WATCH VIDEO - REC FPO Analysis by ASHOK KUMAR

Issue Details

Floor Price : Rs. 203 No of Shares (FV Rs.10) : 172 million shares Issue Size : Rs. 34,862 million including offer for sale of Rs 8,715 million) Issue Opens-Closes : 19th February 2010 – 23rd February 2010 Listing : BSE and NSE

• Loan sanctions and disbursals for REC remained strong during the quarter on strong investments in the power sector As per the latest results, December 2009, the loans sanctioned by the company stood at Rs 1,00,000 million , while those disbursed stood close to Rs 60,000 million. During the nine months ended December 2009 the aggregate loans sanctioned stands at Rs 4,20,000 million or 420 billion ( Y--o-Y growth of 26 per cent), however only Rs 1,50,000 million stands disbursed. As per the records, the loan book of the company stands at Rs 6,20,000 million, with gross NPA's of Rs 200 million and a net NPA of Rs 20 million.
  
  
• The margins of the company too remained strong with Net interest margins over 4 per cent remains higher than other NBFCs and financial institutions. Though the net profit margins declined marginally over the sequential quarters, it too remained as high as 28 per cent for the quarter ended December 2009. Overall, incremental cost of borrowings has remained low due to higher proportion of short term bonds (duration of 1-3 years) raised and higher liquidity in the system. However the scenario is likely to change as the government has already initiated the process of monetary tightening.
  
  
• Overall, secured loans and advances with a high asset quality (net non-performing assets of almost zero), sustainable spreads and margins are some of the key positives that rank REC above other NBFC’s and financial institutions.
  
  
• The FPO issue will increase the net worth of the company and bring down the debt-equity ratio from 6.3 times to less than 5 times. This would enhance the credit rating but dilute the earnings of the company.

• Potent Power Sector : India’s per capita energy consumption is considerably lower when compared to the rest of the world. The Government’s RGGVY scheme, an ambitious project holds out considerable growth potential for the company. However, the scheme has not been able to deliver thus far. REC being a prominent player in terms of lending to the potent power sector and its exclusive focus on power sector financing which gives it significant domain expertise, is the top most beneficiary of the above scheme. The RBI’s recent policy change which mandates the bank’s risk weights to the borrowers credit rating too favours the company as it is an NBFC.
  
  
• Diversification to enhance presence across the value chain : By diversification of its services portfolio into consulting in the power sector, REC is making an effort to transform itself from being a rural electrification financier to a player with a presence across the value chain in the power sector. Its client portfolio includes public sector power utilities at the central and state levels and private sector power utilities. Additionally, it funds power projects for joint sector clients. Their financial products primarily include long-term loans, short-term loans, bridge loans and debt refinancing. With a judicious mix of funding transmission and distribution networks as well as power projects, REC has grown its loan portfolio over the years.
  
  
• Sound Financial Performance Record : The strong financial performance of the company is yet another positive. This is also reflected in its lower cost of funds that results into higher NIMs. Lower gross and net NPAs despite the fact that it derives major part of its income from State Electricity Boards (SEBs) and State Power Utilities (SPUs) and higher return on investments makes it amongst the best plays in the potent power sector.

Key Concerns

• Rising Cost of Borrowings : With effect from Fiscal 2008, the GoI has placed a ceiling of Rs. 5 million on the amount of 54EC long term tax exemption bonds that could be used by an investors to offset capital gains. Consequently, the company is no longer able to issue 54EC long term tax exemption bonds to the same extent as earlier. The replaced borrowings in the form of 54EC long term tax exemption bonds with higher cost borrowings have resulted into steady rise in its borrowing costs. To put matters into perspective, the cost of funds has increased from 6.25 per cent during the fiscal 2006 to 7.52 per cent for the six months ended September 30, 2009 (based on the unconsolidated restated financial statements). Any further change in the Government’s policy on REC’s status in terms of removal of the 54EC status benefit could adversely affect its cost of borrowings. Notably, the company has thus far been able to pass on the higher cost to its customers and thus negated the adverse impact.
  
  
• High exposure to State Electricity Boards merits attention : As on September 30, 2009, the aggregate loans outstanding to state sector borrowers aggregated Rs. 4,85,547 million or almost 84 per cent of its total loans outstanding. Historically, state sector utilities have had relatively weak financial positions and have in the past defaulted on their indebtedness. However, for the period under review, only 5 per cent of the total loans outstanding of Rs. 5,78,941 million remains unsecured. The rest is secured by charges on assets or have a State Government guarantee as collateral.
  
  
• Susceptible to Government Regulation : The business and this industry is highly dependent on the policies and support of the Government of India which makes it susceptible to changes to such policies. Further, being a government company, it is more vulnerable to government regulations and policies which have thus far subdued the stock performance of most PSU stocks over concerns of lack of transparent accounting and disclosure standards.
  
  
• Monetary tightening to adversely impact operations. The cost of operations are likely to increase as most long term outstanding loans (which account for more than 94 per cent of the total loan book) are known to be fixed-rate loans, with a three to ten year reset clause.
  
  
• Project Delay – a matter of concern : Delays in power projects could to lead to late disbursement and rescheduling of loan repayments. This would dent the loan off-take as well as repayment schedule of the loans already disbursed. Further, as the prospectus indicates, the company faces asset-liability mismatch on account of out of lower maturity deposits and high duration loans. This adds to the potential risk.
  

CONCLUDING NOTES

The stock price of REC had run up sharply on expectation of the disinvestment of the issue. However, once the issue was actually announced, its share price has been correcting sharply.

REC is available at lower valuations including a lower P/E multiple and higher book value than its listed peers despite higher operating efficiency and return on investments making it a satisfactory long term bet.

However, the moot question as in the case of every FPO will have to be, will the stock be available cheaper soon in the secondary market ?

Considering that the probability of this happening is not particularly low, the bigger question its begets is – does the Government need to rethink how it wants to divest its stake at an optimal price and still get retail investors to participate ?

theIPOguru’s Verdict :

INVESTOR TYPE