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IDFC: Coming full circle… - Views on News from Equitymaster
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IDFC: Coming full circle…
May 3, 2006

Performance summary
India’s leading private sector infrastructure financing company, IDFC, announced its maiden full year results (post listing) for FY06. Higher tax incidence and lower treasury gains took a toll on the institution’s 4QFY06 numbers. Also, while pre or re-payment and repricing of loans continue to weigh heavy on the institution’s margins, an appreciable growth in fee income has cushioned the same. The result analysis also includes excerpts of the conference call with the company.

Rs (m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net Interest Income (loan book) 700 750 7.1% 2,560 2,940 14.8%
Net Interest Income (treasury) (20) (30)   10 90 800.0%
Other Income 940 550 -41.5% 1,730 2,300 32.9%
Total operating income 1,620 1,270 -21.6% 4,300 5,330 24.0%
Operating expense 90 200 122.2% 350 550 57.1%
Provisions and contingencies 560 90 -83.9% 650 350 -46.2%
Profit before tax 970 980 1.0% 3,300 4,430 34.2%
Tax (50) 170 -440.0% 210 520 147.6%
Profit after tax/ (loss) 1,020 810 -20.6% 3,090 3,910 26.5%
Net profit margin (%) 63.0% 63.8%   71.9% 73.4%  
No. of shares (m)       1,000 1,123  
Diluted earnings per share (Rs)*         3.5  
P/E (x)         20.7  
* (12 months trailing)            

A 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 4QFY06?
Beyond project financing: Although IDFC continued to enjoy 25% of the market share in the incremental infrastructure lending in the country during FY06, shrinking yields and higher costs seems to have squeezed the profitability in this business. While the total yields declined by 50 basis points, the total cost of funds appreciated by 20 to 30 basis points. This was also a fallout of the rising interest rate scenario in the domestic and global markets and IDFC’s inability to immediately re-price its assets. The institution also reduced its exposure in telecom ventures (now considered a mature segment) and acquired a higher exposure in commercial and industrial infrastructure funding (primarily SEZs).

(Rs m) FY05 FY06 Change
Approvals 64,140 106,310 65.7%
Projects (no.) 77 88 14.3%
Disbursements 55,540 60,450 8.8%
Projects (no.) 80 85 6.3%
Cum. Infrastructure loans 70,771 101,910 44.0%
Cum. borrowings 65,594 93,800 43.0%
Loans /borrowings (x) 108% 109%  

To de-risk its revenue stream from the project financing business, the institution undertook the following initiatives:

  • Partnership with Feedback Ventures: IDFC has taken a 19.4% stake (option to raise upto 30% in the next 3 years) in Delhi based engineering company, Feedback Ventures. The alliance is expected to facilitate the institution in identifying viable infrastructure projects and catalyze private-public partnerships for financing the same.

  • 33% stake in SSKI: IDFC has taken 33% stake in SSKI for having an exposure in equity market linked product offerings. The same is expected to add to IDFC’s fee-income stream, as SSKI has a substantial market share in the investment banking business.

  • MoU with Bank of Baroda: Due to its small balance sheet size, IDFC is constrained in terms of large ticket borrowings. To get rid of this limitation, the institution has entered into a MoU with Bank of Baroda that can help IDFC raise funds for the projects appraised by it from the banking entity. Also, this will help IDFC overcome the handicap of limited geographical reach.

Multiplying fees: IDFC’s share of non-interest income in total income has increased to 43% in FY06 from 40% in FY05 while the share of stable fee income (grew 96% YoY) in total non-interest income has almost doubled to 42% from 28% in FY05. This has helped IDFC cushion the lower treasury gains witnessed in the current fiscal. While the unrealised gains in the institution’s books stand at Rs 2.8 bn, lesser opportunities for unlocking the gains have muted profits on this front.

It is, however, interesting to note that IDFC has garnered US$ 650 m as assets under management through its second private equity fund. It is liable to receive a fee income of 2% of the AUM over and above the returns generated above the hurdle rate over the next 10 years (duration of the fund). This will give it a steady fee revenue stream. Also, the profits above the hurdle rate will be share on a 20:80 basis (20% for IDFC).

Taxing times: 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 6% in FY05 to 12% in FY06. IDFC sees this trend continuing, in line with the growth in fee income.

Returns - not in line with targets: As against the earlier target set by IDFC for sustaining its ROA above 4% for the next 2 fiscals, the same have already shrinked to 3.8% in FY06 (2.6% in 4QFY06) against 4.5% in FY05. A pre-payment ratio of 25% has also been a drag on IDFC’s return ratios. Nevertheless, the entity continues to enjoy the highest return ratios in the sector. Also, with increasing leverage (4.4 x in FY06), IDFC’s return on equity (RoE) has remained stable at 17% despite the post-IPO equity dilution.

What to expect?
IDFC, interestingly, benchmarks itself against players like Australian ‘Macquarie Bank’ that is focussed in investment banking deals for infrastructure projects and has a large chunk of its revenue emanating from stable fee income rather than interest income.

Besides having sufficient equity capital (CAR 26% in FY06) to support growth, IDFC also enjoys the highest operating efficiency in the financial sector. 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.

At the current price of Rs 72, IDFC’s stock is trading at 2.7 times our estimated FY08 adjusted book value. Though the stock seems to be fairly valued in terms of its future growth prospects and possible depression in margins, we believe that given the prospects of private sector financing in the country’s infrastructure lending needs, IDFC is ideally positioned to capitalise on the same.

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