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Cover Story

Just Keep Those Costs Down
Rec has seen its Numbers Grow at a Steady clip in The Past Few Years, but will have to now Tackle Increased Competition
Issue Date - 21/07/2011
Being the nodal agency under the Government of India in charge of financing rural power projects in India, the challenge for Rural Electrification Corporation is always about managing the opportunity, rather than looking for it. Unsurprisingly, the company has been experiencing y-o-y growth of 15-20% on an average over the past decade.

For FY 2010-11, REC reported a growth in net profit by 28.4% to reach Rs.25.70 billion, which has catapulted it to rank 33 in the B&E Power 100 list from 38 last year. Revenue grew by 26.09% to reach Rs.81.09 billion. Strong return on equity with low cost of funding allowed REC to generate superior spreads, which is currently around 4.34% despite the zooming interest rates. REC was able to maintain this margin largely because of the fact that they had gone for international borrowing of $1.2 billion & also set domestic borrowings to the G-Sec benchmark. Cost of borrowing for last year on an incremental basis was around 7.25%; whereas overall cost of borrowing was around 7.62%. Furthermore, REC successfully brought NPAs down to 0.03% due to the escrow mechanism and managed margins of 4.3% despite high cost of funds. The major bad news this year was the resignation of CMD J. M. Phatak, who joined the company in June 2010. Phatak is accused of playing a role in the Adarsh society scam when he was Municipal Commissioner of Mumbai.

The role of REC comes only when all delays & clearances, particularly environmental clearances & securing of coal linkages issues are accounted for & finalized. Last year saw loan sanctions of Rs.664.21 billion (growth of 46.44% y-o-y) but disbursals were just Rs.245.19 billion, a growth of 16.03% y-o-y. REC is now focusing on creditworthy projects by turning their attention towards power generation projects rather than exclusively on the transmission & distribution sector When asked about the shift, H. D. Khunteta, CMD, REC told B&E, ďIt was a natural shift to all the parts of the power sector & the Ministry of Power has expanded the mandate for REC to include generation projects.Ē The power generation share in the outstanding loan book has almost doubled from 26% in 2007-08 to 48% in 2010-11 and the private sector is also playing a huge role.

With the Infrastructure Finance Company (IFC) status being granted to it, REC gets a competitive edge as lending exposure to the private sector has gone up to 25%. In addition, REC becomes eligible for issuance of Infrastructure Bonds and for raising funds up to $500 million through External Commercial Borrowings (ECB) in a year.

However, the company still faces a significant downside potential as the top 10 customers account for 80% of the loan disbursed. Operating in the power sector does have drawbacks, as deadlines are rarely adhered to in power projects, which affects timely payments; and ironically, SEBs are the major culprits. Power Finance Corporation (PFC) is the immediate competitor of REC. It was meant to disburse loans to the generation sector earlier while REC was concerned with the T&D segment. As requirements increased, they both have got into each otherís ground. RECís five year average return on assets and return on investment stand at 2.58 and 2.71 respectively, while the same for PFC stands at 2.84 and 2.97 respectively (Reuters). If you look at RECís profile, T&D comprises of 51% of the loan book. On an incremental basis, lending towards the generation segment is higher in H1, FY Ď11 which accounts for 59% of the incremental disbursals. There are signs of stiff competition with banks in the T&D segment as banks are also offering competitive market rates due to their access to cheap deposits. Indeed, REC has been quite proactive in tapping cheaper sources of funds in India and overseas in the last year. Foreign currency loans increased to Rs.56.91 billion in FY 2010-11, a mammoth growth of 840% y-o-y (post IFC status). Truly, continued access to low cost funds, monitoring of client spreads and retaining competitive lending costs will remain the key to ensure that RECís numbers stay healthy in the tougher and more competitive times ahead.

Karan Arora           

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