IDFC: On solid ground

Diverse revenue streams and focus on quality lending will help IDFC sustain profitable growth in future.

There is no doubt that India needs to invest huge amount of money towards creation of new infrastructure, given that lack of quality infrastructure has proved to be a stumbling block for the country not reaching its optimum growth rates. Even in these challenging times, the government’s stimulus packages focus on increasing infrastructure spending, as it would help sustain higher growth rates, and would create employment opportunities.

That India is estimated to spend around $450 billion on infrastructure in the eleventh five-year plan (an increase of 2.3 times from the tenth five-year plan), itself speaks of the opportunities therein. Since the increased outlay is beyond the means of the government (30 per cent expected to come from private sector), this would herald growth opportunities for companies that execute projects, as well as those who finance such projects. Infrastructure Development Finance Company (IDFC), a leading player in the infrastructure finance segment with expertise in project financing, should benefit immensely from the same.

At the macro level, the declining interest rates are also positive developments for the industry as well as IDFC. Simultaneously, IDFC has also diversified into less capital intensive but capital market oriented businesses like asset management, equity broking and investment banking to garner near-term visibility in the revenue streams.

Core opportunities
The change of government’s stance from being a financier to a facilitator suggests that greater number of infrastructure projects would be routed through public-private partnership (PPP) mode in the long run. This would enable players like IDFC who fund infrastructure projects in consortiums. In fact, IDFC finances on an average 25 per cent of the total private sector infrastructure projects in the country. IDFC’s project financing is its core business and energy, transportation, telecom and IT (ETT), are its key customer segments accounting for around three-fourths of the loan book.

A planned target to add 78,000 MW of power generation capacity in the eleventh plan and greater participation of private players in power projects would augment opportunities in the energy space. Out of its total lending, exposure to energy space is the highest (around 37 per cent). Increased PPP in roads segment along with privatisation and modernisation of airports would ensure enhanced financing opportunities in the transportation division going ahead. Likewise, the robust growth in the telecom sphere is also throwing up financing opportunities. Overall, with ETT segment’s proposed layout accounting for 75 per cent of total spending in the current five-year plan would ensure adequate demand for funding from these sectors.

The recent pronouncements in fiscal stimulus package, have also re-laid focus on infrastructure. The government has approved issuance of tax-free bonds to the tune of Rs 10,000 crore by India Infrastructure Finance Company (IIFCL) by March 2009 and made provisions to raise another Rs 30,000 crore to fund infrastructure projects. While more clarity is awaited, if these funds are routed through financial institutions like IDFC, then it would open up further opportunities for the latter. Other measures like permitting infrastructure-financing NBFCs to borrow from global bilateral or multilateral financial institutions are also a positive for players like IDFC. Being a key lender in the infrastructure funding space would ensure that access to funds should not be an issue.

Other potential businesses
Apart from the core business, other segments like investment banking, asset management and principal investments also contribute prominently to revenues. Although capital market related businesses are considered to provide higher returns, they are currently fraught with vagaries of market volatilities.

Pockets of investment banking and broking (IBB) have already shown a decline of 20 per cent in revenues in H1 FY09 on the back of lumpy capital markets. Positively, revenues in the asset management business are relatively predictable because of its annuity like fee nature. Interestingly, despite weak market conditions, the assets under management of IDFC Mutual Fund have grown in size from $630 million at the end of FY08 to $2.4 billion in H1 FY09; revenues were thus, up 194 per cent y-o-y to Rs 77 crore in H1. While these businesses may experience some choppiness in terms of revenues in the near-term, there is immense growth potential in each of them.
 

GROWING NUMBERS
in Rs crore	FY 08	FY 09E	FY10E
Net Interest Income	589	803	944
Fee & Other Income	734	755	923
Total Income	1,324	1,558	1,867
Net profit	742	845	1,008
EPS (Rs)	5.7	6.5	7.8
P/E (x)	10.4	9.1	7.6
E: Analysts estimates

Financials
The demand for project financing and an inclination for business growth have ensured loan growth of 40.5 per cent for IDFC in the last two years. While in H1 FY09, the loan book grew by only 24 per cent, it was due to slower demand as well as the management’s cautious stance, to administer existing assets efficiently and delivering superior asset yields on them rather than aggressively scaling up volumes. Thus, expect the net interest margins to be stable (2.8 per cent in FY08) with an upward bias, going forward.

While the deteriorating economic situation suggests that asset quality may come under pressure, IDFC to its credit has been able to maintain net NPAs at around zero in H1 FY09. The asset quality is attributed to superior risk management and higher provisioning done to prevent any slippages.

The deceleration in loan portfolio and the non interest side have slowed net profit growth to 20 per cent in H1 FY09, much lower than its two-year average growth of 38 per cent. Aligning of operations as well as employees in the asset management and IBB, and expansion of distribution network has also increased the operating expenses. This is visible in the dramatic increase in the cost-to-income ratio from 11.5 per cent in FY07 to 19.2 per cent in FY08, and further to 21.5 per cent as of H1 FY 09. Besides higher operating costs, the increased provisions have impacted short-term profitability. Thus, expect lower growth in earnings for FY09. Going forward, net profit is estimated to grow by 18-20 per cent in FY10. Any change of fortunes of the capital markets would add to positive surprises.

Investment rationale
In the depressed market scenario, project restructuring and delays are not ruled out. Although infrastructure funding is said to increase with recent policy initiatives, concerns over financial closure of new projects have not abetted fully. IDFC is also expected to tread cautiously in terms of its lending—with focus on quality rather than volumes. Strong risk management systems, capital adequacy ratio of 22 per cent and rising loan-loss provisioning from 0.5 per cent to 1 per cent would ensure cushion in absorbing losses arising from asset deterioration.

Being a niche player in the infrastructure finance segment with domain expertise across varied infrastructure segments, would enable IDFC to rake in stable revenues in the future. Likewise, presence in high-growth capital market related segments would ensure diversification, both in terms of revenue and profits. At Rs 59.55, the stock is trading at 7.6 times its FY10 estimated earnings and can deliver 20-22 per cent a year, for the next two years.