On solid ground

POUND WISE

A sharp focus on the infrastructure sector and higher operational efficiencies make IDFC score over banks.

Infrastructure spending in the country is rising rapidly. According to the Morgan Stanley estimates, infra spend is likely to jump from the $28 billion (Rs 1.26 lakh crore) in the last financial year to $50 billion (Rs 2.25 lakh crore) in FY09. As a percentage of GDP, it is expected to increase to 4.9 per cent by FY09 from 3.6 per cent now.

If you wish to make the most of the current infrastructure boom, Infrastructure Development Finance Company (IDFC) could be an ideal bet.

Given its superior skill sets in infrastructure lending and fee-based services, operational efficiencies and higher return on assets (ROA), the company looks like a far better play than banks.

It has a strong domain knowledge and expertise in infrastructure lending business focusing on areas such as energy, telecom, transport and commercial/ industrial infrastructure.

The focus has helped it grow its loan book at a CAGR of 54 per cent in the past five years. Analysts expect IDFC's loan book to grow at over 35 per cent a year in the next three years.

The efficient frontier
With more and more banks diversifying their credit portfolio and entering the infrastructure lending business, competition has heightened, leading to pressure on margins. Industry experts say the share of commercial banks in funding infrastructure has risen from 12 per cent in FY01 to over 50 per cent in FY05.

As IDFC plans to double its balance sheet size of about Rs 15,000 crore in the next three-four years, its net interest margins (NIM) "� currently 2.9 per cent, are likely to remain subdued.

Says Managing Director and CEO Rajiv Lall, "Although our margins are expected to be stable in the medium term, they could remain under pressure over the long term with increasing competition from banks."

Additionally, IDFC's costs of funds at about 6 per cent are higher than those of banks at 4-5 per cent, as it hardly has access to low-cost deposits. Instead, the company raises resources through avenues such as debentures, bonds, term loans, foreign currency loans and subordinated debt that carry higher costs.

However, the company's overall costs are lower than banks' as it does not require to maintain SLR (statutory liquidity ratio) or maintain an extensive branch network.

Thus, IDFC scores over its peers like State Bank of India and ICICI Bank on most parameters such as cost-to-income ratio, ROE/ ROA and non-performing assets. 
 

STRONG EDIFICE
Q1FY07 (%)	IDFC	SBI	ICICI	HDFC	UTI	HDFC
ROA	4.00	14.80*	1.10*	1.30*	0.93	2.70#
Cost/income	7.86	50.00	40.00	47.00	43.77	16.00
CAR	23.40	12.00	12.46	11.70	10.28	13.30
Tier I	17.70	9.00	8.60	8.30	6.70	7.80
Gross NPAs	0.40	3.90	NA	1.30	1.25	1.40
Net NPAs	0.00	1.70	0.80	0.40	0.73	0.60
NIM	2.90	3.40	2.50	4.00	2.68	2.14
*FY07E   # As on March06

Focusing on fees
In a bid to differentiate itself from banks and counter the rising competition in the lending business, IDFC is increasing its focus on fee-based activities such as advisory services, asset management (private equity), financial market activities like proprietary equity, debt syndication and equity placements and treasury.

Its private equity and asset management business, which is growing at a rapid pace, is expected to bolster its non-interest income.

Analysts expect the share of other income (including fee-based income) to total net income to remain in the range of 35-40 per cent in the next two years.

While its core lending business will help IDFC grow its topline fast, the fee-based activity will boost its profitability and also lift its ROE. The company aims to maintain its ROE of about 20 per cent, which is comparable with HDFC's and HDFC Bank's.

Further, its low leverage of about 4x vis-a-vis banks' 20x also provides the company a significant scope for improving its ROE. The company has an unrealised gain of about Rs 200 crore in its books, which will prop up its earnings sometime in the future.

Despite a whopping 60 per cent y-o-y growth in net interest income, a substantial increase in gross disbursements and zero provisions, IDFC could post a modest 20 per cent net profit growth in Q1FY07.

This was largely because of a higher tax rate and a fall of 21 per cent in non-interest income "� investment gains in particular. Backed by higher volumes of the lending business and the sustainable fee-based income, IDFC's profitability is expected to remain stable in the future.

Valuations
At Rs 69, the stock has shot up by nearly 100 per cent since its initial public offering in July last year.

Currently, the stock trades at a P/ BV of 2.6 times and 2.3 times its FY07E and FY08E, respectively. Compared with its banking peers, IDFC's valuation appears reasonable.