Stock Review: RURAL Electrification Corporation (REC)

 

A steep fall in REC's stock in the past three months makes it an attractive bet given its good asset quality and better growth

   RURAL Electrification Corporation (REC) is a non-banking finance company catering to financial needs of the power sector. It is the nodal agency for the Rajiv Gandhi Grameen Vidyutikaran Yojana (RGYV), which aims to provide power supplies to rural areas of the country. The company has reported a high profit growth in the past four quarters along with an excellent asset quality. Growth in the power sector and its infrastructure finance company (IFC) status show that the company might grow at a fast pace in future.

BUSINESS:

Incorporated in 1969, REC is a navratna public sector enterprise. Its main objective is to finance and promote domestic rural electrification projects. It provides financial assistance to state electricity boards (SEB), government departments and rural electricity cooperatives for rural electrification projects. The state project offices coordinate financing of SEBs or state power utilities, facilitate formulation of schemes, loan sanctions and disbursements. It also helps in implementing those schemes.

GROWTH PROSPECTS:

The company was accorded the IFC status in September 2010. This has provided it with greater access to banks and overseas funding and also enables it to raise funds through issuance of long-term infrastructure bonds. Moreover, it is present across the value chain of the power sector from generation to transmission and distribution. This helps it to capitalise on growth in all three areas.

   The government's RGYV scheme intends to electrify the rural parts of the country. Being the nodal agency, all the financing needs for such projects would be routed through REC. Also, the government would refund 90% of the costs. This would lead to high disbursement growth. The company would receive a processing fee for all such projects (1% of the cost of project).Its subsidiaries would also receive commissions, thereby stepping up its other income. REC and National Highways Authority of India (NHAI) are the only two companies allowed to issue capital gains tax exemption bonds. Under section 54 EC of the Income-Tax Act, capital gains arising from the transfer/sale of longterm assets can be invested in long-term bonds to claim the benefit of exemption. These bonds cost the company anywhere between 6% and 6.5%, which is 100-150 basis points lower than its average cost of borrowings. These bonds formed around 15% of the company's borrowings. This would help the company in keeping cost of borrowing low even when interest rates rise.

FINANCIALS:

The company's net profit grew 33% in trailing 12 months over the year ago backed by 27% increase in the net interest income . Net interest income is the difference between interest earned and interest expense of the company.

   Its asset quality has been exceptional. Net non-performing assets have been almost nil for the past seven quarters. On the margin front, the company's spread of yield on advances over cost of borrowings has been in the range of 3.2-3.5% for the past seven quarters. In fact, for the quarter ended December 31, 2010, when most companies' profitability hurt due to rising interest rates, the company managed to expand margins by around 20 basis points sequentially. Almost 80% of the company's assets are floating and a similar amount of liabilities are fixed. This should help n a rising interest rate scenario.

   Disbursements, however, has not grown at a similar pace. For the past two quarters, the company's disbursement was flat compared to a year ago due to delay in new power projects. However, there could be a spurt in the disbursement growth as many projects are likely to be awarded by March 2011.

VALUATIONS:

At a price-tobook value (P/BV) of 1.9, the company's stock is trading marginally higher than its peer, Power Finance Corporation's (PFC) P/BV of 1.8. However, the current valuations do not fully discount its growth potential. Its dividend yield of 2.6% is much higher than PFC's 1.8%. Besides, the scrip has fallen by almost a third in the past three months. This represents a good opportunity for investors to buy the stock with a medium-tolong term perspective.