Can IDFC do an HDFC?

IPO WATCH

IDFC resembles HDFC a decade ago, though high execution risks involved in infrastructure projects could make its earnings lumpy.

"IDFC has an HDFC component to it," said Rajiv Lall. The managing director of Infrastructure Development Finance Company (IDFC) was not just referring to HDFC chairman Deepak Parekh's presence on the board of the company.

He was referring to the three factors which make IDFC resemble HDFC 10 years ago "� low leverage, focus of efficiency and strong credit and project appraisal skills which will help his firm mimic the growth of the housing finance major.

Owned by a group of public and private enterprises, including the government of India, IDFC is a leading infrastructure financing institution. Sure, we all agree infrastructure in this country is abysmal and there is tremendous scope for growth. But can infrastructure financing grow as fast and as steady as the housing mortgage business? More importantly, can it be as profitable as the latter? 

Financials
(Rs million)	2004	2005
Income from infrastructure operations	5,337	6,818
Income from treasury operations	972	368
Other income	61	90
Total income	6,370	7,276
Interest and other charges	2,260	3,119
Operating expenses	307	279
Provisions, contingencies and losses from sale of investments	1,084	648
Total expenditure	3,651	4,046
Profit before tax	2,719	3,230
Provision for taxation	128	190
Profit after tax	2,591	3,040
EPS (Rs)	2.59	3.04
Return on net worth (%)	15.28	16.1
Net asset value per share (Rs)	16.99	18.89

For the record, HDFC's total income grew a compounded annual growth rate of 16 per cent over the past 10 years. Earnings grew 22 per cent annually while its stock grew in line with its earnings. With a 22 per cent CAGR in stock price, HDFC now has a market-capitalisation of Rs 18,101 crore.

It built its edifice on two pillars "� housing boom and the consequent demand for housing loans, and excellent domain strengths. IDFC has a similar congruence of factors. It has a capable management with strong domain knowledge and operates in a sector poised for growth. If IDFC can post similar growth, it could be a sure-fire multi-bagger.

But that may not be entirely possible, say analysts, since the dynamics of infrastructure financing is vastly different from that of housing mortgages. Housing mortgages focuses on retail clients where the risk of defaults is relatively low and also failure by some borrowers can't dent performance too much.

In sharp contrast, infrastructure lending involves relatively large individual exposures. Given that new infrastructure projects come with high execution risk, IDFC may not be able to match up to the standard of HDFC in terms of non-performing assets. That's really the critical difference between the two institutions.

However, till now IDFC's financial performance has been splendid. The company has a clean books with no non-performing assets. Growth, too, has been good. Over the last four years, disbursements increased to Rs 8,027 crore, growing 47.6 per cent per annum; total income grew 23.3 per cent to Rs 727 crore and profit after tax increased 20.7 per cent to Rs 304 crore.

One interesting point is that of this Rs 304 crore, Rs 111 crore came from profit on sale of investments in infrastructure companies. But this may not be a one-time earning as the management says that it is already sitting unrealised gains of Rs 220 crore on its infrastructure investments.

In FY05, infrastructure operations accounted for 93.7 per cent of total income. The company's return on assets for FY05 stood at 4.48 per cent, much better than most other banks.

One cause for worry is the pressure on margins. Net interest income decreased from Rs 270 crore to Rs 254 crore in FY05 primarily because of declining yields. In FY05, the company had to reprice Rs 1,483 crore in principle amount of outstanding loans compared to Rs 561 crore in FY04, due to competitive pressures.

Spreads were down to 2.40 per cent in FY05 from 3.82 per cent in FY04. Net interest margin in FY05 was 4.01 per cent, down from 6.32 per cent in FY04. Cost of funds declined from 7.79 per cent in FY04 to 6.53 per cent in FY05, reflecting the lower interest rate environment.

Though IDFC's cost of funds may appear to be high, it may still be able to lend at competitive rates as its operating expenses are significantly lower than that of banks.

The potential for growth is immense. The key to the company's growth is the performance of the domestic economy and the infrastructure industry. Infrastructure services in the country have historically been provided by the central and state governments.

However, given the shortage of infrastructure and the growing demand for products and services, the infrastructure industry will require private participation making the role of financing companies like IDFC vital. IDFC is mainly focused on the energy, transportation and telecommunications sector, all of which are well poised for growth.

While the development of captive power plants is set to boom after the Electricity Act 2003, airport privatisation programme, private port projects, and the National Rail Vikas Yojana are some projects which could set the stage for a leap ahead.

IDFC has a pre-issue capital to risk assets ratio of 28.65 per cent which means that there is still enormous scope for lending. Pretty much like HDFC a decade ago. The additional capital garnered from the issue will only make things better.

IDFC has on offer 40.36 crore shares. the price band for the issue is Rs 29-34. At the higher end of the price band, the stock trades at 12.5 times FY05 earnings. Going by the growth prospects for IDFC, the issue looks attractive. Whether or not it mimics HDFC's growth.