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IDFC: Treading a cautious path - Views on News from Equitymaster
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IDFC: Treading a cautious path
Oct 31, 2014 | Updated on Nov 1, 2014

IDFC declared its results for the first quarter (2QFY15) and first half of the financial year 2014-15 (1HFY15). The institution reported a 15.7% YoY increase in its income from operations for 2QFY15. However, the profits declined by 13.4% YoY for 2QFY15 and 13.5% YoY decline during 1HFY15. Here is our analysis of the results.

Performance summary
  • Consolidated income from operations increases 15.7% YoY in 2QFY15 on the back of 20.0% YoY growth in advances. Loan book, however, declines by 2% YoY. Moreover, the sanctions also dropped by 33.0% YoY during 1HFY15 as IDFC chose to be cautious and consolidate its loan book.
  • Overall asset management revenues increased in 2QFY15, total asset under management (AUM) stands at Rs 591.2 bn at the end of September 2014. While the mutual fund drove the growth largely, fees from the alternatives business arouse too.
  • Net interest margins (NIM) dipped to 3.8% levels in 2FY15 from 4.1% a year ago.
  • Other income sees a whopping increase of 163.6% YoY during 2QFY15 primarily on the back of higher principal gains in investment banking and broking income.
  • Bottom-line declines by 13.4% YoY in 2QFY15 and by 13.5% YoY in 1HFY15. This was primarily on account of staggering 461.6% YoY increase in provisions during 2QFY15 and 344.1% spike during 1HFY15.
  • Capital adequacy ratio stands at a robust 25.9% at the end of 1HFY15 (Tier-1 ratio of 23.7%).
  • Net NPAs spiked to 0.4% at the end of September 2014.

Consolidated financial performance snapshot
Rs (m) 2QFY14 2QFY15 Change 1HFY14 1HFY15 Change
Income from operations 21,485 24,860 15.7% 44,465 46,085 3.6%
Interest expended 12,604 13,851 9.9% 25,379 26,884 5.9%
Net Interest Income  8,881 11,009 24.0% 19,086 19,202 0.6%
Net interest margin       4.1% 3.8%  
Other Income 6 15 163.6% 11 681 5978.6%
Operating expense 1,375 1,984 44.3% 2,759 2,522 -8.6%
Provisions and contingencies 501 2,812 461.6% 1,092 4,851 344.1%
Profit before tax 7,011 6,229 -11.2% 15,245 12,510 -17.9%
Tax 2,099 1,833 -12.7% 4,726 3,249 -31.3%
Effective tax rate 29.9% 29.4%   31.0% 26.0%  
Share of profit from associates 4 (136)   7 (133)  
Minority interest 49 45   86 96  
Profit after tax/ (loss) 4,868 4,214 -13.4% 10,441 9,031 -13.5%
Net profit margin (%) 22.7% 17.0%   23.5% 19.6%  
No. of shares (m)         1,590  
Book value per share (Rs)*         106.6  
P/BV (x)         1.5  
* (Book value as on 30th September 2014)

What has driven performance in 2QFY15?
  • With exactly a year away from setting up a bank, IDFC today stands in a consolidation phase. With cautious credit off-take, higher provisioning buffer and treasury built-up, the company is putting the entire arsenal in place for the bank setup. And these measures have had the impact on margins and earnings alike.

    The reform wheel set to be rolled out by the new government is expected to augur well for the infrastructure development. While the company is on the consolidation mode treading a cautious path, the business growth has been modest. Also, setting up a private bank will call for uncertainties in the medium term for the largest infrastructure financing company. While we continue to have a closer look at these challenges, we believe the benefits of transition into a bank will come with time. Meanwhile, the company continues to consolidate its assets, combat the asset quality challenges and put the structure in place to prepare for the transitional phase.

  • That the infrastructure activity is yet to pick up is no news. And that's being reflected in the IDFC's books. But the company is also treading a cautious path with restricting exposures to quality borrowers and consolidating its loan book. Therefore, the sanctions have witnessed a downward trajectory. Due to the slowdown in infrastructure sector, the company has changed the loan mix and re-evaluated risk-adjusted returns. Moreover, a bank set-up in the near future would also imply pressures on the asset book of the company. However, we do not factor any numbers on this front as on today.

    Despite the fact that IDFC's balance sheet growth has been affected over the last two years, the company has retained its moat of being one of the biggest and profitable lenders to infrastructure with an eye on asset quality and shareholder returns. Moreover, the banking license privilege would bring in additional benefits in the long-run for the company if the new guidelines on infra lending citing regulatory exemptions are anything to go by.

    Significant slowdown in sanctions
    (Rs m) 1HFY14 1HFY15 Change
    Sanctions 152,510 102,130 -33.0%
    Disbursements 57,140 68,540 20.0%
    D/S ratio 37.5% 67.1%  
    Advances 559,570 548,510 -2.0%

  • Focus on risk-free assets has narrowed the spreads of the company. Consequently the margins have declined to 3.8% levels.

  • With infra activity and capex cycle is yet to pick up, asset quality may not put up a strong show. Yet the asset quality for IDFC has remained stable. While the gross NPAs have gone up to 0.6% in 2QFY15 and the net NPAs too have gone up to 0.4%, they remain one of the lowest in the industry. The net restructured loans have been reported at 6.1% of the total loan book during the 1HFY15. On prudential grounds, the company has been proactively providing higher than the regulatory norm to avoid any major shortcomings in the future particularly on the bank front. While this might dent the short-term profitability of the company, the company would continue to maintain buffer treading a cautious path

  • IDFC has boosted its capital adequacy by raising capital through a QIP issue. Also the Board has approved de-merger of the company into a banking subsidiary. It has also been decided that the IDFC shareholders would also be accorded the shares of the newly formed IDFC Bank. Besides, the management is proactively engaged with hiring executives for its banking operations.
What to expect?
At the current price of Rs 157, the stock is valued at 1.3 times our FY17 adjusted book value. IDFC is one of the best poised institutions in the financial sector to weather sectoral headwinds. It has the highest capital adequacy ratio and high operating efficiency. The company today stands in a transition phase moving cautiously on the growth path. We are particularly impressed by the prudent management skills on the provisioning front and the consolidation of the balance sheet to fulfill the regulatory requirements stands equally commendable. This will help the company to build up a healthy bank structure in place.

We have factored in muted growth in loan book and risks to margins and asset quality in our assumptions. The near term hiccups stand imminent as the company transitions into a bank. While negative sentiments towards the infrastructure sector may prevail in the near to medium term, investors should reap the benefit of steady long term players like IDFC. We thus reiterate our BUY view on the stock with a long-term perspective.

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