Rural Electrification Corporation: Electrifying Rural India

Rural Electrification Corporation (REC) is a financial company that helps power companies construct power projects and finances them. It is listed by SEBI as NBFC (Non-banking financial corporation). Its business is to provide loan to power infrastructure companies for distribution, transmission and manufacturing. The primary business of REC is to finance project based long term loan in power sector.

REC covers end to end power finance and consulting, starting from planning, financing to monitoring and change control. With enormous demand for power, it has a list of clients that are top power companies in the country. It has been instrumental in powering rural India’s growth by distribution and transmission of much needed electricity.

REC is well placed to reap the benefit of increased emphasis on power and infrastructure by the Government. It sanctioned 45000 crore (about $10b) in FY 2010.

REC’s financial muscle has enabled it to be on top performer in the Government owned companies list. It had phenomenal listing in the bourses and since then the company has given good returns to the investors. Let’s look at the financials in details to understand the company in detail.

Year	Mar ’06	Mar ’07	Mar ’08	Mar ’09	Mar ’10
Revenue (in Crore)	2,241.64	2,838.75	3,527.88	4,894.12	6,672.83
COGS	42.50	49.82	92.30	87.22	117.10
Gross Profit	2,199.14	2,788.93	3,435.58	4,806.90	6,555.73
Operating Profit	2,013.62	2,566.49	3,217.35	4,671.49	6,389.70
Net Profit	637.51	660.26	710.49	1,272.07	2,001.42
EPS	8.17	8.46	10.02	14.81	20.27
GPM	98%	98%	97%	98%	98%
OPM	90%	90%	91%	95%	96%
Current Assets	28557.71	34962.50	41724.08	54881.99	70309.84
Inventories	0.00	0.00	0.00	0.00	0.00
Total Assets (FA + CA – CL)	28237.54	34293.71	39650.48	51126.02	67028.57
Current Liabilities	1709.55	1926.96	3298.89	4841.73	4281.04
Long Term Debt	24039.22	30281.00	34282.79	44935.95	55948.23
Account Receivables	0.00	0.00	0.00	0.00	0.00
NWC	26848.16	33035.54	38425.19	50040.26	66028.80
SH Equity or Net worth	4198.33	4012.71	5367.71	6190.08	11080.34
Total Debt	24039.22	30281.00	34282.79	44935.95	55948.23
BookValue per share	53.78	51.41	62.51	72.09	112.21
Dividend (%)	24.5	22.67	30	45	65
Interest Charges	1355.77	1762.96	2052.81	2887.35	3896.07
Depreciation	1.1	1.13	1.39	1.36	2.16
EBITDA	2,154.03	2,756.14	3,216.97	4,808.79	6,595.75
Operating Cost	228.02	272.26	310.53	222.63	283.13
Growth in revenue		26.64%	24.28%	38.73%	36.34%
Growth in Net Profit		3.57%	7.61%	79.04%	57.34%
Growth in Inventory		#DIV/0!	#DIV/0!	#DIV/0!	#DIV/0!
TAX	159.65	331.79	452.28	648.01	696.10
No of Stocks (in Lakhs)	7,806.00	7,806.00	8,586.60	8,586.60	9,874.59
EPS	8.17	8.46	8.27	14.81	20.27
Cash and Bank Balances	680.64	178.77	874.65	328.89	675.59
Cash per share	8.72	2.29	10.19	3.83	6.84
Reserves	3,417.73	3,232.11	4,509.05	5,331.42	10,092.88
Reserves per share	43.78	41.41	52.51	62.09	102.21
Fixed Assets	23.75	55.37	70.25	56.63	67.1
EPS as per current shares	6.46	6.69	7.20	12.88	20.27
BV per share as per curr shares	42.51	40.64	54.36	62.69	112.21

The data looks excellent. Based on this data, let’s look at the performance of the company in terms of fundamental ratios.

