Buy REC Ltd for the Target Rs.460 by Motilal Oswal Financial Services Ltd
Provision write-backs drive earnings beat; NIM up 10bp QoQ
Loan growth remained muted but asset quality continued to improve
* Rural Electrification Corp’s (RECL) 1QFY26 PAT grew ~29% YoY to INR44.5b (~8% beat). NII grew ~19% YoY to ~INR55.7b (in line). Other income stood at - INR3.4b (PY: INR3.5b) due to currency translation losses of INR6.4b.
* Opex declined ~12% YoY to ~INR1.9b and cost-income ratio stood at ~2.5% (PQ: 3.1% and PY: ~3.4%). The decline in opex was driven by lower CSR and other employee expenses during the quarter. PPoP grew 5% YoY to INR50.3b (~5% miss), primarily because of higher currency translation losses.
* Yields (calc.) rose ~20bp QoQ to ~10%, while CoB rose ~5bp QoQ to ~7.2%, resulting in ~15bp QoQ growth in spreads (calc.) to 2.8%. Reported NIM rose 10bp QoQ to ~3.74% (PQ: 3.63%). Previous quarter’s yield is not comparable as it included one-off interest income from recovery in KSK Mahanadi.
* GS3 improved ~30bp QoQ to ~1.05%, while NS3 improved ~15bp QoQ ~0.25%. PCR on Stage 3 rose ~5pp QoQ to ~77%.
* Provisions write-backs stood at INR6.2b (est. provision of INR1.1b). This translated into annualized credit costs of -11bp (PY: 9bp and PQ: 14bp). During the quarter, TRN Energy, with an outstanding loan amount of ~INR15b, was restructured. As part of the resolution, REC wrote off INR3.92b, accompanied by a corresponding reversal in ECL of INR2.7b.
* Management reiterated that REC aims to become a net zero NNPA company by the end of FY26. It indicated that most of the stressed assets are in advanced stages of resolution, and REC expects provision reversals of INR7- 8b over the next three quarters as these exposures get resolved.
* AUM stood at INR5.85t, up 10.4% YoY and 3% QoQ. Management has guided for loan growth of ~12% in FY26, with expected spreads in the range of ~2.75-3.0% and NIMs of ~3.5-3.75% for the year.
* We raise FY26 EPS estimate by ~3% to factor in higher provision writebacks from stressed asset resolutions. We model a CAGR of 17%/13%/10% in disbursement/loans/PAT over FY25-27E. We estimate RoA/RoE of 2.6%/20% and a dividend yield of ~5.6% in FY27. Reiterate BUY with a TP of INR460 (premised on 1.2x Mar’27E BVPS).
* Key risks: 1) weak loan growth from high pre-payments and business loss to peers from refinancing; 2) rising exposure to high-risk power projects without PPAs; and 3) compression in spreads and margins amid high competition.
Key highlights from the management commentary
* Management shared that the resolution of Hiranmaye Power, Sinnar Thermal, and Bhadreshwar are in advanced stages and expected to be completed within FY26.
* Kaleshwaram Project, sanctioned in FY21-22, was funded by REC, based on state guarantees and budgetary allocations, with equal responsibility from the state governments. The account has remained in Stage 2 for the past 18 months, and REC does not anticipate it slipping into Stage 3.
Valuation and view
* RECL delivered a decent performance, driven by strong disbursement during the quarter. However, as per management guidance, overall loan growth remained modest at ~10%. Asset quality continued to improve, aided by the resolution of TRN Energy during the quarter. Notably, the company reported a ~10bp expansion in NIMs, which was a positive.
* RECL trades at 1x FY27E P/ABV, and we believe that valuations are attractive for this franchise, which offers decent earnings growth and ~20% RoE.
* The company is well equipped to achieve a loan book CAGR of ~13% and a PAT CAGR of ~10% over FY25-FY27. We estimate RoA/RoE of 2.6%/20% and a dividend yield of ~5.6% in FY27. Reiterate BUY with a TP of INR460 (premised on a target multiple of 1.2x Mar’27E P/BV).
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