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IDFC: Bank set up costs weigh on profits - Views on News from Equitymaster
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IDFC: Bank set up costs weigh on profits
May 6, 2015

IDFC declared its results for the fourth quarter and financial year ended March 2015 (FY15). The institution reported 13.3% YoY increase in net interest income for FY15. However, the profits declined by 5.3% YoY for the fiscal. Here is our analysis of the results.

Performance summary
  • Consolidated income from operations increases 9.9% YoY in FY15 despite 8% YoY fall in project loans. The disbursement to sanction ratio also remained below 60% as IDFC chose to be cautious and consolidate its loan book.
  • Overall asset management revenues increased by 6% in FY15, total asset under management (AUM) stands at Rs 622 bn at the end of March 2015. While the mutual fund drove the growth largely, fees from the alternatives business rose too.
  • Net interest margins (NIM) dipped to 4.2% levels in FY15 from 4.5% a year ago.
  • Other income sees a whopping increase of 229% YoY during FY15 primarily on the back of higher principal gains in investment banking and broking income.
  • Bottom-line declines by 5.3% YoY in FY15 primarily on account of doubling of operating costs and increase in provisions. Cost to income ratio increases to 17.3% from 9.7% in FY14.
  • Capital adequacy ratio stands at a robust 24.3% at the end of FY15 (Tier-1 ratio of 23%).
  • Net NPAs stood at 0.2% at the end of March 2015 (0.4% in FY14).

Consolidated financial performance snapshot
Rs (m) 4QFY14 4QFY15 Change FY14 FY15 Change
Income from operations 22,022 25,689 16.7% 87,613 96,284 9.9%
Interest expended 12,493 14,842 18.8% 52,552 56,577 7.7%
Net Interest Income† 9,529 10,847 13.8% 35,061 39,707 13.3%
Net interest margin       4.5% 4.2%  
Other Income 173 141 -18.5% 285 940 229.8%
Operating expense 1,364 2,585 89.5% 3,438 7,051 105.1%
Provisions and contingencies 4,825 3,751 -22.3% 6,283 10,134 61.3%
Profit before tax 3,513 4,652 32.4% 25,625 23,462 -8.4%
Tax 1,037 846 -18.4% 7,854 6,491 -17.4%
Effective tax rate 29.5% 18.2%   30.6% 27.7%  
Share of profit from associates 6 (57)   20 6 -70.0%
Minority interest 92 73 -20.7% 235 92 -60.9%
Profit after tax/ (loss) 2,574 3,822 48.5% 18,026 17,069 -5.3%
Net profit margin (%) 11.7% 14.9%   20.6% 17.7%  
No. of shares (m)     1,590  
Book value per share (Rs)*         108.6  
P/BV (x)         1.5  
* (Book value as on 31st March 2015)

What has driven performance in FY15?
  • With just a few months away from setting up a bank, IDFC today stands in a consolidation phase. The cautious credit off-take, higher provisioning buffer and treasury built-up are all in an effort to meet regulatory requirements for the banking business. And these measures have had the impact on margins and earnings alike. Having said that, the challenges pertaining to infrastructure sector continue to haunt IDFC's books.

  • The disbursement to sanction ratio continued to remain disappointing despite the fact that corporate have started availing the loans that they got sanctioned in the past. However, we believe this loan demand could strengthen IDFCs balance sheet going forward.

    Sluggish disbursement to sanction ratio
    (Rs m) FY14 FY15 Change
    Sanctions 256,830 239,300 -6.8%
    Disbursements 162,960 138,300 -15.1%
    D/S ratio 63.5% 57.8%  
    Advances 595,054 547,450 -8.0%

  • Focus on risk-free assets has narrowed the spreads of the company. Consequently the margins have declined to 4.2% levels.

  • Even though IDFC is much better off as compared to most other large banks exposed to infrastructure lending, the gross NPAs have gone up to 0.7% in FY15 while the net NPAs have come in lower at 0.2% due to conservative provisioning. On prudential grounds, the company has been proactively providing higher than the regulatory norm to avoid any major shortcomings in the future particularly on the bank front. While this might dent the short-term profitability of the company, the company would continue to maintain buffer treading a cautious path

  • As entity is still in the process of setting up the banking arm, the incremental impact on cost to income ratio has been significant. We expect this ratio to normalize as and when the banking entity becomes a revenue centre.
What to expect?
At the current price of Rs 162, the stock is valued at 1.3 times our FY17 adjusted book value. IDFC is one of the best poised institutions in the financial sector to weather sectoral headwinds. It has the highest capital adequacy ratio and high operating efficiency. The company today stands in a transition phase moving cautiously on the growth path. We are particularly comfortable with the prudent management skills on the provisioning front.

We have factored in muted growth in loan book and risks to margins and asset quality in our assumptions. The near term hiccups stand imminent as the company transitions into a bank. While negative sentiments towards the infrastructure sector may prevail in the near to medium term, investors should reap the benefit of steady long term players like IDFC. However, investors must keep a watch on the return ratio (RoE) which has fallen to 10.3% in FY15. While we continue to reiterate our buy view on the entity, investors must ensure that the stock does not comprise more than 5% of their overall portfolio.

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