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REC: Cost advantages set to flow in - Views on News from Equitymaster

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REC: Cost advantages set to flow in

Oct 28, 2010

Rural Electrification Corporation (REC) declared its 2QFY11 results. The institution grew its interest income by 30% YoY and profits by 25% YoY.

Performance summary
  • Income from operations grows 30% YoY in 2QFY11 as well as in 1HFY11, on the back of 26% YoY growth in advances (excluding interest accrued and due).
  • Disbursements grow by 12% YoY, sanctions by 6% YoY in 1HFY11.
  • Non-interest income increased by just 4.4% YoY in the quarter, while falling 3% during the first half.
  • NIMs improve to 4.5% at the end of 1HFY11 from 4.3% at the end of 1HFY10.
  • Bottomline grows by 25% YoY in 2QFY11 as well as in 1HFY11 backed by a healthy growth in net interest income.


Standalone numbers…
Rs (m) 2QFY10 2QFY11 Change 1HFY10 1HFY11 Change
Income from operations 15,324 19,877 29.7% 29,818 38,647 29.6%
Interest expended 9,413 12,076 28.3% 18,148 23,088 27.2%
Net Interest Income  5,911 7,801 32.0% 11,670 15,560 33.3%
Net interest margin**       4.3% 4.5%  
Other Income 905 945 4.4% 1,501 1,462 -2.6%
Operating expense 351 385 9.7% 651 727 11.8%
Provisions and contingencies 1 1 44.4% 2 1 -40.9%
Profit before tax 6,465 8,360 29.3% 12,518 16,292 30.2%
Tax 1,521 2,178 43.2% 2,856 4,237 48.3%
Effective tax rate 23.5% 26.0%   22.8% 26.0%  
Profit after tax/ (loss) 4,944 6,182 25.1% 9,662 12,056 24.8%
Net profit margin (%) 32.3% 31.1%   32.4% 31.2%  
No. of shares (m)       859 987  
Book value per share (Rs)*         124.4  
P/BV (x)         2.9  
* (Book value as on 30th September 2010)
** Annualized

What has driven performance in 2QFY11?
  • Due to increased demand for funding power projects and banks’ reluctance to fund long term assets with their short term liabilities, REC saw its advances grow by 26% YoY in 1HFY11. The growth in sanctions and disbursements was however muted at 6% and 12% YoY respectively during the first half of FY11. The company had ramped up on the same in the previous quarter, and is now consolidating its position. Sanctions were equally divided among generation and transmission & distribution (T&D). This was compared to a 61% and 32% split in 1HFY10. However, disbursements had a higher leaning towards generation with 59% going to the segment, compared to 44% previously. T&D projects got a 31% share. 86% of the company’s loan book continues to be exposed to state governments.

    Cautious growth…
    (Rs m) 1HFY10 1HFY11 Change
    Sanctions 314,760 332,700 5.7%
    Disbursements 91,220 101,910 11.7%
    D/S ratio 29.0% 30.6%  
    Advances* 578,940 729,000 25.9%
    * excludes interest accrued and due

  • REC has witnessed an improvement in its net interest margin (NIM) in recent years. Besides lower cost of funds the fact that it derives market linked yields for funding transmission and distribution schemes (capped at 5% until FY07), also provides an upside to its NIM. Further, 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. This is because 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 point in time. Hence there are very few downsides to REC's NIM even in a rising interest rate scenario. Its margins improved to 4.5% from 4.3% at the end of 1HFY10.

  • The company received the status of an infrastructure financing company (IFC) in 2QFY11, enabling it to make a bigger impact in financing the power sector. With the status it can raise funds through tax free infrastructure bonds and additional borrowings through ECBs. REC has been trying to reduce its average cost of borrowing by diversifying its funding sources. It raised additional funds from capital gain bonds and foreign currency loans at a lower average cost of borrowing in 1HFY11. Additional funding was also raised from banks and financial institutions, albeit at a higher cost due to the new base rate regime, central bank rate hikes. REC plans to raise tax free infrastructure bonds by the end of the year following such issues by IDFC and L&T Infra. Its average annualized borrowing cost was 7.82% at the end of 1HFY11 compared to 7.52% at the end of 1HFY10.

    Borrowing Profile
    (Rs m) 1HFY10 % of total 1HFY11 % of total Change
    Capital Gain Bonds 112,250 22% 102,650 17% -8.6%
    Institutional Bonds 269,380 52% 338,800 56% 25.8%
    Banks, FIs, etc. 99,610 19% 107,640 18% 8.1%
    Foreign Currency 16,830 3% 40,690 7% 141.8%
    Commercial Paper 17,950 3% 14,500 2% -19.2%
    Total 516,020 100% 604,280 100%  
    * FIs = financial institutions

  • REC had 0.03% gross NPA levels and provision coverage ratio of 90% at the end of 1HFY11, thus maintaining its strong asset quality.

What to expect?
At the current price of Rs 363.7, the stock is valued at 2.3 times our estimated FY13 adjusted book value. With one of the highest capital adequacy ratios, high NIMs and one of the best asset qualities; we reiterate our positive view on the company from a long-term perspective. The company has also recently received an IFC status, putting it on an even footing with other players such as IDFC, PFC, L&T Infra etc. REC was also given approval from the RBI to raise FII stake limit in the company to 35% from existing 24%, which however might add to some volatility in share prices. The company is keen on applying for a banking license, either with PFC or a foreign bank. This however depends on RBI policy, for which details are not yet out.

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