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REC rating: Buy — Performance was steady in Q3

REC rating, PFC, REC performance, stress resolutions

We are upgrading REC to 'BUY' from 'HOLD' with visibility on its fundamentals improving in the wake of stress resolutions and the merger talks with PFC taking a backseat. We argue this would remove the near-term overhang on the stock and cause it to re-rate to 0.85x FY21e multiple (from 0.7x earlier), which yields us revised TP of Rs 177 (Rs 154 earlier). The resolution of stressed projects, though slower than expected, is gathering steam, evident in the Q3FY20 earnings.

Impaired loan assets came off to 6.4% from 6.9% following the recovery of RattanIndia (exposure of Rs 7.44 bn). Besides, credit cost was contained with a write-back of Rs710 mn. A further increase in coverage to 50.6% lends comfort on credit cost not being abnormally high. Ex-asset quality too, core operating performance was steady in Q3FY20 - with loan growth sustaining around 14% and NIMs steady at 3.83%. A lower runrate of forex swap losses led to a PAT outperformance (at Rs16.4bn).

Core steady-growth sustained, NIM holding up: Growth momentum was steady with disbursements at Rs199 bn, leading to 14%-plus loan growth. By segment, growth was driven by T&D (up 20% y-o-y) and generation (up 17% y-o-y) while renewal saw a decline (down 28% y-o-y). Contrary to scepticism, NIM stood broadly steady at 3.83% due to a more balanced disbursal approach that's spread across quarters. We will monitor the trend closely before taking a positive call on NIM.

Outlook and valuation-visibility improving: Over the past few quarters, REC's performance has been volatile (swap losses), but asset quality and growth have been steady. Given improved visibility on stress resolutions (anticipating much controlled credit cost), and merger taking a backseat, we are upgrading the stock to 'BUY/SP' from 'HOLD/SU'.