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IDFC: Seeking stability - Views on News from Equitymaster
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IDFC: Seeking stability
Jul 24, 2006

Performance summary
India’s leading private sector infrastructure financing company, IDFC, announced a good set of numbers for 1QFY07 yesterday. While the institution’s bottomline growth is well in line with what has been witnessed over the past few quarters, lower pre-payment and repricing of loans has led to stability in its net interest margins. Higher tax incidence and lower treasury income has, however, acted as dampeners.

Consolidated numbers…
Rs (m) 1QFY06 1QFY07 Change
Interest income 2,598 3,388 30.4%
Interest expended 1,114 1,643 47.5%
Net Interest Income 1,484 1,745 17.6%
Other Income 2 6 320.0%
Total operating income 1,486 1,751 17.9%
Operating expense 92 132 43.6%
Provisions and contingencies 213 10 -95.5%
Profit before tax 1,181 1,610 36.3%
Tax 89 298 234.9%
Profit after tax/ (loss) 1,092 1,312 20.1%
Net profit margin (%) 42.0% 38.7%  
No. of shares (m) 1,002 1,122  
Diluted earnings per share (Rs)* 4.4 3.6  
P/E (x)   13.9  
* (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 1QFY07?
Reaping rate hike benefits: 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 a staggering 71% YoY during 1QFY07. The disbursement to sanction ratio has also showed a marked improvement from 40% in 1QFY06 to 51% in 1QFY07. But more importantly, it is the difference between gross and net disbursements (net of re/pre-payments) that has narrowed down due to the rising interest rate scenario. These repayments were earlier not only depriving IDFC of higher spreads but also causing an asset liability mismatch. As against this, the institution had a well-matched balance sheet at the end of 1QFY07 (asset duration 2 years, liability duration 2.1 years).

Accelerating growth…
(Rs m) 1Q06 1Q07 Change
Approvals 19,130 26400 38.0%
Disbursements 7,789 13,320 71.0%
D/S ratio 40.7% 50.5%  
Cum. Infrastructure loans 71,756 111,940 56.0%
Cum. borrowings 66,653 111,310 67.0%
Loans /borrowings (x) 108% 101%  

The net interest margins (NIMs, 3% in 1QFY07) of the institution that were consistently falling since the past five quarters have started showing some signs of stability. IDFC has explained this with the following rationale. The interest rate scenario is divided into 4 phases:

  1. Early stage of falling interest rates: Corporate lending institutions like IDFC face a pressure on NIMs during this stage as the re-pricing of assets happen faster than that of the liabilities.

  2. Mature stage of falling interest rates: These institutions enjoy higher NIMs during this stage as it gets access to lower cost of funds as compared to the yield on assets.

  3. Early stage of rising interest rates: The institutions enjoy stable NIMs during this stage the re-pricing of assets stops while the cost of funds remain stable (the liabilities having been booked for longer term).

  4. Mature stage of rising interest rates: These institutions face a pressure on NIMs during this stage as the liabilities also start getting re-priced higher.

IDFC, which is at the third stage of the cycle currently, therefore, sees its NIMs remaining stable in the near term. We have, however, factored in lower NIMs in our projections for FY08 and FY09.

Leveraging for growth: IDFC continues to enjoy the highest return ratios in the sector. Also, with increasing leverage (4.6 times debt to equity in 1QFY07), IDFC’s return on equity has improved to 20%. The institution is targeting a leverage ratio of 7.5 times and hopes to reach an optimal capital structure in the next 36 months.

Higher tax incidence: 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 9.1% in 1QFY06 to 18.5% in 1QFY07). IDFC sees this trend continuing, in line with growth in its fee income.

A fillip to fee: IDFC’s non-interest income has fallen by 23% YoY in 1QFY07 largely due to the impact of lower treasury gains. The unrealised gains in its equity book stood at Rs 1.9 bn at the end of 1QFY07. However, the share of fee income (grew 9% YoY) to other income increased from 31% in 1QFY06 to 42% in 1QFY07. To de-risk its revenue stream from the project financing business and provide a fillip to fee income, the institution has undertaken the following initiatives:

  • Partnership with Feedback Ventures: IDFC has bought 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 catalyse private-public partnerships for financing the same.

  • Stake in SSKI: IDFC has acquired a 33% stake in SSKI for 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 memorandum of understanding (MoU) with Bank of Baroda that can help the former raise funds for the projects appraised by it from the banking entity. Also, this will help IDFC overcome the handicap of limited geographical reach.

What to expect?
At the current price of Rs 50, IDFC’s stock is attractively valued at 1.7 times our estimated FY08 adjusted book value. IDFC interestingly benchmarks itself against players like the 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 of 23% in 1QFY07) 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. Given the stability in margins and the institution’s capability to cater to country’s private sector infrastructure lending needs, IDFC is amongst our preferred plays from a long-term perspective.

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