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IDFC: Concrete progress - Views on News from Equitymaster

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IDFC: Concrete progress

Apr 26, 2007

Performance summary
IDFC declared results for the fourth quarter and fiscal ended March 2007. While the institution’s asset growth and fee income pipeline remained robust in the last quarter, it marginally underperformed our profit estimates for the full year, primarily due to higher tax incidence. 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 and higher operating costs have dented its net profit margins by nearly 700 basis points (0.7%) despite lower provisioning benefits.

Rs (m) 4QFY06 4QFY07 Change FY06 FY07 Change
Interest income 2,553 4,058 59.0% 10,009 15,006 49.9%
Interest expended 1,415 2,660 88.0% 5,008 8,555 70.8%
Net Interest Income 1,138 1,398 22.8% 5,001 6,451 29.0%
Net interest margin       2.8% 2.9%  
Other Income 17 45 164.7% 19 52 173.7%
Operating expense 164 183 11.6% 407 573 40.8%
Provisions and contingencies 142 169 19.1% 421 215 -48.9%
Profit before tax 849 1,091 28.5% 4,192 5,715 36.3%
Tax 115 241 110.2% 437 1,087 149.0%
Profit after tax/ (loss) 735 850 15.8% 3,756 4,628 23.2%
Net profit margin (%) 28.8% 21.0%   37.5% 30.8%  
No. of shares (m) 1,122 1,126   1,122 1,126  
Diluted earnings per share (Rs)* 2.6 3.0   3.3 4.1  
P/E (x)         23.8  
* (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 FY06. 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 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 4QFY07?
Signs of slowdown...
(Rs m) FY06 FY07 Change
Approvals 106,310 130530 22.8%
Disbursements 60,450 72,070 19.2%
D/S ratio 56.9% 55.2%  
Slow but steady growth: Curtailment of the high rate of pre-payments that existed in a falling interest scenario and re-pricing of loans at higher rates than those booked in FY06 continued to aid IDFC’s net interest margins in the final quarter of FY07. This was helped by the fact that the institution accessed 8% of its borrowings from overseas at lower interest rates. The institution has, however, recorded a lower disbursement to sanction ratio (55% in FY07 from 57% in FY06) thus suggesting a slowdown in incremental offtakes.

A higher exposure to the growth oriented sectors such as energy (grew 13% YoY) and commercial and industrial infrastructure (largely hotels, IT Parks and SEZs), has enabled IDFC grow its disbursements by 19% YoY during FY07 (lower than the sector). Although IDFC has not divulged the NIMs at the end of FY07, we estimate that the institution has seen some stability in margins in the last quarter due to the higher re-pricing of funds. While yield on infrastructure loans has improved by 30 basis points, that on treasury assets has expanded by 60 basis points. 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 had estimated the NIMs at 2.9% for FY07 and the institution is targeting NIM of 2.0% by FY09.

Fees – Asset management fillip: The share of non-interest income to IDFC’s operating income has declined from 43% in FY06 to 37% in FY07, in line with the institution’s guidance. Although the institution’s fee income has grown by 41% YoY during the period, the contribution of the same to other income increased from 42% to 50%, while the contribution to total operating income improved from 18% to 19% in FY07. The asset management fees grew by 84% YoY and other fees grew by 22% YoY. 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. The SSKI stake contributed Rs 110 m (2%) to the institution’s bottomline in FY07. The unrealized gains in the institution’s equity book stood at 2.1 bn in FY07 excluding the stake in NSE.

The institution is targeting its AUM (assets under management) to go up from US$ 700 m currently to US$ 2 bn by the end of FY08 and US$ 3 bn to 4 bn by FY10. The asset management fees on these funds (at 1.5% to 2% of the corpus) are expected to significantly propel the growth in fee income base. Revenues from the infrastructure fund in collaboration with Citigroup and Blackstone are also expected top filter in 4QFY08 onwards.

Low provisioning cushions 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 10.4% in FY06 to 19.0% in FY07). IDFC sees this trend continuing, in line with growth in its fee income (expected effective tax rate of 22% in FY08).

While IDFC continues to have zero net NPAs (gross NPAs of 0.2%) in its books, it has had a one-time settlement of non-performing loans for which it has written back provisions to the tune of Rs 520 m during the fiscal, which has to some extent muted the impact of higher tax incidence.

Future outlook: In a very important outlook with respect to the direction of its business growth and profit generation, IDFC has given a perspective on its future funded and non-funded income generation. The institution sees its return on assets contracting from 3.3% in FY07 to 2.5% by FY09 (due to decline in net interest income), while its leverage increases from 5.5 times to 7 times over the same period.

FY07 – Operating income to total assets is 4.7% of which 2.8% is derived from interest income and the rest 1.9% from non-funded income. Of the non-funded income, 50% is from the sale of equity while the rest is pure fee income.

FY10E – Operating income to total assets will be 4.0% of which 2.0% will be derived from interest income and the rest from non-funded income. Of the non-funded income, 60% will be from the sale of equity while the rest will be pure fee income.

IDFC plans to raise US$ 500 m (Rs 20 bn at an exchange rate of Rs 41 per dollar) by FY09 through a private placement. This will lead to equity dilution to the tune of 16% to 20%. The funds will be used towards seed capital for capitalising its asset management business.

What to expect?
At the current price of Rs 99, the stock is reasonably valued at 2.9 times our estimated FY09 adjusted book value (without factoring in further equity dilution). The improved leveraging has helped enhance the return on equity to 18% in FY07 from 17% in FY06. The cost to income ratio has, however, risen to 5.3% in FY07 due to addition of 50 employees (35%) and rise in pay scales. With one of the highest capital adequacy ratios (CAR above 20% in FY07), highest operating efficiency and one of the best return ratios, we reiterate our positive view on the stock.

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