CRISIL IPO grade 3/5 assigned to the IPO of Rural Electrification Corporation Ltd.

CRISIL has assigned a CRISIL IPO Grade “3/5” (pronounced “three on five”) to the proposed initial public offer of Rural Electrification Corporation Limited (REC). This grade indicates that the fundamentals of the issue are average in relation to the other listed equity securities in India. However, this grade is not an opinion on whether the issue price is appropriate in relation to the issue fundamentals. The grade is not a recommendation to buy / sell or hold the graded instrument, the graded instrument’s future market price or its suitability for a particular investor.

The grading reflects the Indian government’s majority stake in REC and its developmental role in the government’s plans for the power sector in India, especially the non-urban centres. REC’s continuing role as an instrument of government policy and the consequent government support translates into significant advantages for REC as a borrower of funds viz the ability to raise bonds with tax benefits to the investors. CRISIL believes that REC will continue to discharge its developmental role over the medium term and shall display moderately strong business performance.

Notwithstanding the advantages on the liability side, REC’s mandate requires it be one of the key lenders to state government power utilities, which have had a troubled credit history. Though REC is planning to increase its lending to the private sector, CRISIL believes that lending to state government utilities would continue to constitute a majority of REC’s asset book over the medium term.

The company’s profitability could come under pressure in the future as the share of market borrowings in REC’s funding mix increases and the company begins to follow the RBI’s prudential norms for NPA provisioning. REC will also need to considerably strengthen its internal control systems and loan pricing mechanisms to support the significant increase in business planned by the company.

REC’s business operations are susceptible to the effects of frequent top management changes as is the case with many other government run entities. REC’s shareholders remain vulnerable to the possibility of REC’s business operations being used by the government more as a tool for public policy than an engine for profit maximization.