Year	Mar ’06	Mar ’07	Mar ’08	Mar ’09	Mar ’10
Profitability Ratio
NPM	28.44%	23.26%	20.14%	25.99%	29.99%
ROA	2.26%	1.93%	1.79%	2.49%	2.99%
ROE	15.18%	16.45%	13.24%	20.55%	18.06%
Liquidity Ratio
Current Ratio	16.70	18.14	12.65	11.34	16.42
Quick Ratio	16.70	18.14	12.65	11.34	16.42
NWC to Asset	0.95	0.96	0.97	0.98	0.99
Interval Measure
Leverage Ratio
Total Debt Asset Ratio	0.85	0.88	0.86	0.88	0.83
Debt Equity Ratio	5.73	7.55	6.39	7.26	5.05
Equity Multiplier	6.73	8.55	7.39	8.26	6.05
Long Term Debt Asset Ratio
Interest Coverage Ratio	1.59	1.56	1.57	1.67	1.69
Asset Utilization Ratio
NWC Turnover	0.08	0.09	0.09	0.10	0.10
Fixed Asset Turnover	-7.00	-4.24	-1.70	-1.30	-2.03
Total Asset Turnover	0.08	0.08	0.09	0.10	0.10
Face Value	10	CMP	252.85	P/E Ratio	12.47
PEG Ratio	0.40	Revenue Gr (CAGR)		31.35%
PB / RoE Ratio	0.12	Op Profit (CAGR)		33.47%
Price to Sales Ratio	3.74

We will follow the same pattern; discuss positive points and concern areas and few details such as opportunity and risks. The investors then can take better decision.

Positive Points:

• The company is fairly valued at the PE of 12.47
• Net profit margin is excellent at about 30%. NTPC, another power giant has net profit margin about 18%. In fact this is improving for last 4 years.
• The ROE is attractive at 18%.
• The company is paying dividend consistently. The average dividend payout ratio in last 5 years is excellent at 35%. The yield at current market price is about 2.57%.
• Current ratio and quick ratio are excellent.
• The revenue and profit growth are very good. Both exceed 30%.
• EPS is good but that is because of high debt on the balance sheet of the company.
• This is also a Navaratna by Government of India but let’s not read too much into this. Most of our Navratnas’ have not been able to satisfy investors’ expectation.
• The loan given by REC is of high quality and the NPA is negligible at 0.03% in FY2010. REC’s loan while safe to a large extent, are concentrated on a very small number of borrowers.

Concern Areas:

• Cash flow is throughout negative for last 5 years.
• While the debt look high but this is normal for financial companies. In case of REC, it takes loan from Government at a cheaper cost and lends to private and public companies at some spread.

There are many good points in REC but the lending to public sector and state electricity board is sign of worry. The company should be able to manage with it as India is slated to grow and the demand for power is all set to touch new highs. While the potential growth and emphasis on power by the Government makes it an attractive investment, we should keep in mind the following risks.

This company is Government owned and hence has all the risk that a typical Government owned company in India has. Its performance depends heavily the GoI’s policy and hence susceptible to irresponsible action of the Government (like free electricity etc.).

The company’s loan to top 10 customers account for about 80% of the loan disbursed. This is a big risk because any default from these borrowers will impact financial stability of REC.

The biggest risk we may encounter is the fact that majority of REC is owned by the Government and power is a political issue and the Government acts very irresponsibly when it comes to power. We have seen the deleterious effect on economy because of free power schemes. Moreover, Government may also force REC to provide loan to other public sectors even if the other public sector firms are not on a sound footing. In fact, almost all the loans that REC has lent is to public sector electricity companies and state electricity boards.

Lastly, most of the Navratna’s are hyped up story. The Navrantas got their time under the sun because of monopoly and restrictive trade policies of the Government in license raj time. In today’s scenario, maintaining the lead will be difficult. REC can very well prove all of us wrong and do wonders for investors. However, as far as history is concerned, Government owned firms rarely have created wealth for investors.

Disclaimer: This site gives opinions on companies that trade on BSE and NSE. This doesn’t give any suggestion on whether to buy and sell. Investors are requested to go by their own judgment.

