REC’s exit from Nifty CPSE doesn’t affect fundamentals, but is a worry


After REC Ltd was dumped rather unceremoniously from the Nifty CPSE index, the stock took a sharp knock. The company’s shares are down 14% since the news of its exit from the index on 8 July.

As index changes go, underlying stocks that are excluded tend to swing wildly. REC’s exit from the Nifty CPSE (central public sector enterprises) has meant that exchange-traded funds (ETFs) holding this stock have to sell these shares in the market.

The CPSE ETF holds about 6.6% in REC, which was worth about 660 crore in June 2019. Although the changes come into effect from 15 July, the stock has reacted early to the news. While any changes in indices are not good for the stocks, this hardly has anything to do with the companies’ performance.

Much of REC’s performance remains quite stable. The company’s is aiming at a growth of about 28,000 crore in its loan book in FY20 in an “excellent-case” scenario and about 27,000 crore in a “very good” scenario. Besides, it aims to maintain its non-performing loans at about 4.1% in the first scenario. It has set a target of 16% return on equity in FY20.

(Graphic: Vipul Sharma/Mint)
(Graphic: Vipul Sharma/Mint)

Performance continues to be driven by the transmission and distribution (T&D) sector, which was reflected in REC’s steady disbursement to this segment. “At 19,900 cr, disbursements were robust supported by renewables, take-out financing and state transmission projects. This percolated to steady loan growth of >17% YoY to 2.8tn in Q4FY19. Management expects continued traction, particularly in the T&D segment, and thus sustainable loan growth of 15%-plus,” said analysts at Edelweiss Securities Ltd in a note.

The good part is that asset quality has been steady, with gross non-performing assets (NPAs) at about 7.2% in FY19. Provisions have been increasing, which has meant that net NPAs have reduced to 3.8% in FY19 from 5.2% in FY18.

Investors need to watch for the provisions going forward. REC has been acquired by Power Finance Corp. Ltd, and hence the provision norms, particularly in case of co-lending, could change.

While on the valuations front the REC stock appears reasonable, investors must keep an eye out on the dividend payout. The company has paid good dividends over the years and dividend yields have been upwards of 5%. But, after the ownership change, analysts say dividend payouts could shrink, bringing down investor yields.

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