Rural Electrification Corporation FPO

Rural Electrification Corporation (REC) is a public financial institution in the Indian power infrastructure sector engaged in the financing and promotion of transmission, distribution and generation projects throughout India. REC's clients primarily include Indian public sector power utilities at the central and state levels and private sector power utilities.

REC's primary financial product is project-based long-term loans. It funds its business with market borrowings of various maturities, including bonds and term loans.

Besides financing all segments of the power sector, including generation, throughout the country, its mandate was further extended in September 2009 to include financing other activities with linkages to power projects, such as coal and other mining activities, fuel supply arrangements for the power sector and other power-related infrastructure.

As of September 30, 2009, REC's loans outstanding by sector included 54.7% relating to transmission and distribution, 37.7% relating to generation, and 7.5% relating to other types of financing.

The company is coming out with a follow-on issue of 17.17-crore equity shares which comprises fresh issue of 12.88-crore equity shares and offer for sale of 4.29-crore equity shares to carry out disinvestment of government of India's stake.

The company intends to utilize the funds being raised through the fresh issue to augment its capital base to meet future capital requirements arising out of growth in its business.

Strengths

The Eleventh Plan, which came into effect from fiscal 2008, was then estimated to require funds in excess of Rs 1000000 crore for investment in transmission, distribution and generation. For the Twelfth Plan, which will come into effect from Fiscal 2013, it is estimated that funds in excess of Rs 1100000 crore will be required.

REC's loan sanctions and loan disbursements have grown at a CAGR of 25.71% and 23.23%, respectively, between fiscal 2005 and fiscal 2009.

REC compares better with PFC in almost all financial parameters: lower cost of funds, better net interest margin, higher spreads and almost same yield on investments

REC's net NPA is virtually nil in the half year ended September 2009.

Weaknesses

REC is a power sector-specific public financial institution. This sector has a limited number of borrowers and future exposure is anticipated to be large with respect to these borrowers. In addition, many of these borrowers are public sector utilities that are loss making and, therefore, may have liquidity concerns while repaying their borrowings

The GoI, since January 2007, has limited the amount of Section 54EC long-term tax exemption bonds that an individual investor can utilise to offset capital gains to Rs. 50 lakh, which has reduced the amount of bonds REC have been able to offer for subsequent periods. As a result, the share of Section 54EC long-term tax exemption bonds in the total rupee borrowings stood reduced to 21.7% as on 30 September 2009 from 46.03% as on 31 March 2007. Compared to this, taxable bonds' share has increased to 51.63% from 23.01% in the same period. The weighted annual average interest rate on all of outstanding Section 54EC long-term tax exemption bonds, as on September 30, 2009, was 5.56% compared to 8.95% for taxable bonds.

Valuation

The floor price of Rs 203 discounts the annualized nine months ended December 2009 EPS of Rs 19.4 on post-issue equity of Rs 987.49 crore by 10.4 times. PFC is currently trading (around Rs 242) at P/E of 11.9 times its nine-month annualized EPS of Rs 20.4.

While the current price is Rs 220, the 50-day average, 100-day average and 200-day average works out to Rs 244, Rs 229, Rs 199. The scrip's beta is 0.8, indicating below average market-related risk.

Pre-FPO book value (BV) is Rs 95.6 including earnings of nine month ended December 2009. P/BV is 2.1 compared to 2.2 of PFC. Post-FPO BV of REC will be Rs 109.6 (assuming Rs 203 as issue price), which translates into P/BV of 1.9.