Buy Rural Electrification Corp Ltd For Target Rs.350 by Motilal Oswal Financial Services Ltd
Strong sequential loan growth but NIM under pressure Earnings miss; management guides for ~10-12% loan growth in FY27
* Rural Electrification Corp’s (REC) 2QFY27 PAT declined ~23% YoY to INR33.9b (~14% miss). NII declined ~6% YoY to ~INR51.3b (~7% miss). Other income stood at -INR1.8b, which included fee and commission income of INR597m (PQ: INR1.1b and PY: INR4.7b) and exchange loss of INR2.6b (PQ: INR9.1b and PY: INR795m).
* Opex grew 120% YoY to ~INR3b (est. INR1.6b). Cost-income ratio increased to ~5.9% (PQ: 2.3% and PY: 2.5%). PPoP declined ~18% YoY to INR46.5b (~8% miss). Provisions for the quarter stood at INR3.7b (est. INR1.2b). This translated into annualized credit costs of 6bp (PY: 2bp and PQ: -16bp).
* Reported NIM for 1HFY27 declined ~12bp to ~3.22% (1QFY27: 3.34%). Yields (calc.) rose ~25bp QoQ to ~9.8%, while CoB (calc.) rose ~45bp QoQ to ~7.35%, resulting in spreads (calc.) declining ~20bp QoQ to ~2.45%.
* Management does not expect significant pressure on profitability from rising borrowing costs, given the floating-rate asset-liability mix and efforts to optimize funding costs. REC’s predominantly fixed-rate borrowings and largely floating-rate loan book provide a natural hedge, with asset yields resetting annually or in line with benchmarks. We model NIMs of ~3.4%/3.3% in FY27E/FY28E (FY26: 3.8%).
* REC guided for disbursements of INR2t in FY27 (implying steady disbursement momentum in 2HFY27), and loan book growth of ~10–12%. Management highlighted that elevated prepayments had limited loan book growth despite healthy disbursements in FY26. The sharp decline in prepayments to ~INR190-200b in 1HFY27 (vs. ~INR1t in FY26) is expected to improve the conversion of disbursements into stronger loan growth in FY27. We model loan growth of ~11% in FY27E.
* We reduce our FY27/FY28 EPS estimates by ~8%/10% to factor in lower NIMs due to a moderation in yields and higher funding costs. We model a CAGR of 10%/-1% in loans/PAT over FY26-28E. We expect REC to deliver RoA/RoE of 2.2%/16% in FY28E. Maintain BUY with a TP of INR350 (premised on 0.8x Sep’28E BVPS).
Sequential pickup in disbursements; loan book grew ~6% YoY
* Loan book stood at INR6.2t, up ~6% YoY and ~4.5% QoQ. Repayments rose sequentially to ~20.3% (PQ: 18.8% and PY: 39.9%). Renewable loan book grew 27% YoY to INR867b, representing ~14% of the overall loan mix.
* 2Q disbursements grew 1% YoY and 67% QoQ to INR565b.
* Beyond power financing, REC is exploring biogas, aided by the government’s recently announced INR230b biogas plan, as well as shipping and broader infrastructure financing. Management believes its strong financial credentials, lending capacity and ability to provide long-term funding will help REC sustain its position as a preferred lender.
Valuation and view
* REC delivered a mixed quarter, with strong loan growth and lower-thanexpected earnings. The earnings miss is driven by higher funding costs and NIM compression, while strong sequential loan growth is supported by healthy disbursements. Asset quality is at a comfortable level, with credit costs remaining benign. While the stock trades at an attractive valuation of 0.7x FY28E P/BV, a stable improvement in loan growth and margin trajectory is key to driving earnings growth, warranting a cautious near-term outlook.
* We model a CAGR of 10%/-1% in loans/PAT over FY26-28E. We expect REC to deliver RoA/RoE of 2.2%/16% in FY28E. Maintain BUY with a TP of INR350 (premised on 0.9x Sep’28E BVPS).
Key risks:
1) persistently weak loan growth
2) compression in spreads/margins amid high competition.
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