Operational Autonomy Will Strengthen India's Power And Infrastructure Development

Key Takeaways

• REC's operational autonomy and strategic position in key sectors enable growth through strategic investments, enhancing revenue and margins.
  
• Expansion into renewable energy and improved asset quality drive significant revenue growth and financial stability, supporting stronger profitability.
  
• Diversifying loans into infrastructure increases risk of non-performing assets, while reliance on government-backed loans and foreign borrowings exposes REC to revenue and currency risks.

Catalysts

Engages in the provision of financing services for power generation, transmission, and distribution projects in India.

• REC's strategic position in the Indian Power, Infrastructure, and Logistics sector, coupled with its Maharatna status, provides operational and financial autonomy, potentially leading to strategic investments and growth, likely boosting revenue and net margins.
  
• The company is focusing on expanding its renewable energy portfolio, targeting a 20% market share in new coal-based plants and renewable projects, which is expected to significantly increase revenue.
  
• REC's anticipated 15-20% growth in assets under management over the next few years, driven by substantial disbursements and a robust loan pipeline, suggests a substantial increase in earnings and overall financial stability.
  
• The reduction in gross and net NPAs indicates improved asset quality, which can lead to better net margins and stronger profitability as provisioning requirements decrease over time.
  
• REC's focus on longer tenure loans and diversified funding sources, including cheaper foreign borrowings, is expected to sustain net interest margins, which should positively impact earnings.

REC Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming REC's revenue will grow by 13.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 75.1% today to 72.7% in 3 years time.
• Analysts expect earnings to reach ₹211.2 billion (and earnings per share of ₹75.58) by about December 2027, up from ₹148.5 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as ₹163.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.3x on those 2027 earnings, up from 10.1x today. This future PE is lower than the current PE for the IN Diversified Financial industry at 18.2x.
• Analysts expect the number of shares outstanding to grow by 2.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.1%, as per the Simply Wall St company report.

REC Future Earnings Per Share Growth

Risks

• REC's significant increase in diversifying its loan portfolio into infrastructure sectors, where asset quality and cash flow assurance may vary, increases the risk of non-performing assets and impacts future revenue and profitability.
  
• High dependence on state government-backed loans and guarantees, primarily in the power sector, could lead to revenue volatility and risk exposure if government backing weakens or defaults occur.
  
• Increasing competition from banks and market institutions in providing financing for renewable energy projects could pressure interest margins and affect future earnings.
  
• Reliance on foreign currency borrowings that constitute a significant portion of REC's funding profile could expose the company to currency fluctuation risks, affecting net margins due to increased financing costs.
  
• The anticipated decrease in funding costs is contingent on central bank rate cuts, which if not realized, could compress earnings through higher-than-expected borrowing costs.

Valuation

• The analysts have a consensus price target of ₹678.67 for REC based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹755.0, and the most bearish reporting a price target of just ₹630.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be ₹290.5 billion, earnings will come to ₹211.2 billion, and it would be trading on a PE ratio of 13.3x, assuming you use a discount rate of 14.1%.
• Given the current share price of ₹569.75, the analyst's price target of ₹678.67 is 16.0% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.