IDFC- In for the long haul:: RBS

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IDFC
In for the long haul
Core earnings momentum and business growth appear on track. Spreads will
likely come under marginal pressure in a rising rate environment. We adjust our
earnings forecasts for interest on zero-coupon bonds. We continue to find IDFC a
good way to gain exposure to the infra growth story in India. New TP Rs223; Buy.





Spreads likely to come under marginal pressure, front ended loan growth in FY11F
Spreads declined 30bp to 2.4% on a rolling-12-month basis during October 2009-September
2010. In a rising interest rate environment, IDFC is likely to see some pressure on spreads.
However, the diversification of the liability mix (access to ECBs), ability to do large-ticket
loans (post the recent equity raising) and improved pricing power will likely cushion the
spread compression. During 1HFY11, IDFC posted 231% yoy growth in approvals and 254%
yoy growth in disbursements. According to management, the high loan growth (58% yoy as
of September 2010) is partly the result of large-ticket loans underwritten in the recent past,
which IDFC plans to sell down in due course.

We adjust our forecasts for interest expense on zero-coupon bonds; no impact on BV
According to management, IDFC has about Rs27bn in outstanding zero-coupon bonds
(ZCBs). IDFC charges interest on these bonds to the securities premium account (Rs277m
as per FY10 annual report). We assume the average effective cost of these ZCBs is about
7% and factor their interest expense into our forecasts. Note that this adjustment has no
impact on the book value, and reported spreads already factor in the interest expense on
ZCBs.

Structural infrastructure growth drivers intact; maintain Buy with new TP of Rs223
According to the planning commission, projected investment in the infrastructure sector is
about US$460bn in the 11th Five-Year Plan (FY08-12) and is expected to be about US$1trn
in the 12th Five-Year Plan. This gives some visibility on the long-term growth potential of the
infrastructure financing business. We factor into our model the recent equity dilution (QIP
issue) and revise our FY11-12F earnings. The increase in our core earnings estimates for
FY11-12 is largely offset by the interest expense on ZCBs. We revise our SOTP-based target
price to Rs223 (from Rs181), largely due to increasing our terminal growth rate from 3% to
5% and our terminal ROE from 18% to 20%. At our target price, IDFC would trade at 3.1x
FY12F adjusted book value (net of goodwill) and 20.2x FY12F earnings.