiative for rural electrification. Over the last decade, the company has diversified into urban areas and it plays a strategic role in GoI plan to improve the transmission and distribution infrastructure of India. REC, along with Power Finance Corporation (PFC), is the nodal agency for APDRP, a GoI initiative to improve the financial viability of state power utilities. Loans to T&D projects constituted ~50% to the total loan book as on March 31, 2011.

Investment Theme

Over the Eleventh and Twelfth Five Year plans (FY07 17), India targets to add ~170 GW, creating huge investment opportunities across the power value chain. High growth, long term visibility and sustainable returns, coupled with demand supply gap (~12% peak deficit) and rising energy consumption, make the sector an attractive investment option. REC, being

a specialised power financier, plays a strategic role in GoI’s ongoing financing plans for

development of the power sector. Superior domain knowledge, financing expertise and government support will enable it to leverage emerging financing opportunities in the power sector over Eleventh and Twelfth plans (FY07 17) as well. According to the estimates

of Working Group of Power, REC is expected to disburse at least INR 592 bn in the Eleventh

Plan (against the expected disbursement of INR 812 bn for PFC). We believe REC will be able

to fund 1520% of its total funding requirement in the Eleventh Plan. We, thus, expect its loan book to grow at 17% CAGR over FY12 14E delivering a ROAE of ~20% over FY12 14.

Key Risks

REC’s growth depends on its ability to remain effectively competitive in the power financing space and to pass the higher cost of funds to customers. Also, benefits under Section 54EC are being curtailed continuously and there are uncertainties surrounding the level of benefits REC will receive from these instruments, going forward.

REC’s gross NPAs are at near zero levels. Any major slippage or ineffective recoveries can raise NPAs significantly, adversely affecting profitability and growth.

REC is subject to risk arising from asset liability mismatch as majority of its loans are longterm in nature due to wholesale financing of large power projects, whereas its borrowings are relatively for shorter term.

REC’s ability to borrow from banks may be restricted with the limit on exposure of a bank in infrastructure finance companies at 25% of bank’s capital funds (tier I+tier II).

REC is exposed to project specific and general risks inherent to the power sector. Any delay in the power sector projects due to lack of fuel supplies, supply of key equipment or delay in getting environment clearances can adversely affect the profitability of power projects, increasing the company’s NPAs.

There have been qualifications by auditors with respect to internal control and audit system; these do not have any quantifiable impact as of now, but could impact REC’s business in the long term

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Banking and Financial Services

Banking and Financial Services

Financial Statements

Income statement

(INR mn)

Year to March

FY10

FY11

FY12E

FY13E

FY14E

Interest income

65,687

82,318

101,189

120,237

138,886

Interest expended

39,256

48,510

61,852

74,321

86,422

Net interest income

26,431

33,808

39,337

45,916

52,463

Non interest income

1,189

1,481

1,681

1,683

1,719

Income from operations

27,620

35,289

41,018

47,599

54,182

Other income

200

300

330

363

399

Net revenues

27,820

35,589

41,348

47,962

54,582

Operating expense

1,326

1,674

2,174

2,790

3,314

Employee exp

1,171

1,275

1,635

2,191

2,648

Depreciation /amortisation

22

30

35

35

35

Other opex

133

369

503

564

631

Preprovision profit

26,494

33,915

39,174

45,172

51,268

Provisions

2

2

1,276

2,129

2,568

Loan loss provisions

2

2

1,276

2,129

2,568

Profit before tax

26,492

33,913

37,898

43,043

48,699

Provision for tax

6,478

8,847

9,755

11,109

12,582

Profit After Tax

20,014

25,066

28,143

31,935

36,117

Extraordinaries

633

(333)

(296)

(296)

Reported PAT

20,014

25,699

27,810

31,639

35,821

Basic shares outstanding (mn)

987

987

987

987

987

Basic EPS (INR)

