After a strong Q2 in FY24 REC is ready for the rerating saga

Company Overview:

REC Limited (formerly Rural Electrification Corporation Limited) is a non-banking financial company (NBFC) under the administrative control of the Ministry of Power, Government of India. It is also registered with the Reserve Bank of India (RBI) as a public financial institution (PFI) and an infrastructure financing company (IFC).
REC was incorporated in 1969 to finance and promote rural electrification projects in India. Over the years, it has expanded its scope of business to include financing of the entire power sector, including generation, transmission, and distribution. REC also finances projects in the renewable energy and infrastructure & logistics sectors.

REC’s Q2 earnings soar on lower costs and higher margins:

REC Limited’s Q2FY24 earnings were strong on all counts, with a 17bps QoQ NIM uptick, provision reversal of ~INR 5bn, and high 20% YoY loan growth. The company is upbeat on growth guidance of 20% YoY, NIM steadying at 3.5%, and anticipated provision reversals for FY24, which signals strong book value accretion and potential valuation multiple re-rating.
a. NIM uptick: REC’s NIM uptick was driven by asset re-pricing across products, with yields climbing 15bps QoQ, and a favourable liability mix with ~40% borrowings being priced at ~7% (23bps lower than average CoF).
b. Provision reversal: REC reversed provisions of ~INR 5bn, including standard asset provisions created on grounds of prudency during the pandemic and ~INR 2.5bn write-backs led by resolutions of two assets.
c. Loan growth: REC’s loan growth accelerated to 20% YoY after a hiatus of four years, largely led by renewables, LPS, and infra portfolios.
d. Outlook: REC is upbeat on growth guidance of 20% YoY, NIM steadying at 3.5%, and anticipated provision reversals for FY24. This signals strong book value accretion and potential valuation multiple re-rating.

RECL’s loan growth surges on renewables, non-power sectors; FY24E-26E outlook upbeat:

RECL (presumably a financial institution) recorded a strong loan growth of 4% quarter-over-quarter (QoQ) and 20% year-over-year (YoY). This growth was largely driven by non-power loans in sectors like infrastructure, logistics, and e-mobility, as well as loans related to LPS (possibly referring to Loan Protection Scheme) and renewables.
The renewables sector constitutes 7% of RECL’s assets, approximately INR 300 billion. There is an expectation that this figure may increase significantly to INR 3 trillion by FY30 (fiscal year 2030). This growth could be triggered by a recent Memorandum of Understanding (MoU) worth INR 280 billion and the government’s goal to increase the share of renewables to 30% of the mix by FY30. Additionally, Q2 saw 25% of overall loan sanctions coming from renewables.
The non-power sector’s share in RECL’s portfolio has increased from 8% in Q1 to 13% of the mix. RECL is actively expanding its capabilities in terms of talent, skillsets, and pricing strategies, with a focus on state-backed, low-risk assets. The report suggests that RECL anticipates a higher loan Compound Annual Growth Rate (CAGR) of 19% in the fiscal years FY24E-26E. This expectation is based on the quality of renewable corporate clients and high-value infrastructure projects, which provide a robust outlook for the business.

RECL aims to maintain steady NIMs, write-backs to boost FY24 profits:

RECL is aiming to maintain steady NIMs. They are working to control credit costs with the goal of achieving a 0% net Non-Performing Asset (NPA) ratio by FY25. It’s noteworthy that RECL has not experienced any slippages in the past seven quarters, and they expect write-backs in FY24.
In the second quarter (Q2), RECL reported that Stage 3 assets, which typically refer to non-performing or impaired assets, stood at a five-year low of 3.14%. At the moment, there are 19 stressed projects with a total value of INR 149 billion in Stage 3. Out of these, five projects worth INR 18.8 billion are being pursued for resolution outside the National Company Law Tribunal (NCLT), and the remaining 14 projects worth INR 130 billion are undergoing resolution within NCLT. It is estimated that there will be a build-up of Gross Non-Performing Assets (GNPA) in the range of 2-2.4% and write-offs during FY24E-26E.

Valuations: Analyst sees 30% upside in RECL:

Despite recent price momentum, RECL is seen as having the potential for further re-rating. This is attributed to the company’s high double-digit growth visibility, positive performance in Q2, and the ability to maintain steady margins in a challenging funding environment. Additionally, the significant write-backs are expected to lead to a high return profile with an anticipated Return on Equity (RoE) of 18-19% and Return on Assets (RoA) of 2.8% in the fiscal years FY24-26E. In light of these positive factors, there has been a revision of the estimates for FY24E and FY25E, with an increase of 15% or more for each of these fiscal years.

REC Ltd Reports Strong Q2FY24 Result:

REC Ltd reported net sales of Rs 11,688.24 crore in September 2023, reflecting a significant increase of 17.4% compared to the same period in September 2022 when it was Rs 9,955.99 crore. The company’s quarterly net profit for September 2023 amounted to Rs 3,789.90 crore, indicating substantial growth of 38.72% from the figure of Rs 2,732.12 crore in September 2022. The EBITDA for September 2023 were reported at Rs 12,193.52 crore, showing strong growth of 32.98% from the EBITDA of Rs 9,169.73 crore in September 2022. REC Limited has a market capitalization of ₹79,668 Crores, reflecting the total market value of its outstanding shares. The stock’s Price-to-Earnings (P/E) ratio stands at 6.19, indicating its valuation in relation to its earnings. A lower P/E ratio suggests potential undervaluation. REC Limited’s Return on Capital Employed (ROCE) is 9.14%, showcasing its profitability relative to the total capital employed in the business. The company reported a Profit after Tax of ₹12,739 Crores, representing its net income after accounting for all expenses and taxes. REC Limited has a Price to Book Value (P/B) ratio of 1.25, implying that the current market price of the stock is slightly higher than its book value per share.

Conclusion:

REC Limited, a government-controlled financial company, posted impressive Q2FY24 results. The highlights include a remarkable 17.4% YoY increase in revenue, reflecting strong growth. Notably, the company saw an uptick in Net Interest Margin (NIM), provision reversals, and a substantial rise in loan growth. REC is confident about its future, with a projected 20% YoY growth and stable NIM. The surge in loan growth was primarily fuelled by non-power sectors, and REC anticipates a higher growth rate in loans for FY24-26E. They are also focused on maintaining NIMs and managing non-performing assets.