Quantitative Easing 2 (QE2): Its impact on emerging market

Quantitative Easing, popularly known as QE, has been in the news for some time. Especially after the recession of 2007 when central banks poured money in the system to improve liquidity and encourage individuals and businesses to borrow, invest, and spend.

Lack of liquidity or liquidity trap is bad for a market and economy. It essentially discourages people from investing and consuming. Central banks and Governments reduce the interest rate to increase consumption and borrowing. This keeps the economy going. There are situations when the interest rate is close to zero and there may not be any scope of further reducing the interest rate. In this situation, quantitative easing is the only option left with central bank to improve liquidity in the system.

Hence quantitative easing is the last resort to central banks and the Governments. In quantitative easing, the central bank prints new money and buys Government bonds and other financial assets from commercial banks. As a result of it, commercial banks acquire money which can be lent to borrowers for investment, business expansion, or consumption. This is supposed to spur the growth, improve liquidity in the market, and pull out the country from economic recession. One of the unintended consequences of quantitative easing is rise in inflation which can kill the purpose of it if not handled effectively.

 

Impact on Emerging market

Let’s analyse the situation here. US Federal Bank prints $500b – $1000b and infuses commercial banks with it. The commercial banks will lend this money to companies and individuals. Where will the companies and individuals go to invest this money? Where will the investors and borrowers find higher yield? Developed economies will certainly not give high yield because most of them are suffering from deep slowdown.

American manufacturing and service industry is saturated. The issue is not having money to fuel the growth but the issue in America is not having ample scope of growth. American consumers have everything. There is nothing they can add new to their consumption. They can only replace one thing from another but this will not encourage growth. This will not provide returns to industry and investors.

The easy availability of money will soon find its way to emerging markets where the growth is good and returns are high. Let’s analyse where this money can go in emerging market.

Manufacturing Sector:

Chinese manufacturing sector is overflowing with products. It hardly has any capacity to absorb new expansion and plans. Indian Manufacturing sector is not big enough to absorb QE2 money. Moreover, despite India’s focus on infrastructure, the underlying issues are too complex that foreign investors will risk their money. The third reason why the money will not go into manufacturing is the fact that China is taking steps to cool off its economy.

Services Sector:

Services sector, such as biotechnology and pharmaceuticals, do look lucrative. These industries have long gestation period. The new money may not flow to this sector as well. In fact, the quantity may be very low. The other point is that most of emerging markets’ service economy is based in export to developed market.

Currency:

The pressure on currency will increase as slush of American dollar will depreciate and dollar will become cheaper. This will make export to United States much expensive thus impacting the emerging market where dependence on export is fairly significant.

Stock Market:

Most of the QE2 money will end of in stock markets as speculative investment. The stock markets will go up. In fact, the market is bullish for last 1 year and going strong. This will create stock market bubble which is dangerous for the economy of emerging market. It will also depend on what is the amount of QE2. The market has factored some of it but if the amount is big (closer to a trillion USD), market may see tremendous upside.

Import Export:

Increase in dollar currency will depreciate its value against major currencies of the world. This will have impact on emerging markets that draw a good proposition of their national income from export. Weakening of dollar will make American products cheaper and emerging markets’ products expensive. This will reduce export to some extent.

Inflation:

It will also make the major import items such as Oil dearer as dollar is the currency for buying Oil. Needless to say, Oil prices impact everything and it is the driving factor of inflation. Emerging markets have been facing higher inflation for last few quarters. This will further increase it.

However, there are economists who expect the developed market to outperform emerging market in 2011. If this happens, a major part of QE2 money will be used within US. This may lessen the impact of QE2 money on emerging market.

 

Options before emerging market

Many countries have foreign capital control policy to slowdown the flow of speculative money and there is enough emphasis by emerging nations’ Government on controlling the foreign capital to avoid extreme situation.

CEAT Tyres: Wheels in motion

CEAT is a very old company that has worked with Tata and then with RPG group and now operates under the brand name CEAT. This company’s main business is tyre manufacturing, distribution, and sales. The business segments of CEAT are replacement, new tyre, farm sector, and export. The replacement segment is the most revenue generating one.

