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 prospects

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. This helps the company contain a rise in borrowing costs when interest rates are rising. Moreover, it is present across the value chain of the power sector from generation to transmission and distribution. This helps it achieve diversification benefits and 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 the company. However, the government would refund 90% of the costs. This would lead to high disbursement growth. Further, 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 long-term 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. This was on the back of 27% increase in the net interest income over the same time period. 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 doubly benefits the company in a rising interest rate scenario.

Disbursements, however, has not grown at a similar pace. For the past two quarters, the company has seen almost flat disbursements compared to last year. The management indicated that the slow growth is mainly on account of delay in awarding of power projects, which is turning into low demand for funds from the sector. Major players in power and capital goods sector have expressed similar concerns. 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-to-book 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-to-long term perspective.

Beta: 0.9
Institutional holding: 4.1%
Current dividend yield: 2.8%
Current P/E: 9.3
Current m-cap: Rs 22736 crore
Current market price: Rs 230.3