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IDFC: Research meet extracts - Views on News from Equitymaster
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IDFC: Research meet extracts
Sep 26, 2005

We recently met the management of IDFC to understand their perspective on the infrastructure funding potential in the country, IDFC’s positioning in the same and the institution’s future growth prospects. Following are the key extracts of the meeting. Key focus areas
IDFC concentrates its operation on four key areas of infrastructure funding.

  • Energy: In the energy sector, IDFC focuses on power generation, transmission and distribution and had 34% of its total exposure in this segment in FY05. The Government aims to add 0.1 m megawatts of generation capacity by 2012, 23% of which would be in the private sector. This would provide access to the 45% of households still without power and would require an investment of approximately US$ 100 bn. Also, the National Power Grid calls for investment of Rs 700 bn of which Rs 300 bn would be required from private sector. Given these and the implementation of the Electricity Act 2003, IDFC sees significant financing opportunities in this segment.

  • Transportation: In the transport sector, IDFC focuses on roadways and port financing and had 26% of its total exposure in this segment in FY05. The National Highways Development Project (Phases II, III and IV) is likely to require investment of Rs. 1,720 bn over the next 7 years. Also, privatisation of ports, financing of new airways and ports offers financing opportunities to private players like IDFC.

  • Telecommunication: India’s mobile penetration of 5% is very low as compared to 21% in China and 54% in the United States. Although, IDFC believes that the sector has sufficiently matured in terms of policy initiatives and established players, it contemplates that consolidation in the sector will provide attractive financing opportunities. However, IDFC’s exposure to this segment is expected to reduce from the current levels of 27%.

  • Industrial and commercial infrastructure: According to estimates of the World Travel and Tourism Council, Indian tourism is expected to grow at an annual rate of 8.8% through 2014, indicating significant opportunities for infrastructure financing in the sector. 70% of IDFC’s exposure in this segment is concentrated in tourism while the remaining proportion is disbursed to SEZs and IT parks. Although this segment comprised only 8% of IDFC’s total exposure in FY05, IDFC is envisaging a strong traction in this segment going forward.

Overall, while the company does not envisage sustenance of the exponential rate of credit growth that it has witnessed in the last couple of years (3 year CAGR 63%), it does expect the credit offtake to remain buoyant. We have assumed a 3-year CAGR of 37% in the advance portfolio with a credit to borrowing ratio of 98% (historical credit to borrowing ratio 110%).

Competition
IDFC sees banks like SBI and ICICI Bank as its main competitors in the infrastructure financing space given their corporate exposure and project appraisal skills. Also, given the liquidity overhang in the system most banks are gearing up to enhance their exposure to the corporate book and capitalise on the capex cycle. Although IDFC acknowledges that competition from banks is a significant threat to it due to the inherent disadvantage of lack of access to low cost funds (unlike banks), it believes that not having to comply with the SLR and CRR requirements gives it an edge of 200 to 250 basis points in spreads.

Margins – re-pricing effect
IDFC has witnessed a contraction in its net interest margins to 3.1% in 1QFY06 (from 3.5% in 1QFY05) due to re-pricing of yields of some of its old assets. The institution cites this as an exception and does not see this trend continuing in the coming quarters. We, however, have assumed the net interest margins to reduce to 2.5% by FY08E.

Fee over treasury
Thanks to the huge gains made in its treasury portfolio, treasury income comprised 80% of IDFC’s non-interest income at the end of FY05. The institution has booked Rs 520 m of treasury profits in 1QFY06 and continues to hold proprietary equity investments with market value of Rs 2.2 bn in its books. Further, the IRR on the treasury book stands at an impressive 37%. However, going forward, IDFC wishes to reverse the contribution in favour of the more stable ‘fee income’ and sees this segment contributing 70% of the non interest income in the coming years. Also, it has constituted dedicated SBUs to concentrate on fee revenue streams such as debt syndication, equity placements and advisory services.

Human resource
The institution has total staff strength of 120 in FY05 of which 87 are in the middle management level. While the institution will be looking at addition to the existent strength in the coming years, it is essential to point out that it has enjoyed very low attrition rate of 3% to 4%.

Our view
While IDFC’s management does see its ROA (return on asset) of 4.1% in FY05 (one of the highest in the industry) reducing going forward, with an increase in the leverage ratio (4 times in FY05), it does not expect it to fall below 2.5% in the next 5 fiscals. Also, the institution is confident of sustaining its cost efficiency by capping the cost to asset ratio at 0.5% (0.1% in FY05) and maintaining its asset quality.

While we are very enthused by IDFC’s focused growth plans and operational efficiency, pressures on the margin front are well anticipated. However, we believe that IDFC is ideally positioned to capitalise on the infrastructure financing opportunities in the country and operate on well-guided parameters like one of its promoters, HDFC. At the current price of Rs 68 per share, IDFC’s stock is trading at 2.5 times our estimated FY08 adjusted book value. We would thus recommend investors to hold on to the stock for the longer term.

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