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IDFC: Pressure point

Jan 19, 2007

Performance summary
IDFC declared results for the third quarter and nine month ended December 2006. Despite being India's leading private sector infrastructure financing company, the institution's performance numbers barely reflect the perceived buoyancy in the country's infrastructural development. While the lower pre-payment rates and repricing of loans have helped the institution grow its interest income above the sector average, pressure on cost of funding, no fee income cushion and higher tax incidence have dented its net profit margins by nearly 700 basis points during 3QFY07.

Standalone numbers…
Rs (m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Interest income 2,448 3,863 57.8% 7,458 10,028 34.5%
Interest expended 1,317 2,291 74.0% 3,593 5,008 39.4%
Net Interest Income 1,131 1,572 39.0% 3,865 5,020 29.9%
Other Income - - 2 19 1017.6%
Operating expense 82 138 67.7% 242 405 67.4%
Provisions and contingencies 18 53 194.4% 282 442 56.7%
Profit before tax 1,031 1,381 34.0% 3,343 4,192 25.4%
Tax 135 229 69.6% 322 436 35.4%
Profit after tax/ (loss) 896 1,152 28.6% 3,021 3,756 24.3%
Net profit margin (%) 36.6% 29.8% 40.5% 37.5%
No. of shares (m) 1,122 1,125 1,122 1,125
Diluted earnings per share (Rs)* 3.2 4.1 3.6 4.4
P/E (x) 18.4
* (12 months trailing)

Headstart in infrastructure funding
Established in 1997 as a private sector enterprise by a consortium of public and private investors, IDFC operates as a professionally managed infrastructure financing entity whose focus areas are energy, telecom, transportation and industrial and commercial projects. IDFC financed 25% of the total infrastructure outlay in the country in FY05. Its expertise in the infrastructure sector and strong relationship with government and infrastructure sponsors provides it with a platform for facilitating private investment and public-private partnerships in infrastructure projects in sectors where market structures, government policy and regulations are evolving. IDFC has capitalised on its domain knowledge and structuring expertise in financing activities to garner fee-based revenues.

What has driven performance in 3QFY07?
Disbursements scale up: The rising interest scenario has proved to be very benign for IDFC. Besides curtailing the high rate of pre-payments that existed in a falling interest scenario, the institution has also been able to re-price loans at higher rates than those booked in FY06. These repayments were earlier not only depriving IDFC of higher spreads but also causing an asset liability mismatch. The institution has also improved the disbursement to sanction ratio (from 55% in 9mFY06 to 59% in 9mFY07) thus clearing most of its pending backlog of approved loans.

Accelerated disbursements…
(Rs m) 9mFY06 9mFY07 Change
Approvals 74,770 91050 21.8%
Disbursements 41,240 53,480 29.7%
D/S ratio 55.2% 58.7%

A higher exposure to the growth oriented sectors such as energy and commercial and industrial infrastructure (IT Parks and SEZs), has enabled IDFC grow its disbursements by 30% YoY during 9mFY07 (in line with the sector). Although IDFC has not divulged the NIMs at the end of 9mFY07, we estimate that the institution has seen some stability in margins in the last quarter to the higher re-pricing of funds. However, the rise in the institutions funding costs cap the possibility of improvement in margins. It may be recalled that the net interest margin (NIMs, 3% in 1HFY07) of the institution that was consistently dropping until FY06 has started stabilising since the first quarter of FY07. This, as explained in our earlier analyses, has been a fallout of the ‘early rising interest rate stage', wherein IDFC enjoys stable NIMs with the arrest in the re-pricing of assets while the cost of funds remain stable (the liabilities having been booked for longer term). We have, however, taking a conservative stance, factored in lower NIMs in our projections for FY08 and FY09.

Fees – Not filtering into margins: The share of non-interest income to IDFC's operating income has fallen from 43% in 9mFY06 to 37% in 9mFY07. Although the institution's fee income has grown by 38% YoY during the nine month period, the contribution of the same to the total remains stagnant at 15%. The unrealised gains in its equity book stood at Rs 2.2 bn at the end of 9mFY07. To de-risk its revenue stream from the project financing business and provide a fillip to fee income, the institution has undertaken several initiatives that include partnership with Feedback Ventures, a 33% stake in SSKI for an exposure in equity market linked product offerings and an MoU with Bank of Baroda for appraising big ticket loans. However, these initiatives are yet to start paying off.

Higher tax incidence: As seen in the past few quarters, the changing income mix (more contribution from other income) and the removal of benefits under section 10 (23 G), has doubled the effective tax rate for IDFC (from 10.3% in 9mFY06 to 19.4% in 9mFY07). IDFC sees this trend continuing, in line with growth in its fee income.

Provision write back aids bottomline: While IDFC continues to have zero NPAs in its books, the institution has had a one time settlement of non performing loans for which it has written back provisions to the tune of Rs 65 m during the nine month period, that has to some extent muted the impact of higher tax incidence.

What to expect?
At the current price of Rs 87, IDFC's stock is reasonably valued at 2.7 times our estimated FY09 adjusted book value. The improved leveraging (debt to equity ratio of 5.2 times in 9mFY07 against 4.4 times in FY06) has helped enhance the return on equity to 20% in 9mFY07 from 17% in FY06. The institution has set a metric of maintaining costs below 0.5% of average assets and plans to sustain a lean franchise going forward, even with the expansion in balance sheet size. With one of the highest capital adequacy ratios (CAR above 20% in 9mFY07), highest operating efficiency (cost to income ratio of barely 9%), and one of the best return ratios, IDFC is amongst our preferred play in the financial sector.

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