IDFC- Consistency should be rewarded ::Espirito Santo,

IDFC
Consistency should be rewarded
We rate IDFC as the high quality franchise in the Infrastructure
finance segment, the with best quality book among its peers. Gross
NPAs at the end of FY12 were a mere 0.3% and only 2.6% of the
book is exposed to fuel risk. Also, we expect the company to be one
of the key beneficiaries of a decline in interest rates and any
improvement in Infrastructure segment. Q1 results could be a
catalyst to re-rate the stock as we expect high growth in the loan
book (as compared with last year) and no negative surprises either
on credit quality or margins. We reiterate our Buy stance on IDFC
and rate it as silver bullet buy for Q3 CY12.

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Remains a quality franchise in the secular growth market
IDFC has a strong franchise and despite our expectation of sub 15% ROE we
have a positive view on its prospects.
Diversified and well underwritten book: IDFC has one of the most diversified
loan books in the sector, with power the main component with 41% exposure.
Within the power segment it has minimal exposure (2.6%) to coal/gas based
power plants that are in the construction phase, without captive fuel and no
exposure to any of the SEBs. We believe that IDFC has one of the best
underwriting capabilities and this was proven true at the time of 2G license
cancellation, when the company had no exposure to any of the telecom players
which are expected to close down.
Faster growth in loan book expected: Although we are not expecting it to
grow at more than 40% CAGR, if the operating environment in the
infrastructure space even improves slightly we could see loan book growth of
>25% given the smaller size of the book and the quality of the franchise. We
are already seeing some traction on the road side; however, we expect the
positives to impact loan growth in H2FY12. In H1FY12, the bulk of the growth is
expected to come from refinancing and corporate loans.
Declining interest rate environment should help: In line with the thesis that a
declining interest rate environment is beneficial for the wholesale funded
NBFCs, we would expect IDFC also to do well with NIMs expanding. Lower
interest rates should also help IDFC become more competitive with the banks
and win business.
Q1 results can act as a catalyst
For FY12 the company’s growth was back end loaded with 14% growth in the
H1 compared to 28% for the full year. For FY13 also we would expect some
back-ending of the growth, however not to the extent of the last year and we
expect growth in Q1 to be more than 15% on a YoY basis. Also, we expect NIMs
to remain stable with no surprises on NPLs and hence we expect some rerating
of the stock with investors’ faith returning. The stock is trading at one standard
deviation below its 6 year average rating of 2.4x fwd P/B.
Macroeconomic environment a risk to our fair value
IDFC is exposed to macroeconomic risks, where macro deterioration would
mean infrastructure finance companies see slower loan growth and increase in
NPLs, though IDFC’s diversification means it would be one of the least
impacted firms in the sub-sector, in our view.
Valuation
We have used SOTP to value IDFC with the financing book valued at Rs. 126
per share (implied 1.8x FY13E BV), the alternative investment book at 12% of
assets leading to Rs.6 per share, broking business at Rs. 4 per share and the
asset management book at 2.5% of AUM implying a valuation of Rs.5 per share
and other investments at Rs.24 per share, leading to total valuation of Rs 165
per share.