Stock pick of the week: Why analysts are bullish on Rural Electrification Corporation

Analysts’ interest in Rural Electrification Corporation (REC), a Navratna public sector undertaking, has not declined despite the company’s lacklustre performance in the second quarter of 2017-18. There are several reasons why analysts are bullish on REC. The central government’s focus on improving rural electrification boosts the growth prospects of REC.

With less than two years left for this government, its rural focus is likely to sharpen. Due to the successful implementation of the Ujwal Discom Assurance Yojana (UDAY) by the central and most state governments, there has been a marked improvement in the financials of several stressed power distribution companies in the country. This is another factor that should help REC report faster growth, 2018-19 onwards.

However, the financial improvement of power utilities has put pressure on REC’s net interest margin (NIM) because now these utilities can access cheaper funds from other agencies as well. However, despite the recent fall, REC’s NIM, placed at 4.1%, is significantly higher compared to other financial institutions. REC is using its PSU parentage and power sector exposure to its advantage and this has helped it maintain its NIM edge. For instance, REC is allowed to issue capital gain bonds under Section 54EC of the Income-Tax Act. At 5.25%, the interest cost of these bonds is low. The company has raised low-cost funds using tax-free bonds earlier as well.


There is clarity on REC’s asset quality front as well. The company has been following RBI norms from 2014-15 and, after an initial jump in bad loans, its asset quality became quite stable. More importantly, it has been improving now. While REC’s gross nonperforming assets (NPAs) fell from 2.6% in the first quarter to 2.54%, net NPAs fell from 1.73% to 1.66%.

Though some NPA provisioning had happened due to regulatory issues, loss of money from them is not expected because all of the company’s big borrowers are the erstwhile state electricity boards. Its two biggest borrowers are Maharashtra State Power Generation Company—accounts for 6.1% of total loans—and Maharashtra State Electricity Distribution Company, which makes up 5.24% of all its loans. With the improving financial situation of some of these state utilities, some of the NPAs for which REC has provisioned in the previous quarters may get upgraded starting the fourth quarter of 2017-18.

The recent price correction has also made the counter attractive. It has brought valuations to much cheaper levels and REC is now trading at a historical PE of just 5.54.

Analysts’ views
Buy: 10
Hold: 5
Sell: 2

Performance of REC compared with the Sensex. Stock price and index values normalised to a base of 100. Source: ETIG Database & Bloomberg

Selection Methodology
We pick the stock that has shown the maximum increase in ‘consensus analyst rating’ in the past one month. Consensus rating is arrived at by averaging all analyst recommendations after attributing weights to each of them (5 for strong buy, 4 for buy, 3 for hold, 2 for sell and 1 for strong sell) and any improvement in consensus analyst rating indicates that the analysts are getting more bullish on the stock. To make sure that we pick only companies with decent analyst coverage, this search is restricted to stocks that are covered by at least 10 analysts.