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We initiate coverage with an IN-LINE rating and price
target of Rs175.
We believe IDFC’s margins are likely to be under
pressure over FY11-13E due to its dependence on
wholesale funding.
We expect low leverage and pressure on spreads to
keep IDFC’s RoEs low at 14% through FY13E.
Frequent dilution and need to maintain higher-thansector
CAR are the key reasons for its low leverage.
In 3Q FY11, IDFC’s loan growth moderated to 2% qoq
from 37% ytd in 1H FY11.
Target price of Rs175 based on sum-of-parts – We value
IDFC’s core business at Rs138/sh based on 1.9x FY12E
P/BV. We value the private equity business at Rs24/sh and
other businesses at Rs13/sh. The stock has
underperformed the Bankex due to concerns that rising
rates will put pressure on loan growth and spreads.
Investors are also concerned about possible deterioration in
asset quality with rising risks in the telecom and power
sectors.
RoEs to remain subdued – Based on management
guidance of tripling balance sheet over three years, we have
built in strong loan growth of 40% over FY10-13E. We
expect spread on infra loans to decline from 3.45% in FY10
to 2.9% by FY12E. We expect RoE to remain subdued at
13.2% for FY12E and 13.9% for FY13E. RoA will decline to
2.7% in FY13E from 3.1% for Jan10-Dec10.
Risks – Higher-than-expected credit cost due to large ticket
lending, tighter-than-expected liquidity which will put
pressure on IDFC’s wholesale borrowings and increasing
competition from banks are the key downside risks. Higherthan-
expected profits on principal investments and higherthan-
expected carry on the private equity business will likely
be the key upside risks to our earnings for IDFC.
Investment argument and valuation
Stock price relatively more sensitive to loan growth
We expect IDFC to post loan growth of 48% in FY11E and 30% in FY12-13E. Management has
guided that it wants to triple the size of the balance sheet over the next three to four years. This
was one of the reasons for raising fresh equity. We believe IDFC’s stock price remains more
sensitive to loan growth than stock prices of other financials because of IDFC’s low leverage.
Leverage has come under further pressure with the new funds raised in FY11.
IDFC is one of the key beneficiaries of higher infrastructure spending in India. While there is little
doubt that the infrastructure segment will require huge funds, which will be positive for loan
growth for infrastructure players such as IDFC, the near to medium growth can be affected by the
following factors: 1) Slowdown in government clearances for key projects; 2) Increasing
competition from banks to lend to infrastructure; and 3) Regulatory norms on single / group
lending can also constrain bulky exposures to a few sectors.
Pressure on spreads likely
IDFC’s borrowings are wholesale in nature, which are more vulnerable to rising rates and tight
liquidity than retail borrowings. Given our view on liquidity, we expect IDFC’s spread on
infrastructure loans to decline to 2.9% in FY12E from 3.2% in FY11E and 3.5% in FY10, driven
by rising cost of funds. Aggressive competition from banks will also cap margins for IDFC.
Fee income growth to slowdown
IDFC’s non-interest income posted strong growth of 48% over FY07-10 even if we exclude fees
coming from IDFC-SSKI. We expect growth in non-interest income to moderate to 14% over
FY11-13E. While we have built in strong growth for loan related fees, we expect fees from asset
management to grow only moderately as we do not see private equity AUMs increasing rapidly.
Higher-than-expected ‘carry’ from the private equity business can pose upside risks to our
forecasts for non-interest income but it is difficult to forecast this with accuracy. Contribution from
fees to total revenue for IDFC is higher than that for other financials at 29%.
Frequent dilutions
IDFC has raised capital frequently. At the time of each issuance, the pre-issue leverage has been
low, which has put pressure on post issue RoEs. After its IPO in FY06, IDFC raised fresh equity
in FY08 and then in FY11. The dilution was 12% from the IPO in FY06, 15% from the issue in
FY08 and a high 30% from the issue in FY11. In FY11, IDFC diluted despite having strong capital
adequacy and low leverage. The key reasons for raising funds in FY11 are 1) Management
believes it can triple balance sheet size over the next three years given the strong demand for
funds for infrastructure projects. 2) A higher capital base will enable IDFC to take larger
exposures to single/group entities. The RBI has imposed exposure norms to single and group
borrowers that are linked to shareholders’ funds. 3) Rating agencies in the past have expressed
that infra NBFCs (non-bank finance companies) like IDFC that are into large ticket lending should
maintain capital adequacy at levels that are significantly higher than banks’ and other finance
companies’ that are not involved in infra financing. Capital raising could therefore be positive for
IDFC’s credit rating.
