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Monday, July 14, 2014

IDFC = Discipline + Fortitude

IDFC

In my view it is value for money and has ingredients to be a multi-bagger. FIIs can't buy IDFC post IDFC's getting the banking license. So there were virtually no reports and keen interest post April 2014. The stock got stuck as the rally is driven by FIIs. Infra companies where IDFC does funding has seen good rally. Most of the people were negative about the counter due to several such reasons.

IDFC has seen its ever high in Jan 2008 at 235 levels. Since then the balance sheet has quadrupled. IDFC did a QIP sometime in 2010 at around 168 levels and since then the balance sheet has doubled. The stock is still languishing below 150. The company has a revenue of close to Rs9000crores v/s MCap of Rs22,000Crores. It's book value is Rs 100 and trading at a multiple of less than 1.5 to its BV. The NPLs and GPLs of IDFC are 0.37% and 0.56% respectively. IDFC has an extremely well capitalized balance sheet. The bank will start with around Rs.11,000 crore, Rs.12,000 crore of net worth on day one.

The company has an advantage to start the banking business now. In the last 10 years, there have been important developments in banking regulation and in technology, both of which, for somebody like IDFC, i.e., with deep pockets and no legacy creates an important opportunity. They may use the best of the technology available and thereby reducing the cost of operations. It is expected that their cost of operations will be lower by 10-15% of a typical private sector bank as there is no legacy technology involved. This will help them in getting better ROEs in times to come.

IDFC, if you notice, has started the recruitment for its banking business. They are at another advantage since not too many banking licenses are distributed. Had it been 3-5 more licenses given then it would have put pressure to pick the right employees at a higher cost. Between Bandhan and IDFC, IDFC is better placed to attract talent. Some of the recent recruitment announced by IDFC includes: (1) Pavan Pal Kaushal as chief risk officer. Kaushal, with over 30 years of experience in the financial services sector, is expected to bring in the expertise to start a bank. Prior to joining IDFC, Kaushal led the financial services risk practice at EY India covering credit risk, operational risk, market risk, corporate and treasury risk management. He has also served as chief risk officer for ANZ Banking Group Ltd in India. (2) Avtar Monga, formerly with Bank of America-Merill Lynch, has been brought in to head operations and technology. Avtar Monga, formerly with Bank of America-Merill Lynch, has been brought in to head operations and technology.  (3) Ajay Mahajan, formerly with Yes Bank Ltd, will be leading the markets and institutional banking team.

The stock has not moved since FIIs can't put money and in fact their holding has to come down to below 49%. The decision about FII holding will happen in the upcoming AGM in the last week of July. There are two ways to do it. Go for QIP route and give the additional shares to DIIs or go for FPO and give it to DIIs and Retail. In my view the company should prefer the first one.

After their holding comes down below 49%, they may divide the business in three companies and all three may get listed, subject to approvals from regulators. If that happens then it will lead to value unlocking. Also FIIs will be allowed to increase stakes beyond 49% in businesses other than banking.

Recently MS upgraded IDFC from UW to OW with revised price target from 115 to 175. It was done before the budget. But more importantly, MS report gave a reference of Raghuram Rajan's statements, the governor of RBI. It was about relaxation of CRR and PSL norms. The report gave a target of Rs 300 in best case scenario.

At present, for every Rs 100 crore raised through deposits, banks have to keep Rs 4 crore with Reserve Bank India as CRR (which earns zero interest income) and invest Rs 22.5 crore in government bonds to meet SLR norms. Beside, Rs 40 crore has to be lent to priority sectors.  The budget accepted this relaxation for infra funding by banks. It has to be seen whether these norms are prospective or retrospective. If retrospective, no doubt it will benefit IDFC more. But in either case it will benefit IDFC as they understand infra funding more than anyone else. The relaxation in norms would mean IDFC will have better profitability and thereby ROE.

The stock may or may not come down due to variety of reasons including more provisioning in upcoming quarterly results to lower ROE due to investments in banking business. In my view IDFC has to be in core portfolio for next couple of years, at least without too much worrying about the short term hiccups. It has good management, and they did well with the infra sector funding business. If we are confident of Indian story then it will benefit the banking sector the most.

Disc.: I am holding and my views can be completely biased. So please do your research before you take any decision. I wish to increase on every fall.

Happy investing.

Cheers,
Niteen S Dharmawat
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IMPORTANT DISCLAIMER: Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective. The information contained herein is based on analysis and up on sources that I consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it & take no responsibility whatsoever for any financial profits or loss which may arise from the discussion above. I sincerely request you to do your homework before you take any position whatsoever. I, my relatives or friends may have/have positions in the stocks discussed here.

6 comments:

ketanthacker said...

Yes, Niteen. I agree fully to your views on IDFC as an investment stock in core portfolio.The stock has underperformed the rally in banking stocks and the outlook for infra is much better than it was before 6 months.It can become multibagger as we have witnessed stupendous returns given by large private banks like HDFC BANK, ICICI BANK, YES BANK, AXIS BANK etc and i am sure IDFC would be compared to like of the above once its banking operations are streamlined.

Niteen S Dharmawat said...

@Ketan, agree with your views. I would like to add that starting from 2002-03 to 2013 when Indian economy did well some of the banking sector stocks did really well e.g. Axis Bank 25times, J&K Bank 12 times, ICICI 10 times, HDFC 13 times. Also banking sector has been a constant performer.

Narayanaswamy S said...

Broadly Agree on fundamentals. Operating Income grew +20% CAGR L5 yrs,absolute NP +14% cagr, almost doubled in L5 yrs. However note that the cost of funds has goneup at higher rate,+ 27% annually compounded. Agree that the current prices are low vs the last 5 years peak prices 235 ( 2008). Q4 2014 NP dropped by 50 % due to trebling of operational expenses vs avg last 4 quarters. Is there a risk here...going forward. Any thoughts why such a big jump in expenses in last quarter?

Niteen S Dharmawat said...

@Narayanaswamy S. thank you for your comments. Regarding expenses it was due to higher provisioning. The company stated before the election results sometime in April after the QTR results that they will do further provisioning in next QTR due to their exposure to the power sector and gas supply is causing them trouble. They did not want to start the bank with a weak balancesheet so they took the provisioning numbers and intend to do that in June QTR also, mind it it was before election results. They stated that the actual number will depend if the policy paralysis is addressed and there is a clear sense of direction to the economy. So with new found vigor, IDFC may continue to do well in infra lending business and the provisioning numbers may not be as harsh as expected earlier.

Chandra Mohan Gopalakrishnan said...

Thanks for the informative post i would love to know What will be the equity capital of IDFC BANK and IDFC Ltd post demerger.

P. said...

Niteen,
How would the share prices of IDFC and IDFC Bank be determined after the demerger process? I'm debating if I should buy IDFC now or should I wait for the demerger for long term investment.