REC: Impressive act in Q3

Despite good performance & healthy near-term outlook, slowing power sector capex remains a concern for FY15

At a time when India’s power generation sector has been marred with numerous issues which have impacted its growth, the strong performance by power sector financier, Rural Electrification Corporation (REC), is commendable. REC, which outperformed Street expectations on loan growth, asset quality and profitability for the December 2012 quarter, managed this feat due to its focus on the transmission and distribution (T&D) segment.

REC’s loan growth in the December 2012 quarter remained strong at 25 per cent aided by disbursements to the T&D segment. The same grew three times in the quarter compared to the year-ago period, propping up overall disbursements by 64 per cent to Rs 10,425 crore. Sanctions also grew by 46 per cent year-on-year (y-o-y) to Rs 12,866 crore, though the same was half of the September 2012 quarter sanctions, thanks to slower loan approvals to the T&D segment and the base effect.

Consequently, its net interest income grew 39 per cent y-o-y to Rs 1,430 crore for the quarter. Net profit (Rs 1,027 crore) growth, though robust at 33 per cent, would have been better but for the Rs 109-crore impact on account of forex transactions.

REC’s performance on the profitability front was good, aided by margin expansion. Net interest margin (NIM) expanded 25 basis points (bps) sequentially to a five-year high of five per cent, driven by upward re-pricing of three-year floating rate loans. A four bps sequential dip in cost of funds further aided margin expansion. In the near-term, margins are likely to be supported by easing wholesale funding costs. Analysts expect NIM to range between 4.5-4.7 per cent over the next two years, which is still healthy.

Given the sanctions line-up, REC is estimated to clock annual loan growth of 20-22 per cent in FY13 and FY14. But, if the slackening capex in the power sector does not improve, it could pull down REC’s loan growth in FY15. For now, analysts expect REC’s earnings to grow at a compounded annual rate of 17 per cent over FY12-15 and return on equity to remain strong at over 20 per cent. Going forward, the on-going SEB reforms should rub off positively on REC’s asset quality, which remains healthy given the unchanged gross non-performing assets at 0.44 per cent.

REC’s stock (Rs 249) trades at fair valuations of 1.35 times FY14 estimated adjusted book value. The upsides from hereon hinge on progress in the power sector investments.