Monday 11 February 2008

Moderate rating for Rural Electrification IPO

CRISIL has assigned a CRISIL IPO Grade "3/5" (pronounced "three on five") to the proposed initial public offer of Rural Electrification Corporation Limited (REC). This grade indicates that the fundamentals of the issue are average in relation to the other listed equity securities in India. However, this grade is not an opinion on whether the issue price is appropriate in relation to the issue fundamentals. The grade is not a recommendation to buy / sell or hold the graded instrument, the graded instrument's future market price or its suitability for a particular investor.

The grading reflects the Indian government's majority stake in REC and its developmental role in the government's plans for the power sector in India, especially the non-urban centres. REC's continuing role as an instrument of government policy and the consequent government support translates into significant advantages for REC as a borrower of funds viz the ability to raise bonds with tax benefits to the investors. CRISIL believes that REC will continue to discharge its developmental role over the medium term and shall display moderately strong business performance.

Notwithstanding the advantages on the liability side, REC's mandate requires it be one of the key lenders to state government power utilities, which have had a troubled credit history. Though REC is planning to increase its lending to the private sector, CRISIL believes that lending to state government utilities would continue to constitute a majority of REC's asset book over the medium term.

The company's profitability could come under pressure in the future as the share of market borrowings in REC's funding mix increases and the company begins to follow the RBI's prudential norms for NPA provisioning. REC will also need to considerably strengthen its internal control systems and loan pricing mechanisms to support the significant increase in business planned by the company. REC's business operations are susceptible to the effects of frequent top management changes as is the case with many other government run entities. REC's shareholders remain vulnerable to the possibility of REC's business operations being used by the government more as a tool for public policy than an engine for profit maximization.

About the company and the issue
REC is a public sector non-banking finance company (NBFC). REC operates under the administrative control of the Ministry of Power (MoP) and is wholly-owned by the Government of India (GoI). Established in 1969 with the sole objective of financing rural electrification schemes in the country, it services its clients -through a network of 17 project offices spread across India.

The company's schemes are primarily aimed at extending and improving the supply of electricity by providing adequate funds for transmission and distribution projects, especially in rural areas. However, over a period of time REC's mandate evolved, permitting it to finance all segments of the power sector in the country. In line with its overall objective of assisting the government's rural electrification strategy, REC also acts as the nodal agency for disbursing grants provided under the Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY). The company enters into a Memorandum of Understanding with MoP, which outlines its yearly performance targets and the commitments from the government.

For 2006-07, the company's fund-based income and net profits were Rs 28.3 billion and Rs 7.7 billion, respectively. The operating income of the company has grown at a CAGR of 11.4 per cent over the past 5 years, while PAT has grown at a CAGR of 14.5 per cent in the same period.

REC aims to raise Rs 14 billion to Rs 16 billion by this proposed public issue of 156,120,000 equity shares.

About CRISIL IPO Grading
CRISIL IPO (Initial Public Offering) Grading is an opinion on the fundamentals of the graded issue that reflects CRISIL's independence and expertise. This opinion is expressed as a relative assessment in relation to other listed equity securities in India. The assessment is based on a grading exercise carried out by industry specialists from CRISIL Research. A CRISIL IPO Grade 5/5 indicates strong fundamentals and a CRISIL IPO Grade 1/5 indicates poor fundamentals. CRISIL IPO Grading reflects its assessment of the graded company's equity fundamentals as distinct from an assessment of debt fundamentals. A CRISIL IPO Grade should not be construed to mean a comment on the price of the graded security nor is it a recommendation to invest or not to invest in the graded security.