The Hindu Business Line : IDFC: Buy

IDFC's high return on assets, low leverage, limited proportion of bad loans and low operating costs outweigh concerns on rising cost of funds and declining spreads.

Capitalising on the infrastructure boom.

We believe, the IDFC stock has the potential to appreciate from the current levels as the possibility of a decline in spreads due to hardening interest rates has been factored into the stock price.

At Rs 54, the stock trades at 13 times its expected FY-07 per-share earnings.

The valuation can support an upside, considering the comparatively higher return on assets (RoA), low operating costs, high quality of assets and immense scope for business growth.

Growth in income from core fund-based business may slow further as spreads get squeezed. However, strong volume growth for the fund-based business and immense growth potential in the fee and advisory segment can provide a cushion. Given the relatively low gearing, there is potential to increase return on equity through higher leverage.

High growth, shrinking spreads

The core infrastructure lending business has immense potential for growth. According to Morgan Stanley, the total infrastructure spending in the country is estimated to almost double to $46 billion by 2009.

Mr Rajiv Lall, MD and CMD

Given the opportunity, a 35 per cent per annum growth in the core lending business for the next three years appears achievable for IDFC.

However, competition from commercial and private sector banks and hardening interest rates may ensure that IDFC does not enjoy high RoA anymore.

At 3.8 per cent for the year-ended 2006, IDFC still enjoys the best RoA in the industry. The RoA may drop to 3 per cent or below and appears sustainable at those levels.

The scope for high growth in the loan book may mitigate the risk of shrinking spreads to some extent.

Moreover, substantial growth potential for the advisory and fee-based services could perk up earnings. IDFC generates 55 per cent of its income from infrastructure loans.

Fee-based services

IDFC has been diversifying into infrastructure services and fund management in a big way to provide bottomline growth.

It manages a dedicated infrastructure fund and plans to raise and manage more such fee-generating funds to invest in listed equities or pre-IPO opportunities.

IDFC can also leverage its contacts in the government to get involved in infrastructure projects at the conception stage. It is looking at increasing its role in the advisory space that aims to bridge the gap between project conception and actual execution. The services segment might provide an impetus to growth and stability to the earnings stream. This segment is expected to grow at 40-50 per cent and may provide the necessary cushion. Income from fee and advisory services grew 96 per cent and contributed 18 per cent to the net operating income in the year-ended March 2006.

CORE strengths

IDFC continues to enjoy high RoA, and low leverage, proportion of bad loans and operating costs. An eminent management with high exposure and expertise in the infrastructure segment is an added advantage. These fundamental strengths outweigh concerns on rising costs of funds and declining spreads. Its operating costs at 0.5 per cent of assets are still the lowest in the industry.

IDFC's cost of funds has increased and yield on assets has decreased in 2006. Though the company is not eligible for low-cost funding unlike its peers in the banking sector and is more vulnerable in a rising interest rate scenario, these core strengths make IDFC equally competitive.

At 4.4 times debt-to-equity, IDFC still has the potential to fund business growth. This could further improve the return on equity from 17 per cent that it enjoys now.

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