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IDFC: Building blocks - Views on News from Equitymaster
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IDFC: Building blocks
Dec 19, 2005

Performance Summary
Accentuating the prospects in infrastructure financing, IDFC continued to register impressive growth and margins for the second consecutive quarter in 2QFY06. The profit expansion, albeit on a lower base, was contributed by both core infrastructure lending and treasury activities. However, in stark distinction to the previous quarter, contribution from other income was negligible. Also, high provisioning seems to have had a very trivial dampening effect on the margins.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 1,581 2,577 63.0% 2966.9 5139.5 73.2%
Other Income 25 0 -99.2% 24.6 1.6 -93.6%
Interest Expense 722 1,163 61.2% 1386.8 2,279 64.3%
Net Interest Income 860 1,415 64.5% 1580.1 2860.3 81.0%
Other Expense 51 91 77.0% 112.3 159.3 41.9%
Operating Profit 809 1,324 63.7% 1,468 2,701 84.0%
Operating profit margin (%) 51.1% 51.4%   49.5% 52.6%  
Provisions and contingencies (6) 177   85 388.8 359.0%
Profit before tax 839 1,147 36.7% 1,408 2,314 64.4%
Tax 92 103 11.4% 151.2 186 23.0%
Profit after tax/ (loss) 747 1,044 39.8% 1,257 2,128 69.3%
Net profit margin (%) 47.2% 40.5%   42.4% 41.4%  
No. of shares (m) 1,000 1,122   1,000 1,122  
Diluted earnings per share (Rs)* 3.0 3.7   2.5 3.8  
P/E (x)         18.7  
* (annualised)            

A 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, telecommunications, 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 relationships with government and infrastructure sponsors, provide 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. The company's clients include prominent participants in infrastructure development and it has capitalised on its domain knowledge and structuring expertise in financing activities to garner fee-based revenues. The company had its initial public offering in July 2005.

What has driven performance in 2QFY06?
Competition weighing on yields: With 67% YoY growth in approvals and 54% YoY growth in disbursements, IDFC registered a 63% YoY growth in its operating income for 2QFY06. Although the contribution of treasury activities to the same has marginally increased, the growth remains largely infrastructure financing driven. Till the end of 2QFY06, IDFC had made disbursements (for 130 projects) to the tune of Rs 130 bn. The institution has a disbursal to sanction ratio of 42%, which is expected to improve given the availability of sufficient capital going forward. But its repayment ratio of 28% stands higher than that of HDFC (12% to 15%). Going forward, as the risk weightage on its asset profile (infrastructure advances) reduces, with projects nearing completion and revenue streams getting unlocked, IDFC plans to securitise them to asset hungry financial entities at a premium.

(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Revenue 1,581   2,577   63%
(i)Infrastructure 1,490 94.2% 2,365 91.8% 59%
(ii)Treasury 92 5.8% 212 8.2% 131%
Profits 856   1,204   41%
(i)Infrastructure 892 104.2% 1,218 101.2% 37%
(ii)Treasury (36) -4.2% (14) -1.2% 61%

Despite being deprived of accessing low cost deposits, IDFC enjoys very respectable margins. However, although the entity’s net interest margins (NIMs, 3.4% in 2QFY06) are currently comparable to the most efficient players in the sector (including banks), the pressure on yields seems to be weighing heavy on margins. The institution has witnessed a consistent slippage in yields on both infrastructure lending (80 basis points YoY) as well as treasury (150 basis points YoY). Having said this, the sustainability of margins in the future is a concern. Nevertheless, higher contribution of other income to the company’s topline will also augur well for the longer term. The institution’s profit on sale of equity investments increased 6 times (628% YoY) while fees and advisory income increased by 70% YoY in 2QFY06.

Higher realisations: IDFC’s return on assets (RoA) increased from 4.0% in 2QFY05 to 4.7% in 2QFY06. Since the institution witnessed a contraction in average spread on infrastructure lending, the increase in RoA can be largely attributed to the profits realized on proprietary equity investments and a higher contribution of treasury gains. The entity continues to enjoy the highest return ratios in the sector.

Operating efficiency: IDFC also enjoys the highest operating efficiency in the financial sector. While its lower cost to income ratio (3.4% in 1HFY06) as compared to banks is understandable (because of leaner size of branches and employees), it is also lower as compared to HDFC. The institution plans to sustain a lean franchise going forward, even with the expansion in balance sheet size.

What to expect?
At the current price of Rs 71, the stock is trading at 2.6 times our estimated FY08 adjusted book value. Given its impressive growth history (CAGR of 31% in assets, 50% in topline and 21% bottomline over the past 5 years) and asset quality (zero net NPAs), the valuations look attractive compared to most of its peers in the industry. While the premium valuations accorded to the entity seem to have reasonably factored in its future growth prospects, the sustenance of the same remains dependant on its ability to capitalise on the infrastructure lending opportunities in the country. We reiterate our confidence in the stock from a long-term perspective.

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