20.3

25.4

28.5

32.3

36.6

Diluted equity shares (mn)

987

987

987

987

987

Diluted EPS (INR)

20.3

25.4

28.5

32.3

36.6

Dividend per share (INR)

6.5

7.5

8.0

8.5

8.5

Dividend payout (%)

32.1

29.5

28.1

26.3

23.2

Growth ratios (%)

Year to March

FY10

FY11

FY12E

FY13E

FY14E

Revenues

37.5

27.9

16.2

16.0

13.8

NII growth

39.6

27.9

16.4

16.7

14.3

Opex growth

19.4

26.3

29.9

28.3

18.8

PPP growth

38.6

28.0

15.5

15.3

13.5

Provisions growth

(93.6)

NA

66.8

20.6

Net profit

45.2

25.2

12.3

13.5

13.1

Operating ratios

Year to March

FY10

FY11

FY12E

FY13E

FY14E

Yield on advances

10.9

10.9

11.0

10.9

10.8

Yield on assets

11.0

11.0

11.0

10.9

10.9

Net interest margins

4.4

4.5

4.3

4.2

4.1

Cost of funds

7.8

7.7

7.9

7.9

7.9

Spread

3.3

3.3

3.1

3.1

3.0

Costincome

4.8

4.7

5.3

5.8

6.1

Tax rate

24.5

26.1

25.7

25.8

25.8

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Rural Electrification Corporation

Balance sheet

(INR mn)

As on 31st March

FY10

FY11

FY12E

FY13E

FY14E

Equity capital

9,875

9,875

9,875

9,875

9,875

Reserves & surplus

96,643

112,750

130,241

150,841

175,549

Net worth

106,518

122,624

140,116

160,716

185,424

Reserve for doubtful debts

4,282

5,263

6,338

7,557

8,850

Secured loans

462,447

462,674

568,648

676,325

776,848

Unsecured loans

97,035

237,364

291,731

346,972

398,543

Deferred tax liability

(74)

(128)

(128)

(128)

(128)

Total liabilities

670,208

827,798

1,006,706

1,191,442

1,369,537

Loans

664,520

821,321

1,002,734

1,187,079

1,367,814

Investments

9,100

8,124

8,517

8,930

9,364

Total current assets

20,837

34,447

28,519

35,472

38,501

Total current liabilities & provisions

25,149

36,976

33,939

40,910

47,008

Net current assets

(4,312)

(2,529)

(5,420)

(5,437)

(8,507)

Fixed assets

900

881

876

871

866

Total assets

670,208

827,798

1,006,706

1,191,442

1,369,537

Loan growth

29.3

23.6

22.1

18.4

15.2

Deposit growth

24.5

25.1

22.9

18.9

14.9

EA growth

28.6

23.5

21.6

18.4

15.0

Gross NPA ratio

0.5

0.8

1.0

Net NPA ratio

0.4

0.5

0.7

Provision coverage

90.0

90.0

20.0

30.0

35.0

Book value per share (INR)

112.2

129.5

148.3

170.4

196.7

Sanctions and disbursements

Year to March

FY10

FY11

FY12E

FY13E

FY14E

Sanctions (INR mn)

453,570

664,210

650,926

716,018

787,620

Disbursements (INR mn)

211,325

245,190

268,843

304,673

323,185

Disbursements to sanction ratio (%)

46.6

36.9

41.3

42.6

41.0

Disbursements growth (%)

23.2

16.0

9.6

13.3

6.1

Sanctions growth (%)

11.3

46.4

(2.0)

10.0

10.0

RoE decomposition (%)