CEAT achieved very good operational optimization by its cost cutting measures and some innovative rubber procurement initiatives. The company has a good brand name and its performance has been good.

The company is also focusing on radial tyres which will commence the development by December 2010 – January 2011 timeframe. This will grow to 30% of the market in 3 years.

The Business:

The tyre industry is very sensitive to the raw material cost. The cost of rubber (the key raw material for the tyre) has been spiralling for quite some time and this has impacted the profitability. However, even though the prices went up, CEAT managed the raw material costs very well. The bad news is that this price is not going to come down in next year too.

Hence while the company expects robust growth in the coming year, the cost of raw material will impact its bottom line and hence the top line growth will not be able to contribute to the bottom line in the same proportion.

The Financials:

The financials look reasonably good though there are extreme fluctuations. This is because of the thin margin that CEAT operates at. Any variation in cost of raw material impacts its bottom line. Let’s take a look at the data for last 5 years.

Year	Mar ’06	Mar ’07	Mar ’08	Mar ’09	Mar ’10
Revenue (in Crore)	1,787.00	2,150.29	2,439.36	2,569.48	2,869.60
COGS	1,507.37	1,774.32	1,887.41	2,169.96	2,319.81
Gross Profit	279.63	375.97	551.95	399.52	549.79
Operating Profit	84.36	148.51	203.71	34.86	317.27
Net Profit	0.52	39.25	71.06	-16.11	161.04
EPS	0.11	8.60	43.40	-4.71	47.03
GPM	15.65%	17.48%	22.63%	15.55%	19.16%
OPM	4.72%	6.91%	8.35%	1.36%	11.06%
Current Assets	564.62	591.04	775.02	831.49	1039.73
Inventories	183.45	221.22	341.06	219.42	406.08
Total Assets (FA + CA – CL)	766.63	755.64	843.27	949.54	1058.11
Current Liabilities	651.77	673.35	731.45	719.57	1042.90
Long Term Debt	417.64	377.00	330.02	461.13	429.37
Account Receivables	253.23	263.17	307.91	318.71	376.32
NWC	-87.15	-82.31	43.57	111.92	-3.17
SH Equity or Net worth	349.00	378.64	513.25	488.37	628.71
Total Debt	417.64	377.00	330.02	461.13	429.37
BookValue per share	76.44	82.93	145.96	141.25	183.6
Dividend (%)	0	18	40	0	40
Interest Charges	72.63	70.26	66.47	79.94	74.84
Depreciation	22.45	31.06	32.99	25.62	26.88
EBITDA	100.30	162.24	219.23	80.27	340.72
Operating Cost	1,702.64	2,001.78	2,235.65	2,534.62	2,552.33
Growth in revenue		20.33%	13.44%	5.33%	11.68%
Growth in Net Profit		7448.08%	81.04%	-122.67%	-1099.63%
Growth in Inventory		20.59%	54.17%	-35.67%	85.07%
TAX	4.70	21.67	48.71	-9.18	77.96
No of Stocks (in Lakhs)	456.57	456.57	342.43	342.44	342.44
EPS	0.11	8.60	20.75	-4.70	47.03
Cash and Bank Balances	30.79	34.92	37.55	43.48	35.95
Cash per share	6.74	7.65	10.97	12.70	10.50
Reserves	303.32	332.96	465.56	449.45	594.47
Reserves per share	66.43	72.93	135.96	131.25	173.60
Fixed Assets	721.7	700.01	786.62	775.39	768.93
EPS as per current shares	0.15	11.46	20.75	-4.70	47.03
BV per share as per curr shares	101.92	110.57	145.96	141.25	183.60

Based on these numbers, fundamental ratios were calculated. Here are the fundamental ratios:

