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April 8, 2015


REC Ltd: Attractive Risk-Reward – BUY
OFS Floor Price Rs315, Target Rs392, Upside 24%
*Retail to get 5% discount on issue price
Rural Electrification Corporation (REC), a niche power sector financier, would be a prime beneficiary of the ongoing power sector reforms which over a period of time would enhance economic efficiency across the value chain and kick start the stalled investment cycle. While financial viability of SEBs is improving through the restructuring package under implementation, steps taken by the current government towards augmenting fuel supply is encouraging. REC’s competitive position remains strong in the power financing space supported by its nodal agency status, ability to lend for longer tenures versus banks and benefit of lower funding cost due to Government’s support.
REC having Rs170,000cr of loan assets, well distributed between generation and T&D segments, is likely to witness a pick-up in disbursements and asset growth over the coming three years. We estimate company’s loan assets to grow at 17% pa during FY14-17 driven by faster growth in the private sector generation space. Company’s NIM has significantly improved over the past few years aided by strengthened pricing power (banks have become risk averse), largely stable funding cost and material improvement in the lending yield driven by higher private sector generation share and decline in the contribution of lower yielding short term loans. Even if competition from banks were to increase in the medium term, REC’s NIMs would remain steady cushioned by softening of borrowing cost.
While uncertainty around asset quality has been the key concern for a while, REC has not witnessed worrying accretion of stressed assets so far. The reform steps are only moderating the probability of a negative shock. However, credit cost will inch-up due to adherence to stricter regulatory requirements. Still, the company would deliver RoA above 3% and RoE in excess of 20% in the longer run.
The floor price (Rs315) of the OFS implies an inexpensive valuation of <1x FY17 P/ABV which we believe is an attractive entry point for long term investors. Recommend to subscribe in the OFS with 12m target of Rs392.
Click here for the detailed report on the same.

Warm Regards,
Amar Ambani
Head of Research, IIFL

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