Valuation
Our price target of Rs175 is based on sum of parts. We value the core business at Rs138 per
share based on RoA of 2.7%, CoE of 13.1% and g of 8%. Out target P/BV for the core business
works out to 1.9x FY12E. We value the private equity business at Rs24 per share based on 12x
net fees and PV of carry. We value the mutual fund at Rs2 per share, IDFC-SSKI at Rs3 per
share and IDFC’s stake in NSE at Rs8 per share.
Risk reward using peak and trough multiples: The stock currently trades at 1.8x P/BV for the
core business against the five-year average multiple of 2.3x. Our target multiple is 1.9x. In our
risk reward framework explained earlier in the report, IDFC stands out as one stock which shows
more upside risks than downside risks. Our risk reward framework attempts to work out the bull
case and bear case EPS using different assumptions for margins, growth and loan losses. Our
price target for the bull case is based on IDFC’s average trading multiple of 2.3x. IDFC traded at
this high multiple over the last five years on expectations that the company will not dilute
frequently, AUMs of the private equity business will grow rapidly over FY09-FY12E and
competition from banks will be less intense given that banks could possibly run into ALM risks if
they finance a high proportion of project loans. However, with slow growth in AUMs, aggressive
competition from banks, frequent dilutions and risks to earnings from rising rates, IDFC’s
valuations have corrected. We do not see any immediate strong triggers for valuations to move
up. Hence, we have an IN-LINE rating for the stock though the risk reward framework suggests
more upside than downside risks.
Fig 8 – Sum of the parts valuation
Rs per share % stake Basis
Lending 138 100% 1.9x P/BV FY12E, sust RoE of 18% and CoE of 13%
Private equity 24 100% 12x fees and 15x PV of carry
Mutual fund 2 100% 2% of AUM of Rs184bn
SSKI 3 67% 15x FY12 P/E
NSE 8 8% Benchmark value of Rs120bn for the company in the
last pvt equity deal in Jun 09
Others -
Total value 175
Rounded off to 175
Source: Company, Standard Chartered Research estimates
Company profile
IDFC was established in 1977 as a private company, with a mix of public and private companies
as the principal shareholders. IDFC was set up to provide finance to the infrastructure sectors.
While it was set up on the initiative of the government, the government’s holding in the company
has declined over the years from 34% to 18%.
Management team
Managing Director and CEO: Dr. Rajiv B. He is the Managing Director and Chief Executive
Officer of IDFC. He has held this post since Jan ’05. He has over two decades of experience with
leading global investment banks, multilateral agencies and in academia. Prior to joining IDFC, he
was variously, a Partner with Warburg Pincus in New York, Head of Asian Economic Research,
with Morgan Stanley Asia Limited, and Economist with the World Bank, Washington DC and the
Asian Development Bank (ADB), Manila, Philippines and a member faculty of Florida Atlantic
University.
Executive Director: Vikram Limaye. He is the Executive Director and a Member of the Board of
Directors of IDFC. He has over 20 years of experience working with Global Investment Banks,
International Commercial Banks and Global Accounting firms. Prior to joining IDFC, he served at
Credit Suisse First Boston (CSFB) in the US in a variety of roles in Investment Banking, Capital
Markets, Structured Finance and Credit Portfolio Management.
Group Head – IDFC Project Finance: A.K.T Chari. He is the Group Head at IDFC Project
Finance. A keen Project Finance Specialist, he has over 35 years of experience. Prior to joining
IDFC, he worked with the Industrial Development Bank of India (IDBI) for 25 years where he held
the position of Chief General Manager/Adviser – Corporate Finance.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
We initiate coverage with an IN-LINE rating and price
target of Rs175.
