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IDFC: Facing cyclical hiccups - Views on News from Equitymaster

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IDFC: Facing cyclical hiccups
Jul 26, 2007

Performance summary
  • Operating income grows 73% YoY on the back of 30% YoY growth in advances and 84% growth in incremental disbursements.

  • Net interest margin drop to 1.9% from 2.8% in 1QFY07.

  • Non-interest income to operating income at 30%.

  • Bottomline grows by 38% YoY despite higher provisioning and operating expenses.

  • Net profit margins decline from 37.8% to 30.1%

Standalone numbers…
Rs (m) 1QFY07 1QFY08 Change
Operating income 3,211 5,568 73.4%
Interest expended 1,643 3,106 89.0%
Net Interest Income 1,568 2,462 57.0%
Net interest margin 2.8% 1.9%  
Other Income 6 0 -98.4%
Operating expense 102 225 120.6%
Provisions and contingencies 10 73 656.3%
Profit before tax 1,463 2,165 48.0%
Tax 250 486 94.4%
Profit after tax/ (loss) 1,213 1,679 38.4%
Net profit margin (%) 37.8% 30.1%  
No. of shares (m) 1,122 1,128  
Book value per share (Rs)*   25.5  
P/BV (x)   5.3  

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 1QFY08?
Little filtering to NIMs: IDFC reported a 30% YoY growth in advances in 1QFY08 on the back of a buoyant 83.5% YoY growth in disbursements. The sanction to disbursement ratio also improved to 58.8% in this quarter as against 50.5% in the corresponding quarter of FY07. However, despite the lower rate of pre-payments that existed in a firm interest scenario and re-pricing of loans at higher rates than those booked in FY07, IDFC failed to shield its net interest margins from slippage of nearly 90 basis points YoY. This was due to the fact that the institution accessed high cost borrowings during FY07.

Signs of slowdown…
(Rs m) 1QFY07 1QFY08 Change
Sanctions 26,400 41,570 57.5%
Disbursements 13,320 24,440 83.5%
D/S ratio 50.5% 58.8%  
Advances 113,140 147,590 30.4%

The net interest income from infrastructure loans (grew 11% YoY) was 42% of total NII. More than 60% of the institution’s exposure was towards energy (37%) and transportation (28%) sectors in 1QFY08. The YoY growth of outstanding advances in these segments was 41% and 30% respectively. While yield on infrastructure loans has improved by 40 basis points to 9.5%, that on treasury assets has expanded by 90 basis points to 8.6%. However, the rises in cost of liabilities have squeezed the institution’s margins. This, as explained in our earlier analyses, has been a fallout of the ‘mature stage of rising interest rates’, wherein IDFC faces pressure on NIMs during this stage, as the liabilities also start getting re-priced higher. We have estimated the NIMs to stabilise at 2.6% in FY08E once the institution repays the high cost liabilities and replaces them with equity funds.

Fees – Non asset management fillip: The share of non-interest income to IDFC’s operating income has declined from 43% in 1QFY07 to 30% in 1QFY08, in line with the institution’s guidance. Fee income increased 3.4 times to Rs 870 m and the share of fees in non-interest income increased from 42% in 1QFY07 to 53%. Asset management fees, however, decreased by 13% due to higher debt component instead of equity. Profit on sale of equity investments increased by 132% 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 67% stake in SSKI for an exposure in equity market linked product offerings and an MoU with IIFCL for appraising big ticket infrastructure loans. The SSKI stake contributed 39% of the total fee income in 1QFY08. The unrealized gains in the institution’s equity book stood at 2.4 bn in 1QFY08 excluding the stake in NSE. The institution has acquired the stake in SSKI for Rs 2.5 bn.

Non interest income % of fees % of total
Treasury   47.3
     
Fees   52.7
SSKI fees 39  
Equity syndication 15  
Debt syndication 6  
Corporate advisory 40  

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 to filter in 4QFY08 onwards. The asset management fee in 1QFY08 was to the tune of Rs 130 m as against Rs 530 m in the full year FY07.

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 17% in 1QFY07 to 22.5% in 1QFY08). IDFC sees this trend continuing, in line with growth in its fee income (expected effective tax rate to stabilise at 22% in FY08).

Capital requirements addressed: IDFC’s CAR (capital adequacy ratio) had declined to 19.1% in June 2007 from 25.6% at the end of March 2006. The institution raised capital to the tune of US$ 500 m (Rs 21 bn) through a qualified institutional placement (QIP) of 165 m shares at Rs 127 per share. With this, its book value would also rise sharply to Rs 43 per share in FY08 from Rs 26 in FY07. We expect that post capital raising (14% equity dilution), IDFC’s 'return on equity' (17.8% in FY07) would be temporarily depressed in FY08E and FY09E but will rebound to near the same level by FY10. The Board of IDFC has also approved increase in FII shareholding limit from 49% to 74%.

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.

What to expect?
At the current price of Rs 135, the stock is reasonably valued at 2.4 times our estimated FY10 adjusted book value (after factoring in the equity dilution). The enhanced book value poises IDFC attractively against its peers in terms of forward valuations. Also, at the end of FY07, IDFC held 8.2% stake in NSE and going by the valuation of the latter at US$ 2.3 bn (as per the recent deals), the gains per share of IDFC for the stake held in NSE comes to Rs 5 per share (not factored into its book value). With one of the highest capital adequacy ratios, highest operating efficiency and one of the best return ratios, we reiterate our positive view on the stock.

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