Year to March

FY10

FY11

FY12E

FY13E

FY14E

Net interest income/assets

4.4

4.5

4.3

4.2

4.1

Non interest income/assets

0.2

0.2

0.2

0.2

0.1

Investment profits/Assets

Net revenues/assets

4.7

4.8

4.5

4.4

4.3

Operating expense/assets

0.2

0.2

0.2

0.3

0.3

Provisions/assets

0.1

0.2

0.2

Taxes/assets

1.1

1.2

1.1

1.0

1.0

Total costs/assets

1.3

1.4

1.4

1.5

1.4

ROA

3.4

3.4

3.1

2.9

2.8

Equity/assets

15.4

16.0

15.0

14.3

14.2

ROAE (%)

21.9

21.0

20.5

20.3

19.9

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Banking and Financial Services

Banking and Financial Services

Valuation parameters

Year to March

FY10

FY11

FY12E

FY13E

FY14E

Diluted EPS (INR)

20.3

25.4

28.5

32.3

36.6

Y oY growth (%)

26.2

25.2

12.3

13.5

13.1

Book value per share (INR)

112.2

129.5

148.3

170.4

196.7

Diluted PE (x)

9.8

7.8

6.9

6.1

5.4

Price/BV (x)

1.8

1.5

1.3

1.2

1.0

Dividend yield (%)

3.3

3.8

4.0

4.3

4.3

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RATING & INTERPRETATION
RATING & INTERPRETATION

Company

Absolute

Relative

Relative

Company

Absolute

Relative

Relative

reco

reco

risk

reco

reco

Risk

Allahabad Bank

REDUCE

SU

H

Axis Bank

BUY

SO

M

Bank of Baroda

HOLD

SP

L

Federal Bank

BUY

SO

M

HDFC

HOLD

SP

L

HDFC Bank

HOLD

SP

L

ICICI Bank

BUY

SO

L

Indian Overseas Bank

HOLD

SU

H

Infrastructure Development Finance Co Ltd

HOLD

SP

M

ING Vysya

HOLD

SP

H

Karnataka Bank

BUY

SO

L

Kotak Mahindra Bank

REDUCE

SU

L

LIC Housing Finance

HOLD

SP

M

Mahindra & Mahindra Financial Services

 

HOLD

SP

M

Manappuram General Finance

HOLD

SP

M

Oriental Bank Of Commerce

 

REDUCE

SU

H

Power Finance Corp

BUY

SO

L

Punjab National Bank

REDUCE

SU

M

Reliance Capital

BUY

SO

M

Rural Electrification Corporation

 

BUY

SO

L

Shriram City Union Finance

BUY

SO

H

South Indian Bank

HOLD

SP

M

State Bank of India

HOLD

SP

M

Union Bank Of India

HOLD

SP

H

Yes Bank

BUY

SO

M

 
 

ABSOLUTE RATING

     
  ABSOLUTE RATING        
 

Ratings

Expected absolute returns over 12 months

 

Buy

More than 15%

Hold

Between 15% and - 5%

 

Reduce

Less than -5%

 
 

RELATIVE RETURNS RATING

   

Ratings

Criteria

Sector Outperformer (SO)

Stock return > 1.25 x Sector return

   
Sector Outperformer (SO) Stock return > 1.25 x Sector return      
 

Sector Performer (SP)

Stock return > 0.75 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU)

Stock return < 0.75 x Sector return

 
Sector Underperformer (SU) Stock return < 0.75 x Sector return    
 

Sector return is market cap weighted average return for the coverage universe within the sector

 
 

RELATIVE RISK RATING

   

Ratings

Criteria

Low (L)

Bottom 1/3rd percentile in the sector

 
Low (L) Bottom 1/3rd percentile in the sector  
Low (L) Bottom 1/3rd percentile in the sector  

Medium (M)

Middle 1/3rd percentile in the sector

High (H)

Top 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

 
 

SECTOR RATING

     

Ratings

Criteria

 
Ratings Criteria  

Overweight (OW)

Sector return > 1.25 x Nifty return

 

Equalweight (EW)

Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW)

Sector return < 0.75 x Nifty return

 

9

Edelweiss Securities Limited

Edelweiss Securities Limited

 

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