Update 06/10/2017- In last 4 months, from end of May, the asset quality concerns have again resurfaced for PFC & REC. Then there was a CAG report that was also critical about lending practices of these two companies. Even quarterly profits have come down to about 1300cr in alst 2 quarters from peak of 1700cr. In recent TV interactions, mgmt has stated that NIMs can also come down a bit from current levels and guided for a loan growth rate of 15-17% against higher guidance given few months back. Hence I feel comapny won’t deliver earnings growth in accordance to my earlier expectation. Hence I had been reducing our holding in the stock, which I have posted on my twitter account as well. Today me and my family members have fully exited our holding in this stock. REC may or may not do too badly from here, but I believe with same amount of time and effort put elsewhere, better returns can be generated.
Original Unedited Post-
In this post i will talk about my investments in Rural Electrification Corporation Limited trading at BSE & NSE with symbol RECLTD and CMP of 181.
We have been accumulating this stock steadily for over 2 yrs now at an avg cost price of around 130. It has been an exciting roller coaster ride, with the stock falling 50% in 2015-16 only to recover more than 100% from the lows in FY17.
I struck around with the stock because the because of my belief that all the woes of the company were transient in nature and the valuations were extremely compelling and offered great long term value with the stock giving you a double digit dividend yield at the 2016 lows.
After the brutal fall and with increased dividend payout of 30% of profits, stocks like REC are trading at P/E of 3 times,div.yield of 10%.
— Sumit Sethi (@Sethinomics) January 19, 2016
Since then, the stock has more than doubled from the lows and profits are again at all time highs with asset quality among the best in any PSU financial stocks and management guiding of 15-20% growth in loans in the future.
If we examine the monthly charts, there remains a possibility that the stock can even cross 300 if it manages to sustain above 180.
On monthly charts, the stock has been range bound b/w 71& 207 for almost 8 yrs now. This narrowing range can give an upward breakout if stock crosses 180 as shown in the below chart. This will open an upward move of Rs 136 (207-71) from breakout level of 180 giving initial technical target of target of 316 (180+136).
About the biz-
The company raises funds at very low costs as it enjoys various perks of being a govt owned company and then lends to various power projects- mostly related to power transmission. Latest breakup of loan book across power generation & transmission or between govt and private companies can be accessed at earnings presentation on company site here. The bulk of the loan book of the company still comprises of lending to other govt owned companies from T&D sector.
Till FY 14, RECLtd had Gross Non Performing Assets of only 490cr and company was reporting profits around 1600cr per quarter. Since then, bad loans rose continuously to 4691cr in q3FY17. However, in percentage terms, the GNPAs are still at just 2.32% of total loans given by the company. Net NPAs stand lower at 3390 cr or 1.68% as of q3FY17. On qoq basis, the asset quality saw some improvement in the last quarter with marginal fall in NPAs and even restructured assets coming down sharply thanks to the UDAY scheme by the govt.
In the below table i have complied the Earnings per share and book value for the RECLtd stock in the last 6 yrs.
|YEAR||FY 10||FY 11||FY 12||FY 13||FY 14||FY15||FY 16|
Despite the plaguing issues of shortage of coal and various corruption scandals the sector faced during the second term of the previous govt, RECLtd still managed to double its earnings from FY10-14 in 4 yrs. Even after the slowdown during the last 2 yrs caused by prepayment of large loans that got converted into state govt bonds and strict recognition of bad loans, we get a 6 yr growth CAGR of 16% along with a very high dividend yield, paid consistently every year.
Assuming a similar growth rate in high-teens to continue over the long term at the very least, here are the assumptions i am working with regarding the future growth for the stock.
Going by the historical averages, the stock has traded about 6-7 times its trailing earnings in the last 5 yrs and about 1.2X on Price to book basis. At current price of 180 the stock trades at valuations near the historic mean. So unless there is upward re-rating, stock returns from current price should be similar to whatever growth the company delivers.
Strong case for upward re-rating-
The company that manages to survive great NPA crisis plaguing most big banks and emerge stronger can no more be compared to bear market valuations of the past. It also makes no sense to compare it to other PSU banks that are struggling to make profits, have stopped paying dividends and some have NPAs in double digits now. On the other hand, RECLtd posted record profits in the previous quarter and gave a massive dividend. There are several large pvt banks and NBFCs with significantly higher level of NPA stress that are still trading at 2-3X book value.
So if RECLtd demonstrates steady growth and stable asset quality, there is no reason for this stock to trade below 2 times book value as well in next 1-2 yrs.
I expect the stock to continue outperforming the markets and head to 300 this year. However if things go well, I believe stock can even go to 500 in 2-3 years.
- This does not constitute investment advice.
- Actual earnings may vary significantly from projections made in this post.
- Views biased. Me & my family members hold this stock.
Read full disclaimer here.