| IDFC (IDFC IN) 4Q14 Conference Call: Key steps before transitioning to a bank | Overweight Price: Rs114.50 28 Apr 2014 Price Target: Rs150.00 PT End Date: 31 Mar 2015 | |
IDFC management highlighted on a conference call today the key steps it would take before transitioning to a bank in the next 18 months. Management reiterated that asset quality is likely to deteriorate further, given the stress in the infra segment. The focus will be to improve the current loan mix and not to expand the balance sheet aggressively to cushion the CRR/SLR hit in the future.
· Key steps before transitioning to a bank. The key steps will be: 1) reduce the foreign holdings to <50 1="" 2="" 3="" 4="" a="" alternative="" amc="" and="" are="" as="" assets="" at="" b="" bank="" be="" before="" bn.this="" case="" compliant="" comprised="" create="" creating="" crr="" crystallized="" current="" date.="" day="" de-merger-="" dilution="" do="" domestic="" done.="" eligible="" entities="" etc.="" few="" for="" from="" guidelines.="" help="" hence="" however="" idf-nbfc="" idf="" idfc="" in="" infra="" investors="" is="" it="" later="" levels="" licenses="" lighten="" list="" listed="" lower="" months.="" new="" next="" nofhc.="" nofhc="" not="" of:="" of="" on="" once="" operations="" options:="" other="" p="" placement="" preferential="" qip="" requirements="" result="" s="" securities.="" separates="" sheet="" structure="" subsidiary="" the="" there="" thus="" to="" transfer="" transferred="" two="" up="" which="" will="" with="" yet.="">
· Asset quality. Management reiterated that asset quality is likely to deteriorate further, given the stress in the infra segment. Gas-based projects are witnessing heightened stress and there is still no clarity on the ultimate resolution. We believe higher loan loss reserve (2.4% of loans) will cushion against negative surprise on asset quality going forward. Restructured assets mainly comprise of energy sector and gas-based projects.
· Higher provisions. The higher provisions were mainly because of: 1) cushion against asset quality stress anticipated in the future. 2) Lower disbursement growth resulted in inadequate provisions in 9M14 vs. anticipated stress in the infra book.3) conservative provisions at 5% on restructured assets vs. regulatory requirement of 2.75% on the back book.
· Loan growth. Loan growth is likely to remain subdued, in line with our expectations, given the weak macro. The focus will be to improve the current loan mix with less emphasis on infra and term lending. PSL assets are likely to be built up in the interim period of 18 months before converting to a bank.
Investment Thesis
We are our OW on the stock, as:
1. We believe IDFC’s higher loan loss reserves will cushion against any stress on asset quality in the near term. This should mitigate much of the P&L damage from NPLs.
2. We believe IDFC’s foray in to banking business will be a significant advantage in the longer term as it strengthens its funding profile and diversifies its loan book.
Valuation
Our Mar-15 PT for IDFC of Rs150 is based on a target multiple of 1.35x Mar-15E book, which is at a discount to ~25% to ICICI bank. Our valuations factor in Cost of Equity at 15.7%, Normalised ROE of 14.6% and terminal growth of 5%.
Risks to Rating and Price Target
1) Asset quality risk for the power portfolio, given fuel shortage and low merchant rates. 2) Growth: Another risk is continued slowdown in loan growth surrounding the progress of infra projects. 3) Markets: The dependence on markets means that any further weakness will lead to risk in fees and investment profits.
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