Bridging The Power Gap - Rural Electrification Corporation

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India is a power-deficit country and the gap between demand and supply has been only increasing every year. If the government's targets for capacity addition in power sector for the XI Plan are anything to go by, with around 78577 MW to be added by the year 2012, there seems to be a huge growth opportunity for the Rural Electrification Corporation (REC).
With the high demand for funds on the back of huge capacity-addition targets, a relatively low cost of funds and zero mandatory reserve requirements REC seems to be a better play at current level. The company's strong financial performance for 9MFY09, despite a difficult macro environment, also indicates towards the strength of its core business. The management expects better performance in Q4FY09, where the disbursement is expected to increase and even the  spread is expected to improve. On the valuation front also REC seems to be fairly placed. The CMP of Rs 95.80 discounts its trailing four quarters earnings by 7x which is lower than 11.70x of Power Finance Corporation (PFC). Further its price to book of 1.40x is better placed than 1.70x of PFC.

REC is a public sector unit and is into the business of financing power generation and transmission projects. Currently its loan portfolio consists of 33 per cent in generation, 51 per cent in T&D and rest for others. The company's cumulative sanctions stand at around Rs 213000 crore (Rs 33445 crore in 9MFY09) and cumulative disbursement stand at around Rs 87230 crore (Rs 12230 crore in 9MFY09). Here, the gap between cumulative disbursements and amounts sanctioned clearly suggests room for growth in advances even without any fresh sanctions. The management expects total disbursement for FY09, in between 16000-17000 crore and 23000 crore for FY10.  Its operational performance has been good as REC has managed to sustain its spread in a difficult scenario also. For 9MFY09, with average borrowing cost of 7.76 percent and average lending cost at 11 per cent, the average spread stood at 3.24 per cent. Regarding the sustenance of the spread, the management has stated that its incremental borrowing cost has declined considerably and it expects a spread of about 3.75 to 4 per cent in Q4FY09. Borrowing cost, that was around 10 per cent in Q3FY09, has declined to the level of 8.25 -8.50 per now. Another advantage to the company is loans amounting to Rs 2800 crore are expected to be re-priced in the near future, where REC will increase the lending cost to 12.25 per cent from the current level of 7.25 per cent. [PAGE BREAK]

With net NPAs at just 0.48 per cent, that too with a decreasing trend, only indicates towards the better quality of its assets.

On the financial, the performance has been strong for Q3FY09 where the total income stood at Rs 3450 crore (Rs 2537.50 crore in Q3FY08) representing an increase of 40 per cent. The bottomline stood Rs 884 crore (Rs 625.05 crore) representing an increase of 41 per cent over Q3FY08. With the management expecting better spread in Q4FY09, we expect the company to put better performance for FY09 and hence recommend the investors to buy the scrip at current level with a target price of Rs 115 in the next one year.