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IDFC: On stable ground - Views on News from Equitymaster
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IDFC: On stable ground
Oct 31, 2006

Performance summary
India’s leading private sector infrastructure financing company, IDFC’s numbers for 2QFY07 stack up very impressively both in terms of growth and margin fronts. A strong traction in infrastructure lending, lower pre-payment and repricing of loans, coupled with fee income cushion has led to stability in its net profit margins. An extraordinary provisioning write-back has provided a fillip to the bottomline growth despite the higher tax incidence.

Standalone numbers…
Rs (m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Interest income 2,448 3,863 57.8% 5,008 7,072 41.2%
Interest expended 1,162 1,960 68.7% 2,276 3,604 58.3%
Net Interest Income 1,286 1,903 48.0% 2,732 3,468 26.9%
Other Income 0 13 6450.0% 2 19 1112.5%
Operating expense 91 149 64.4% 159 252 58.1%
Provisions and contingencies 49 (15)   261 (8)  
Profit before tax 1,147 1,782 55.4% 2,314 3,243 40.2%
Tax 103 367 258.3% 187 617 230.8%
Profit after tax/ (loss) 1,044 1,414 35.5% 2,127 2,626 23.5%
Net profit margin (%) 42.7% 36.6%   42.5% 37.1%  
No. of shares (m) 1,122 1,125   1,122 1,125  
Diluted earnings per share (Rs)* 3.7 5.0   3.8 4.7  
P/E (x)         17.6  
* (12 months trailing)

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 2QFY07?
Efficiency in growth…
(Rs m) 1H06 1H07 Change
Approvals 62,545 63170 1.0%
Disbursements 23,903 34,420 44.0%
D/S ratio 38.2% 54.5%  
Benign interest rate scenario: Despite an upward movement in interest rates, 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 441% YoY during 1HFY07. The institution has also improved the disbursement to sanction ratio (from 38% in 1HFY06 to 55% in 1HFY07) thus clearing most of its pending backlog of approved loans. 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 1HFY07 (asset duration 2 years, liability duration 2.2 years).

The net interest margin (NIMs, 3% in 1HFY07) of the institution that was consistently dropping until FY06, has started stabilising since the first quarter of FY07. This, as explained in our earlier analyses, has been a fallout of the ‘early rising interest rate stage’, wherein IDFC enjoys stable NIMs with the arrest in the re-pricing of assets while the cost of funds remain stable (the liabilities having been booked for longer term). We have, however, taking a conservative stance, factored in lower NIMs in our projections for FY08 and FY09.

Fees – Cushioning margins: IDFC’s non-interest income has grown by 14% YoY in 1HFY07, of which, the fee income has grown by 45% YoY, bringing the contribution of fees to non-interest income to 35% from 28% in 1HFY07. The unrealised gains in its equity book stood at Rs 1.6 bn at the end of 1HFY07. 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 33% stake in SSKI for an exposure in equity market linked product offerings and an MoU with Bank of Baroda for appraising big ticket loans. The fact that the institution’s other income has multiplied 20 times (albeit on a small base) shows that the initiatives have started paying off.

Leveraging for growth: IDFC continues to enjoy the highest return ratios in the sector. Also, with increasing leverage (5.1 times debt to equity in 1HFY07), IDFC’s return on equity has improved to 21%. 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: 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 8.1% in 1HFY06 to 19.0% in 1HFY07). IDFC sees this trend continuing, in line with growth in its fee income.

Provision write back buoys bottomline: While IDFC continues to have zero NPAs in its books, the institution has had a one time settlement of non performing loans for which it has written back provisions to the tune of Rs 65 m this quarter, that has to some extent nullified the impact of higher tax incidence.

What to expect?
At the current price of Rs 81, IDFC’s stock is attractively valued at 2.8 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. 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. With one of the highest capital adequacy ratios (CAR above 20% in 1HFY07), highest operating efficiency (cost to income ratio of barely 4%, and one of the best return ratios, IDFC is amongst our preferred in the financial sector.

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