A Case for IDFC

In  this post I will talk about the proposed restructuring of IDFC as it embarks on its Banking business.

Introduction to IDFC

IDFC is an NBFC (Non-Banking Finance Corporation) providing end to end infrastructure financing and project implementation services. It was established in 1997. To learn more about IDFC click here.

In April Reserve Bank of India granted in principle approval to IDFC to become a Bank. Therefore IDFC is a current example of an NBFC as it slowly transforms into a bank. Is it worth a buy one may ask. How does IDFC’s valuation stack up against its current and expected performance?

A Digression and Caution:
a. I am not an astrolger, economist, weather forecaster or CNBC stock analyst. Hence any “forecast” that I make is to be treated as a reasonable guesstimate, and could be completely incorrect or completely accurate. Or anywhere in between for that matter.
b. This is not a recommendation to buy or sell or hold or short IDFC – its a theoritical exercise to value IDFC.
c. Please read “a” and “b” again.

Now back to the post.

This was an exercise I had conducted 3-4 months back when the RBI had announced that it would provide provisional Banking License to IDFC and Bandhan. Bandhan being a private Microfinance NBFC MFI was in private domain, and hence I decided to investigate only IDFC.

I started wondering, why IDFC? What did RBI see in IDFC? Is IDFC a good long term bet? And so on and so forth? More on that later. Let us go straight to the heart of the matter – valuation.

Valuation of IDFC

I am presenting below, one of the approaches which I had followed. The below approach is based on industry benchmark or comparitive set valuation (comp-set). Other approaches included discounted cashflow, dividend discount, reverse engineering, guessing and gut-feel based approaches.

IDFC is an NBFC that will eventually become a Bank. Two questions immediately come to mind:
a. As an NBFC how is IDFC priced today? How does it stack up against industry benchmark? Does it command premium valuations or is it trading cheap compared to its peers?
b. If and when it becomes a Bank, how would the vlauations change? How do the Banking Industry’s numbers stack up against NBFC numbers in general?

Using these two themes, I had tried to value IDFC shares somewhere in July.

I compiled data across 13 NBFCs and 36 Banks and developed three sets of industry benchmarks:
a. for NBFCs
b. for Banks
c. for NBFCs and Banks together

A summary of the same is provided below.

NBFC and Bank Benchmark
NBFC and Bank Benchmark

A few things become clear instantly:
a. Banks have high debt to equity ratios and lower Return on Equities as compared to NBFCs
b. NBFCs command greater book value multiples compared to Bank

IDFC Valuation 2

c. As an NBFC, IDFC at Rs 150 was trifle overpriced compared to its fair value of Rs 136 (at which it is trading today incidentally)
d. As a bank, it could be potentially revalued upward to Rs 300 levels (essentially a doubling of price) based on its current financials and fundamentals alone.

Now thats not so bad is it?

Subhodeep Mukhopadhyay

I am a Management Consultant in the Education Sector. In my previous corporate career, I have worked in Banking, Private Equity and Software industry. I am an MBA in Finance/ Computer Engineer and enjoy doing equity research and financial analysis in my free time.

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