Subscribe to REC issue: Religare, Angel

MUMBAI: Religare Securities and Angel Broking have recommended ‘subscribe’ to the initial public offering of Rural Electrification Corporation. The issue opens Tuesday.

The price band of initial public offer of 15,61,20,000 shares has been fixed at Rs 90-105 per share. The net issue to the public will be up to 15,22,17,000 shares constituting 18.18 per cent of the fully diluted post-issue capital of REC. The company plans to raise over Rs 1,640 crore from the issue which closes February 22.

REC proposes to utilise the net proceeds to augment its capital base to meet the future capital requirements arising out of growth in its assets, primarily its loan and investment portfolio. It is seeking top strengthen its capital base to improve its borrowing capacity in order to support the future growth in its assets.



Religare Securities

REC is a leading government-promoted financial institution dedicated to power sector financing. It has extensive expertise in the power sector spanning close to four decades, with the capacity to finance large projects.

REC is instrumental in implementing government power projects in rural areas and hence occupies a key position in the government's future plans for the sector. It is a nodal agency for the Rajiv Gandhi Gramin Vidyut Yojna, a programme that aims at 100 per cent electrification for rural India.

It enjoys several direct and indirect benefits from the government including tax exemptions and concessions. This results in a significantly lower cost of funds and higher margins as compared to other players.

The company has recorded consistent growth in disbursements towards the power sector, at a robust 13.5 per cent CAGR over FY03-FY07. Future growth prospects buoyant considering the planned investments of an estimated Rs 10,316 billion towards power infrastructure over the 11th plan period.

REC’s foray into power generation financing offers tremendous potential for growth, especially considering the entry of private players into the generation segment. It is permitted to finance all projects in the power domain irrespective of project size and location, said Religare in its report.

Religare believes that REC is reasonably priced; considering the strong business growth and comparatively lower valuation and available at a P/BV of 1.8x at the end of September 2007 at the higher end of the price band. Post-issue, the stock would trade at 1.5x FY08E book value. REC's business model is comparable to PFC which, at the current price of Rs 185, trades at 2.3x on FY08E P/BV.

Angel Broking

REC has estimated a capital of Rs 10.3 lakh crore required to set up the power infrastructure targeted by 2012. Within the available funding sources, the government envisages REC’s share to be at least Rs 59,150 crore. It will deliver a CAGR growth of 25 per cent in advances over FY2008-10E.

REC’s primary source of revenue is interest income from power sector lending. Low-cost ‘54EC Bonds’ comprise 45 per cent of its borrowings. The company is expected to deliver net interest margins of 3.2-3.4 per cent over FY2008-10E. Given its lean organisational structure, inherently low credit risk and tax benefit u/s 36(1)(viii), return on assets should sustain at 2 per cent levels.

REC’s leverage cannot exceed 8-9x to maintain AAA credit rating (critical for cost competitiveness). Accordingly, it is expected to deliver return on equity of around 16 per cent by FY2010E, which should increase to around 18 per cent at optimum leverage (post FY2010E), says Angel in its report.

In the past few months, the power sector (on which REC is an indirect play) has seen valuations reaching frothy levels, only to come off recently. Against this backdrop, Angel believes the REC issue comes at a reasonable price based on fundamental value, considering the high visibility of credit demand in the power finance sector, REC’s strong positioning in the same and its reasonably strong financial performance.

At the upper end of the price band of Rs 105, the stock is available at 1.3x FY2009E adjusted book value of Rs 80.7 and 1.2x FY2010E adjusted book value of Rs 90.5. The valuations compare favorably with its closest peer, PFC, which is trading at 1.8x FY2009E adjusted book value of Rs 104 and 1.6x FY2010E adjusted book value of Rs 117 at the CMP of Rs 185.

Angel believes REC can command up to 1.5x 1-year forward adjusted book value, implying reasonable upside even at the upper end of the price band.