We believe IDFC’s margins are likely to be under
pressure over FY11-13E due to its dependence on
wholesale funding.
We expect low leverage and pressure on spreads to
keep IDFC’s RoEs low at 14% through FY13E.
Frequent dilution and need to maintain higher-thansector
CAR are the key reasons for its low leverage.
In 3Q FY11, IDFC’s loan growth moderated to 2% qoq
from 37% ytd in 1H FY11.
Target price of Rs175 based on sum-of-parts – We value
IDFC’s core business at Rs138/sh based on 1.9x FY12E
P/BV. We value the private equity business at Rs24/sh and
other businesses at Rs13/sh. The stock has
underperformed the Bankex due to concerns that rising
rates will put pressure on loan growth and spreads.
Investors are also concerned about possible deterioration in
asset quality with rising risks in the telecom and power
sectors.
RoEs to remain subdued – Based on management
guidance of tripling balance sheet over three years, we have
built in strong loan growth of 40% over FY10-13E. We
expect spread on infra loans to decline from 3.45% in FY10
to 2.9% by FY12E. We expect RoE to remain subdued at
13.2% for FY12E and 13.9% for FY13E. RoA will decline to
2.7% in FY13E from 3.1% for Jan10-Dec10.
Risks – Higher-than-expected credit cost due to large ticket
lending, tighter-than-expected liquidity which will put
pressure on IDFC’s wholesale borrowings and increasing
competition from banks are the key downside risks. Higherthan-
expected profits on principal investments and higherthan-
expected carry on the private equity business will likely
be the key upside risks to our earnings for IDFC.
Investment argument and valuation
Stock price relatively more sensitive to loan growth
We expect IDFC to post loan growth of 48% in FY11E and 30% in FY12-13E. Management has
guided that it wants to triple the size of the balance sheet over the next three to four years. This
was one of the reasons for raising fresh equity. We believe IDFC’s stock price remains more
sensitive to loan growth than stock prices of other financials because of IDFC’s low leverage.
Leverage has come under further pressure with the new funds raised in FY11.
IDFC is one of the key beneficiaries of higher infrastructure spending in India. While there is little
doubt that the infrastructure segment will require huge funds, which will be positive for loan
growth for infrastructure players such as IDFC, the near to medium growth can be affected by the
following factors: 1) Slowdown in government clearances for key projects; 2) Increasing
competition from banks to lend to infrastructure; and 3) Regulatory norms on single / group
lending can also constrain bulky exposures to a few sectors.
Pressure on spreads likely
IDFC’s borrowings are wholesale in nature, which are more vulnerable to rising rates and tight
liquidity than retail borrowings. Given our view on liquidity, we expect IDFC’s spread on
infrastructure loans to decline to 2.9% in FY12E from 3.2% in FY11E and 3.5% in FY10, driven
by rising cost of funds. Aggressive competition from banks will also cap margins for IDFC.
Fee income growth to slowdown
IDFC’s non-interest income posted strong growth of 48% over FY07-10 even if we exclude fees
coming from IDFC-SSKI. We expect growth in non-interest income to moderate to 14% over
FY11-13E. While we have built in strong growth for loan related fees, we expect fees from asset
management to grow only moderately as we do not see private equity AUMs increasing rapidly.
Higher-than-expected ‘carry’ from the private equity business can pose upside risks to our
forecasts for non-interest income but it is difficult to forecast this with accuracy. Contribution from
fees to total revenue for IDFC is higher than that for other financials at 29%.
Frequent dilutions
IDFC has raised capital frequently. At the time of each issuance, the pre-issue leverage has been
low, which has put pressure on post issue RoEs. After its IPO in FY06, IDFC raised fresh equity
in FY08 and then in FY11. The dilution was 12% from the IPO in FY06, 15% from the issue in
FY08 and a high 30% from the issue in FY11. In FY11, IDFC diluted despite having strong capital
adequacy and low leverage. The key reasons for raising funds in FY11 are 1) Management
believes it can triple balance sheet size over the next three years given the strong demand for
funds for infrastructure projects. 2) A higher capital base will enable IDFC to take larger
exposures to single/group entities. The RBI has imposed exposure norms to single and group
borrowers that are linked to shareholders’ funds. 3) Rating agencies in the past have expressed
that infra NBFCs (non-bank finance companies) like IDFC that are into large ticket lending should
maintain capital adequacy at levels that are significantly higher than banks’ and other finance
companies’ that are not involved in infra financing. Capital raising could therefore be positive for
IDFC’s credit rating.
