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IDFC: Resilient to cyclicality - Views on News from Equitymaster
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IDFC: Resilient to cyclicality
Oct 15, 2007

Performance summary
  • Operating income grows 56% YoY on the back of 36% YoY growth in advances and 43% growth in incremental disbursements.

  • Disbursement to sanction ratio improves from 55% to 58%.

  • Net interest margins drop to 2.2% from 2.8% in 2QFY07.

  • Non-interest income grows 97% YoY.

  • Bottomline grows by 27% YoY despite higher provisioning and operating expenses.

Rs (m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Operating income 3,876 6,027 55.5% 7,085 11,595 63.7%
Interest expended 1,960 3,297 68.2% 3,604 6,404 77.7%
Net Interest Income 1,916 2,730 42.5% 3,481 5,191 49.1%
Net interest margin       2.8% 2.2%  
Other Income 0 17   7 17  
Operating expense 149 231 55.0% 252 456 81.0%
Provisions and contingencies (15) 173   (8) 246  
Profit before tax 1,782 2,343 31.4% 3,244 4,506 38.9%
Tax 367 548 49.2% 617 1,034 67.6%
Profit after tax/ (loss) 1,415 1,795 26.8% 2,627 3,472 32.2%
Net profit margin (%) 36.5% 29.8%   37.1% 29.9%  
No. of shares (m) 1,125 1,294   1,125 1,294  
Book value per share (Rs)*         38.5  
P/BV (x)         4.7  
* (Book value as on 30th September 2007)

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 2QFY08?
Indifference to NIMs: Besides a re-shuffle in its loan portfolio, nothing much has changed in the business dynamics of IDFC in the last quarter. While despite the firmness in interest rates, the demand for infrastructure loans remained strong, the institution reduced its exposure to transportation and industrial and commercial infrastructure. The same was routed to energy and telecom sectors. IDFC reported 36% YoY growth in advances in 1QFY08 on the back of a buoyant 43% YoY growth in disbursements. The sanction to disbursement ratio also improved to 57.5% in this quarter as against 54.6% 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 60 basis points YoY. This was due to the fact that the institution accessed high cost borrowings.

Going steady…
(Rs m) 1HFY07 1HFY08 Change
Sanctions 63,170 85,930 36.0%
Disbursements 34,460 49,380 43.3%
D/S ratio 54.6% 57.5%  
Advances 124,000 168,180 35.6%

The net interest income from infrastructure loans (grew 31% YoY) was 76% of total NII. More than 60% of the institution’s exposure was towards energy (40%) and transportation (27%) sectors in 1HFY08. 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 FY08 once the institution repays the high cost liabilities and replaces them with equity funds.

Fees – Well diversified stream: The share of non-interest income to IDFC’s operating income has increased from 21% in 1HFY07 to 25% in 1HFY08. Fee income increased by 2.0 times and the share of fees in non-interest income increased from 42% in 1HFY07 to 57%. More than half of the fee income was derived from investment banking, thanks to the spurt of offshore and domestic inorganic growth initiatives by Indian corporates. Asset management fees comprised 16% of the total fee income generating returns of 4% on the total invested corpus of Rs 600 m. Profit on sale of equity investments and income from dividends increased by 34% 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 unrealised gains in the institution’s equity book stood at 3.2 bn (Rs 2.5 per share) in 1HFY08 excluding the stake in NSE.

Non interest income
1HFY07 1HFY08 Change
Rs m   Rs m % of fees Rs m % of total  
950 Treasury     1,270 43.3% 33.7%
             
540 Fees     1,660 56.7% 207.4%
  Asset Management 260 15.7%      
  Investment Banking 910 54.8%      
  Corporate advisory 40 2.4%      
  SSKI fees + Others 450 27.1%      

IDFC is targeting its assets under management (AUM) to go up from US$ 600 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.

Costs rear their head: 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 increased the effective tax rate for IDFC (from 20.6% in 2QFY07 to 23.4% in 2QFY08). IDFC sees this trend continuing, in line with growth in its fee income (expected effective tax rate to stabilise at 22% in FY08). The operating costs for the institution have also increased by 55% YoY in 2QFY08 and 81% YoY in 1HFY08, with the additional employee intake.

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 (1HFY08 CAR not divulged). 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 has risen sharply to Rs 39 per share in 1HFY08 from Rs 26 in FY07.

What to expect?
At the current price of Rs 185, the stock is fairly valued at 3.3 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 company with a long-term perspective. However, given the valuations, fresh investments at the current levels are unwarranted.

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