Tuesday 19 February 2008

IPO Review - Rural Electrification Corporation


Rural Electrification Corporation (REC), a public institutions financing power infrastructure in India, proposes to enter the capital markets with a public issue of 156.12 million equity shares of Rs 10 each through 100% book building process.

The issue comprises a fresh issue of up to 78.06 million equity shares by REC and an offer for sale of up to 78.06 million equity shares by the president of India acting through the ministry of power. The net issue to the public will be up to 152.21 million equity shares, after allowing for reservation of up to 3.90 million equity shares for subscription by eligible employees. The issue shall constitute nearly 18.18% of the fully diluted post-issue capital of REC.

Net proceeds from the fresh issue are to be utilised to augment capital base to meet the future capital requirement arising from the growth in assets, primarily its loan and investment portfolio.

REC was originally promoted to finance transmission and distribution (T&D) schemes aimed at improving the supply of electricity in rural areas and energise agricultural pump sets.

By this legacy, as the nodal agency for the RGGVY (Rajiv Gandhi Grameen Vidyutikaran Yojana), formed to promote electrification of all villages in India, REC has powers to administer grants and provides loans. It is also responsible for overseeing this programme from conception to completion.

Earlier, Power Finance Corporation (PFC) was the only government controlled financial institution focused on the power sector to fund across the entire chain of generation, T&D. But in 2002, the Union government granted permission to REC to fund power generation projects, too. Now the role of REC and PFC is almost identical: financing all types of power projects including T&D and generation throughout the country. REC enjoys an additional advantage: it gets 1% of the total disbursement under RGGVY as commission. The estimated share of REC in the approved outlay for RGGVY is about Rs 33000 crore in the current five-year plan (FY 2008-12), which is set to touch Rs 50000 crore in the next five-year plan.

Strengths

  • The Eleventh Five-Year Plan (FY 2008-12) envisages addition of 70,000 MW of power capacity in the plan period. The investment needed in the T&D sectors in this plan period is expected to be Rs 1000000 crore.
  • The loan sanctions and disbursements have grown at a CAGR of 28.37% and 13.51%, respectively, between the year ending March 2003 (FY 2003) and FY 2007.
  • The overall cost of funds was 6.55% in the six months ended September 2007, favorably low compared with competitors. The relationship with the government of India provides access to lower cost funds and source of additional foreign currency loans at competitive rates.

Weakness

  • Aggregate loans outstanding to state electricity coards (SEBs) and state power utilities (SPUs) stood at Rs 33764 crore, constituting 96.33% of the total loans outstanding, largely long-term, end September 2007. Thus, the weak credit quality of these public enterprises remains a business challenge as lending to these enterprises forms a major chunk of business.
  • Asset quality remains poor compared with peer. The gross non-performing assets (NPA) and net NPA as a percentage to advances stood at 0.90% and 0.67% end September 2007. This is high compared with peer PFC, whose gross NPA and net NPA as a percentage to advances was 0.06% and 0.02%.
  • Despite access to low-cost funds, net interest margin was comparable with PFC’s 3.76% end September 2007.
  • Financial growth in the past is not encouraging with hardly any growth in profit over the years.
  • There is a possibility of the business operations being used as tool for public policy than engine for profit maximisation by the government. This remains a major concern for shareholders and their wealth creation would remain vulnerable.

Valuation

FY 2007 EPS of REC on post-IPO equity comes to Rs 9. At the offer price band of Rs 90- Rs 105, the P/E works to 10 (on lower band) to 11.7 (on upper price band). Post-IPO, FY 2007 book value will be Rs 52.6- Rs 53.9 (depending on the final issue price). P/book value (BV) is 1.7-1.9. PFC currently trades around P/ FY 2007EPS of 21.5 and P/FY 2007 BV of 2.1.