IDFC Bank might give lower returns, invest for the long term

IDFC listing post the demerger has taken the market by surprise. IDFC is trading well below market expectations. Motilal Oswal puts a fair value from IDFC at Rs 119; Edelweiss feels the stock should trade at Rs 94 while Kotak Securities feels that the holding company should touch a price of Rs 120. Instead IDFC is trading near Rs 63, much lower than the worst case expectation.

But looking at IDFC’s standalone price will be incorrect as it does not correctly captures the value of unlisted business of IDFC Bank. Before the spin-off, IDFC was trading at a price of Rs 141, which would imply that the bank should ideally be trading at Rs 80 when it gets listed. IDFC Bank is expected to get listed by November 6th 2015.

Analysts are bullish on IDFC post the issuance of banking licence. But there is scepticism on the model the bank is using for growth.

Banks in the private sector have used the retail route to enhance their deposit base as well as the advances and in turn higher margins. IDFC Bank is planning to use the deposit base but concentrate on advances through the corporate book, which has been its forte till date. In an interview with Business Standard Rajiv Lall, executive chairman and managing director of IDFC said that while scaling up its business, two thirds will be corporate and wholesale banking, while a third will be personal and business (urban) and Bharat (rural) banking. In the personal business, banking mortgages will be a significant component. In personal and business banking, IDFC is hopeful of acquiring three to four million customers and in Bharat, 10-12 million across the country. That gives a target of 15 million customers in five years.

In five years, their balance sheet will be in the range of Rs 1.5-2 lakh crore. IDFC Bank is starting the balance sheet with Rs 70,000-80,000 crore. 

IDFC and IDFC Bank have to be reviewed only on a long term basis. In its report, Motilal Oswal said that in the near term, quarterly trends are irrelevant—considering that IDFC is creating a cushion by building-up of SLR (statutory liquidity ratio) book, prudent provisioning and moderate growth before starting banking operations.

IDFC bank is expected to start operations with strong Tier I capital of around 16 per cent, which means it will not need capital in the near future. Motilal Oswal feels that the bank can grow at upwards of 20 per cent. Pick-up in the infrastructure segment can push growth to 25 per cent.

Focus of the bank and analysts have been on the wholesale segment of lending. Margins in this segment are lower as compared to the retail segment. But for IDFC as an wholesale financing institution, working in the retail space will be a cultural shift. It worked with HDFC because the culture was of smaller loans, but IDFC Bank will need a genetic transformation.

However, as IDFC Bank starts posting its results analysts will be comparing IDFC with other smaller banks in the space, which will be a problem as the other banks are all strong in the retail space and are slowly increasing their footprint. IDFC might find it tough shoring up its low cost deposits base. JP Morgan, in its report on the spin-off assumes a CASA ratio (current account and savings account) of only 8 per cent by 2018.

Comparing IDFC’s foray with other banks will be unfair as others started with a clean slate. IDFC on the other hand already has long term funding assets in its portfolio. Thus retail book will remain low in the overall scheme of things for a long time. IDFC might have a tough task ahead to attract investors if the economy picks up, analysts will prefer banks with an established base which would grow faster.

It is clear investors will have to put their faith behind the company and its management for chasing growth. But should one hold both the shares – IDFC and IDFC Bank?

IDFC Bank will always get higher discounting of a bank in the market and will be more volatile of the two entities. Analysts are expecting IDFC Bank to trade at above two times its adjusted book value. For IDFC, the parent company, expectations are that it will get a holding company discount and will trade at 0.7 times its book.

However, IDFC as a holding company has an advantage over IDFC Bank. JP Morgan in its report points out that IDFC will have no ceiling for holding as far as FII stake is concerned. This can prove advantageous and improve the valuation of IDFC in the long run. For now, it makes sense to hold both the entities, but patience will be needed over a long period of time for higher returns. The stock is unlikely to give comparable returns as other banks in this bull run but will be a stronger candidate for the next one.