IDFC -Volume growth offsets margin decline: Macquarie

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IDFC
Volume growth offsets margin decline
Event
 Numbers above our estimates: IDFC reported 2Q FY11 net profit of
Rs3.4bn – 12% above our estimate on account of higher-than-expected loan
growth and consequently higher loan and syndication-related fees.

 Raise TP by 11% to Rs200; maintain Neutral: We increase our target price
by 12% to Rs200 but maintain our Neutral rating on the stock on account of
valuations and headwinds to margins.


Impact
 Margin pressures evident; loan growth saves the day: IDFC’s 12m spreads
fell 30bp QoQ to 2.4%, implying the spreads on a QoQ basis would have fallen
very sharply. Despite the sharp compression in spreads, NII growth was healthy
at 11% QoQ, due to a 20% QoQ increase in loan growth, effectively translating
into 56% YoY growth. We think the current level of loan growth is unsustainable
and margins are likely to be under pressure going forward.
 Loan growth up strongly but unlikely to be unsustainable: IDFC
management intends to underwrite infrastructure loans and then sell them off
during the course of the year. By adopting this strategy, it receives
securitisation gains and fees, which are RoE accretive. Management
articulated that corporates want to achieve faster financial closure and hence
are resorting to borrowing from a smaller number of banks/NBFCs; IDFC
intends to take such loans and sell them down later.
 Fees surprise us positively: IDFC’s fee income stream tends to be volatile.
This quarter fees have increased significantly on the back of higher
investment banking revenues and strong sanctions and disbursements growth
– up 51% and 80% QoQ, respectively, thereby resulting in sharp increases in
loan and syndication-related fees.
 Transportation sector has done well this quarter: IDFC has seen good
traction in transportation – roads, ports etc – this quarter, as evident in the
sharp pick-up in disbursements to this sector. However, management
articulated that it is experiencing some slowdown in the bidding and allocation
of road projects, which would be reflected with a lag.
Earnings and target price revision
 We fine-tune our earnings estimates. We raise our TP by ~11% to Rs200 on
the rise in our target multiple for core financing business to 2.2x from 2.05x
because of a higher sustainable RoE emanating from higher fees.
Price catalyst
 12-month price target: Rs200.00 based on a sum-of-the-parts methodology.
 Catalyst: Higher-than-expected loan growth, stronger momentum in fees.
Action and recommendation
 Maintain Neutral: We believe it will be difficult for IDFC to sustain the current
pace of growth to offset margin declines. Moreover, IDFC‘s sustainable RoE is
closer to 17–18% and valuations at 2.5x FY12E P/BV look expensive. We
would potentially look to review our investment opinions at a price level of
Rs180.