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The IDFC stock on Thursday closed 2.38 per cent lower at Rs 124.95 on BSE, after rallying 8.7 per cent in initial trade. On Wednesday, it was announced the company was among the two (out of 25) to secure licences to set up banks.
While the 36 per cent gains in share price since the beginning of March is partly responsible for the fall, IDFC is expected to see slower growth in its balance sheet and earnings and pressure on its return ratios in the initial two-three years of setting up a bank, say analysts. As the focus will now shift to successful transition to a bank, the stock might remain under pressure in the near term. However, most analysts remain optimistic from a long-term perspective, given the management’s proven track record.
| NEAR-TERM CHALLENGES AHEAD |
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“Though in the first and second years of incorporation, RoEs (return on equity) will be dragged down, it is a long-term positive, as it offers cheaper funding options for a large-scale lender. Citing the banking story, we are raising our target multiple to 1.3 times the FY15 estimated adjusted book value, leading to a revised target price of Rs 150,” says Kajal Gandhi of ICICI Securities.
Subramanian Iyer of Morgan Stanley Research, however, says, “This is a long-term positive, as it reduces risk. However, the stock performance over the next 12-24 months will likely be weak, as profitability will come under pressure…The valuation is expensive in that the RoE is less than the cost of equity. By FY20, we expect RoA (return on assets) to decline to one per cent from 2.9 per cent (FY13) for IDFC. Longer-term gains depend on execution,” adds Iyer.
Of the 15 analysts polled by Bloomberg in March, eight have a ‘buy’ rating, six ‘neutral’ and one has a ‘sell’ rating on the stock. Their average target price is Rs 127, an upside of just 1.3 per cent compared to Thursday’s closing price. Currently, IDFC is being traded at 1.1 times the FY15 estimated book value.
Medium-term pain
In the initial years, IDFC will have to comply with the banking licence requirements (in 18 months), which come with challenges. It will have to change the company structure and, more importantly, reduce foreign institutional investor shareholding from 54 per cent to 49 per cent in the existing listed company (IDFC). Also, the non-operating financial holding company (NOFHC) will have to reduce its holding in the bank to 40 per cent in the first three years. This could lead to dilution of book value, depending on the price it is able to get from investors. A premium pricing will, however, result in good gains for existing IDFC investors.
Gandhi says, “The easiest route is to give the NBFC (IDFC) shareholders proportional shareholding in the NOFHC, though it might require an RBI (Reserve Bank of India) nod.”
IDFC will have to expand its branch network, with 25 per cent of those in rural areas (low-ticket, less profitable), as well as maintain the statutory liquidity ratio (23 per cent) and cash reserve ratio (four per cent). These, along with priority sector lending (PSL) norms, will put IDFC’s profits under pressure and RoA and net interest margin could halve to 1.3 per cent and two per cent, respectively, through the next two-three years, say analysts.
On account of the regulatory impact of the CRR, SLR and PSL, the balance sheet might see some pressure.
“We expect lDFC’s core infrastructure loan book to decline 10-15 per cent through the next two-three years; however, the overall loan book is likely to increase due to incremental lending towards the priority sector. RoEs will fall to eight per cent in the first two years and, gradually, increase to 15 per cent by FY20,” says Nischint Chawathe of Kotak Institutional Equities. He expects net profit to decline to Rs 1,300 crore in FY15 from Rs 1,900 crore estimated for FY14.
But others, such as analysts at Motilal Oswal analysts expect a marginal increase in profits.
Strong long-term gains
Apart from enabling IDFC to diversify its loan book, a banking licence will provide access to low-cost current account, savings account deposits, improving the cost of funding, albeit in the long run. As of December 31, 2013, the infrastructure sector accounted for 85 per cent of its loan book of Rs 54,552 crore. While IDFC could leverage its strong corporate relationships, it will be operating with lower capital adequacy norms, which will lead to higher asset (loan) growth, boosting RoEs in the longer run.
“We will be raising our fair value estimate of IDFC from the earlier level of Rs 134, to factor in the banking licence approval. We are quite optimistic about the firm’s prospects, with the licence in hand,” says Suruchi Jain, equity research analyst, Morningstar India.