Valuation
Our price target of Rs175 is based on sum of parts. We value the core business at Rs138 per
share based on RoA of 2.7%, CoE of 13.1% and g of 8%. Out target P/BV for the core business
works out to 1.9x FY12E. We value the private equity business at Rs24 per share based on 12x
net fees and PV of carry. We value the mutual fund at Rs2 per share, IDFC-SSKI at Rs3 per
share and IDFC’s stake in NSE at Rs8 per share.
Risk reward using peak and trough multiples: The stock currently trades at 1.8x P/BV for the
core business against the five-year average multiple of 2.3x. Our target multiple is 1.9x. In our
risk reward framework explained earlier in the report, IDFC stands out as one stock which shows
more upside risks than downside risks. Our risk reward framework attempts to work out the bull
case and bear case EPS using different assumptions for margins, growth and loan losses. Our
price target for the bull case is based on IDFC’s average trading multiple of 2.3x. IDFC traded at
this high multiple over the last five years on expectations that the company will not dilute
frequently, AUMs of the private equity business will grow rapidly over FY09-FY12E and
competition from banks will be less intense given that banks could possibly run into ALM risks if
they finance a high proportion of project loans. However, with slow growth in AUMs, aggressive
competition from banks, frequent dilutions and risks to earnings from rising rates, IDFC’s
valuations have corrected. We do not see any immediate strong triggers for valuations to move
up. Hence, we have an IN-LINE rating for the stock though the risk reward framework suggests
more upside than downside risks.
Fig 8 – Sum of the parts valuation
Rs per share % stake Basis
Lending 138 100% 1.9x P/BV FY12E, sust RoE of 18% and CoE of 13%
Private equity 24 100% 12x fees and 15x PV of carry
Mutual fund 2 100% 2% of AUM of Rs184bn
SSKI 3 67% 15x FY12 P/E
NSE 8 8% Benchmark value of Rs120bn for the company in the
last pvt equity deal in Jun 09
Others -
Total value 175
Rounded off to 175
Source: Company, Standard Chartered Research estimates
Company profile
IDFC was established in 1977 as a private company, with a mix of public and private companies
as the principal shareholders. IDFC was set up to provide finance to the infrastructure sectors.
While it was set up on the initiative of the government, the government’s holding in the company
has declined over the years from 34% to 18%.
Management team
Managing Director and CEO: Dr. Rajiv B. He is the Managing Director and Chief Executive
Officer of IDFC. He has held this post since Jan ’05. He has over two decades of experience with
leading global investment banks, multilateral agencies and in academia. Prior to joining IDFC, he
was variously, a Partner with Warburg Pincus in New York, Head of Asian Economic Research,
with Morgan Stanley Asia Limited, and Economist with the World Bank, Washington DC and the
Asian Development Bank (ADB), Manila, Philippines and a member faculty of Florida Atlantic
University.
Executive Director: Vikram Limaye. He is the Executive Director and a Member of the Board of
Directors of IDFC. He has over 20 years of experience working with Global Investment Banks,
International Commercial Banks and Global Accounting firms. Prior to joining IDFC, he served at
Credit Suisse First Boston (CSFB) in the US in a variety of roles in Investment Banking, Capital
Markets, Structured Finance and Credit Portfolio Management.
Group Head – IDFC Project Finance: A.K.T Chari. He is the Group Head at IDFC Project
Finance. A keen Project Finance Specialist, he has over 35 years of experience. Prior to joining
IDFC, he worked with the Industrial Development Bank of India (IDBI) for 25 years where he held
the position of Chief General Manager/Adviser – Corporate Finance.
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