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REC: Asset quality under pressure - Views on News from Equitymaster

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REC: Asset quality under pressure

Aug 16, 2011

Rural Electrification Corporation (REC) declared its results for the first quarter of the financial year 2011-12 (1QFY12). The institution grew its net interest income and profits at 17% YoY and 13% YoY respectively.

Performance summary
  • Income from operations grows by 23% YoY in 1QFY12, on the back of 24% YoY growth in its advances (including interest accrued).
  • Net interest income (NII) grew at a slower pace, rising 17% YoY in 1QFY12, due to higher cost of funds.
  • Disbursements grow by 18% YoY, while sanctions fell by 7% YoY in 1QFY12.
  • Net interest margins (NIM) declined by 0.3% to 4.3% in 1QFY12 on account of higher funding costs.
  • Bottomline grows by 13% YoY in 1QFY12. Growth was impacted by higher provisioning, and an increase in other expenses.

Sanctions see a slowdown...
Rs (m) 1QFY11 1QFY12 Change
Income from operations 18,771 23,129 23.2%
Interest expended 11,007 14,032 27.5%
Net Interest Income  7,764 9,097 17.2%
Net interest margin 4.6% 4.3%  
Other Income 517 600 16.1%
Operating expense 348 490 40.8%
Provisions and contingencies - 250  
Profit before tax 7,933 8,957 12.9%
Tax 2,059 2,338 13.5%
Effective tax rate 26.0% 26.1%  
Profit after tax/ (loss) 5,874 6,620 12.7%
Net profit margin (%) 31.3% 28.6%  
No. of shares (m)   987  
Book value per share (Rs)*   136.2  
P/BV (x)   1.4  
* (Book value as on 30th June 2011)

What has driven performance in 1QFY12?
  • Despite rising interest rates, and a slowdown in infrastructure activity, especially in the power space, REC saw its loan book grow by 24% YoY in 1QFY12. Sanctions however saw a decline, falling by 7% YoY in 1QFY12. Disbursement growth came in at 18% YoY. Disbursements had a higher leaning towards generation with 55% going to the segment, compared to 70% previously. T&D (Transmission and Distribution) projects got a 34% share (26% previously). 82% of the company's loan book continues to be exposed to state governments.

    Sanctions see a slowdown...
    (Rs m) 1QFY11 1QFY12 Change
    Sanctions 228,820 211,900 -7.4%
    Disbursements 46,440 54,810 18.0%
    D/S ratio 20.3% 25.9%  
    Advances 697,910 862,470 23.6%

  • REC witnessed an improvement in its net interest margin (NIM) in recent years. A rise in interest rates will not hurt REC as the institution's lending rate is not locked at the time of sanctioning the loan. The sanction runs for 3 to 4 years before it gets fully disbursed. Hence the rate of interest is charged on the basis of date of disbursement which takes care of the adjusted cost of borrowing at that particular point in time. Hence there are few downsides to REC's NIM even in a rising interest rate scenario.

  • Its borrowings from banks stand at only 14% of its overall borrowing portfolio. Thus, it may not be as exposed to bank's rising base rates, compared to other NBFC peers. Irrespective, it was not able to fully cushion the impact of the interest rate environment. Its NIMs declined from 4.6% previously to 4.3% currently. It plans to raise money US$ 1 bn from FCCBs (foreign currency convertible bonds) in the future and also has some other forex borrowing plans lined up. It is signing an agreement to raise US$ 300 m this week from various Japanese banks.

  • REC's non-interest income grew by 16%YoY. This was be due to higher fee income under Rajiv Gandhi Gramin Vidyutikaran Yojana (RGGVY), REC currently receives a fee equal to 1% of the project cost from the government for administering the scheme. It is the nodal agency appointed by the Government for this scheme.

  • REC had 0.31% gross NPA levels and provision coverage ratio of 16% at the end of 1QFY12; this is an increase from 0.03% levels seen in 1QFY11. The increase in NPA levels by around Rs 250 m was on account of non-performing assets of Maheshwar Hydroelectric project. REC is hoping that some necessary restructuring will be done for this particular project over the next few months. An equity infusion is necessary either from the promoter or another key investor in order to make up for the shortfall in funds.

What to expect?
At the current price of Rs 186, the stock is valued at 1.1 times our estimated FY13 adjusted book value. As per the management, the company will try and maintain its asset quality as the Ministry of Power is building up pressure on various state governments in order to increase state electricity boards' (SEBs) tariffs. This will help them meet their loan obligations. State governments are also likely to convert loans to SEBs into equity, helping them improve their weak balance sheets. REC is also seeing some delay in payments for its Konaseema Gas Power Project; however it is still meeting the criteria of a performing loan.

However, even in a high interest rate environment, REC is well equipped to manage NIMs and spreads, on account of its overseas borrowings through ECBs. With its status as an infrastructure financing company, it can raise up to 50% of its networth through ECBs on an automatic basis. The company also plans to raise money though FCCBs which it is seeking RBI approval for. The financer has also already increased its lending rates in order to offset higher costs. However some sectoral risks still remain with regards to coal availability for power projects, slowdown in infrastructure growth, and absence of tariff revision. We reiterate our ‘Buy' view on account of the reasonable valuations the stock is trading at currently as most of the pains have been priced in.

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