REC Share Analysis and Review of Dividends

REC or Rural Electrification Corporation is a government of India non-banking financial corporation (NBFC). The company is principally in the business of lending to the power /electricity sector. The company is now expanding its mandate to lend to the infrastructure business as a whole and to sectors such as transportation, green hydrogen, logistics, roads, etc. India’s infrastructure is seeing massive growth due to the government’s huge capex plans for lakhs of crores in the Gati Shakit Plan and there is a huge opportunity of financing in this area. Now let us look at the different areas such as the business model, valuation ratios, past performance, and future growth prospects.

REC Business Model

REC’s business model is that of a traditional NBFC. It raises money from bonds, debentures, and other fixed-income instruments besides loans from banks like SBI, BOB, etc. Being an NBFC it can’t take money from retail deposits like savings accounts, FDs, etc. It also gets money from capital gains bonds where people park money to save capital gains taxes from sales of property etc. The cost of its money is around 6-8%. Given the Government’s support, the company has been able to raise funds at competitive rates and has floated tax-free 54EC low-cost capital gain bonds to raise funds providing financial flexibility to the Co. REC is the first Indian PSU to raise money from the international markets through Green Bonds listed on International Securities Market segment of London Stock Exchange in 2017.

Also, read Why Power Grid Shares Are A Buy on Decarbonization & Green Energy Trends

This money is then given to state-owned power utilities like distribution, and transmission utilities as well as generators of power. In India, distribution utilities are loss-making and owned by state governments. Because of their poor financial condition, no private sector gives money to these companies which have massive capital requirements to fund their infra projects. REC and PFC are the major lenders to this sector. They can easily get 10-11% annual returns from these companies. Also being government-owned, there is almost zero risk of default from these state-owned discom companies as they dare not delay or default on their payments to REC which is central government-owned. The central government can stop the transfer of state share of taxes/GST if they don’t pay REC on time. That is the advantage available to REC which nobody else has. While private cos. can default/go bankrupt, it is impossible for state-owned power utilities to go bankrupt as they provide electricity to the people and no government can afford to stop this basic service to the people. The company is easily able to make a margin of ~2.5%-3% on its loans which is a great profit machine for investors given its loan book size of more than 4 lakh crores. A quick back of the envelope shows that on 4 lakh crores, it makes 3% or 12,000 crores of profit each year.

Rec’s largest loans are to the most distressed discoms in Tamil Nadu, Kerala, Rajashtan, etc. where nobody else will lend, even state banks like SBI and Bank of Baroda don’t want to lend here, but Rec can easily lend and make huge returns with almost risk-free loans. Besides these discoms, Rec is also now lending to new-age renewable energy projects to Serentica, Greenko, etc. in areas like hybrid wind-solar projects, green hydrogen, pumped storage, etc. It is also expanding its loan book to lend to a GH project in Oman to Acme.

Financials

REC’s current market capitalization is around Rs.70,000 crores which has more than doubled in 2023 as the business prospects of this PSU have improved tremendously and people are starting to realize the undervaluation of the PSU and the Power sectors to which REC belongs.  The company is still quite undervalued with a P/E of just 6x compared to the broader market at >20x. The company’s P/B is also just 1.2x which is not that high. The company pays a dividend of almost 5% which also makes it attractive to dividend investors as well as people looking for a steady income in their old age. The ROE is more than 20% and the NPA’s have drastically reduced for the company. It used to carry loans for some private-sector thermal plants which had gone into distress. But now they are being resolved under the NCLT and their percentage has become negligible.

Pricing

The stock price has traded in a range of between Rs.70-150 for a very long time of more than 15 years before breaking out this year and in a very short span of time has reached its all-time high of more than Rs.260. Given the strong momentum and the improving credit cycle of the Indian economy, I think it still has legs to go. Currently, is it trading much above its 50-day and 200-day moving average.

Growth

In the last 3 years, the company’s growth has accelerated with profits up 31% CAGR and sales at 10% CAGR as the NPA’s got resolved.  Going forward, I see the company easily doing a sales and profit growth of at least 10% if not more. The company is seeing massive opportunities given that the power sector driven by renewable energy is going to see massive capacity additions of almost a trillion dollars in India alone in the next 10 years driven by transmission (OSOWOG – One sun, one world one grid), distribution expansion, generator capacity additions in solar, wind energy and huge investments in GH (National Green Hydrogen Mission sees investment of almost $200-$300 billion). It was tagged as “Maharatna” last year and is now expanding to other countries as well.

Dividends

The company has consistently given a dividend payout ratio of more than 30% in the last few years and has maintained a high dividend payout being a PSU with a mandate to return most of its cash to the government in the form of dividends.

Risks

The biggest issue with financial lenders is defaults/NPAs and as REC expands to newer sectors and to private companies, that risk will go up. Though most of its loan book is still towards risk-free state-owned companies, as it expands to foreign countries and newer sectors, this risk will increase going forward. But currently, the credit cycle is on an upswing and the Indian economy is really doing well. Also, PSU governance has improved in the last few years with corruption reducing dramatically from earlier times when loans were given on the whims and fancies of the politicians in the ruling parties from banks and PSUs. The Risk of wilful defaults has also gone down.

Summary

The REC stock has been missed by investors as people don’t like investing in PSUs as they are not aligned with the objectives of the investors as government which is the owner has social obligations. However, this has made the valuation of REC too low and people are starting to realize that these companies have been performing consistently for a long time and paying huge dividends on time. Last year, Rec’s dividend yield was more than 10% which was fantastic. Even with a huge run-up in stock price, it is still around 5%. The company has great growth prospects in the future as well given the huge energy transition financing requirements. Being government-owned it has the advantage of being able to get the money on time from its customers who are also mostly government-owned. While people think that lending to discoms that are loss-making is a big risk, I think it is a big advantage for REC as it is the only company that can lend very profitably to this sector. However, one must remember that REC is an NBFC and moves up and down in the credit cycles of the economy. Currently, there are more legs to go as the country has come out of a deep NPA cycle after the COVID era.