Profitability Ratio
NPM	0.03%	1.83%	2.91%	-0.63%	5.61%
ROA	0.07%	5.19%	8.43%	-1.70%	15.22%
ROE	0.15%	10.37%	13.85%	-3.30%	25.61%
Liquidity Ratio
Current Ratio	0.87	0.88	1.06	1.16	1.00
Quick Ratio	0.58	0.55	0.59	0.85	0.61
NWC to Asset	-0.11	-0.11	0.05	0.12	0.00
Interval Measure
Leverage Ratio
Total Debt Asset Ratio	0.54	0.50	0.39	0.49	0.41
Debt Equity Ratio	1.20	1.00	0.64	0.94	0.68
Equity Multiplier	2.20	2.00	1.64	1.94	1.68
Long Term Debt Asset Ratio
Interest Coverage Ratio	1.38	2.31	3.30	1.00	4.55
Asset Utilization Ratio
Inventory Turnover	8.22	8.77	6.71	7.74	7.42
Days Sales in Inventory	44.42	41.62	54.37	47.14	49.21
Receivable Turnover	7.06	8.17	7.92	8.06	7.63
Days Sales in Receivables	51.72	44.67	46.07	45.27	47.87
NWC Turnover	-20.50	-26.12	55.99	22.96	-905.24
Fixed Asset Turnover	8.85	13.06	35.74	21.77	156.13
Total Asset Turnover	2.33	2.85	2.89	2.71	2.71
Face Value	10	CMP	137.50	P/E Ratio	2.92
PEG Ratio	0.23	Revenue Gr (CAGR)		12.57%
PB / RoE Ratio	0.03	Op Profit (CAGR)		39.26%
Price to Sales Ratio	0.16

We will discuss the numbers and list out the positive points and concern areas of CEAT Tyres. Let’s take the positive points first.

Positive Points:

• Revenue and profit growth (last 5 years CAGR) are good at 13% and 40% respectively.
• Reserve per share at 173 is more than the stock price.
• PEG ratio at 0.23 provides much scope for appreciation.
• The dividend, even though not consistent, looks good. Last year the dividend was Rs 4 per share. Dividend payout ratio has been very good.
• Book value is less than current market price. This is usually a sign underpriced stock. Though we cannot decide the investment worthiness of a company solely by this criterion.
• Cash flow from operation is positive and has been quite healthy for last 5 years.
• The revenue numbers for last 2 quarters show good growth. The revenue is about 1600 crore for last 2 quarters. If we take the same number for the next two quarters, the revenue growth year on year for the FY 2011 will be about 15%.

Concern Areas:

• The net profit margin is very erratic, ranging from negative to positive. Similarly, ROE is very erratic which is quite natural as ROE depends on net profit.
• The company has done great in 2010 by bringing the cost drastically down. The cost of raw material was 71% of the revenue in 2009 while it has come down to 66% in 2010. This is a major achievement. The cost of raw materials prior to 2009 was at around 67%. In fact the cost of raw materials has been the least in 2010 as a percentage of revenue.
• The projected EPS for the year FY2011 is about Rs 16. This is based on last 2 quarters EPS which is Rs 8. This is a major slump from FY2010 EPS which is Rs 47. Despite this the forward PE is less than 10.
• The free cash flow calculation shows extreme variation. This is not a good sign.

CEAT Tyres is a big brand and it has significant market share. However, the investor should not expect great returns immediately as there are some risks apart from the concern areas mentioned above.

Risks in investment

1. The auto sector may not see the same growth as it saw in 2010. The growth in 2011 will be much slower and this will impact the financials of CEAT.
2. Banks have already raised the auto loan interest rate. This will further impact the sales numbers of auto.
3. Petrol and diesel prices may go up (no surprises, it always goes up 2-3 times in a year).
4. Cost of rubber doesn’t seem to ease in near future and hence we will see erosion of margin to continue for few more quarters.

India is slated to grow at 7%-8% in near future and as the economy improves, auto sector will see much growth. However, there is concern that Indian growth story may see slowdown in near term. There is already anticipation that the Indian market may not perform very well in 2011. However, if India has to grow, the auto sector will grow and thus CEAT tyres will grow along with it.

Disclaimer: This site gives opinions on companies that trade on BSE and NSE. This doesn’t give any suggestion on whether to buy and sell. Investors are requested to go by their own judgment.