IDBI - Industrial Development Bank of India

Profile
The Industrial Development Bank of India (IDBI) is one of India’s leading private sector banks and occupies the fourth position in overall ratings. It was established in 1964 as a wholly-owned subsidiary of the Reserve Bank of India (RBI) to provide credit and other facilities for development of the industrial sector. In 2005, IDBI transformed itself into a full-service commercial bank after merging its commercial banking arm, IDBI Bank, into itself. Over the years, IDBI has enlarged its basket of products and services, with its offerings covering almost the entire spectrum of industrial activities, including manufacturing and services. IDBI provides financial assistance, both in rupee and foreign currencies, for green-field projects as well as for expansion, modernisation and diversification purposes.

Also the bank boasts of the distinction of having set up the likes of — The National Stock Exchange of India (NSE), The National Securities Depository Services Ltd. (NSDL) and the Stock Holding Corporation of India (SHCIL).

Promoter

The bank is promoted by the Government of India, with 53 per cent of the stake being vested with the Centre. After that, the biggest chunk is held by institutional investors, who have cornered a fourth of the pie. Of this nearly 12 per cent lies with the financial institutions and banks.

Investment Rationale

Increased Operating Profits

IDBI Bank has over the years successfully transformed itself from a development financial institution (DFI) into a full-service commercial bank. IDBI’s core operating profit witnessed an impressive growth of ~275 per cent year-on-year (YoY) in Q1FY2010. This growth was logged because of an improvement in various operating parameters, margins, lower cost of incomes and healthy growth in advances. However, because of a multi-fold increase in provisioning expenses, net profit growth got restricted to 7.6 per cent.

Operating Expenses Spike

During the quarter, IDBI underwent aggressive recruitment drives and branch expansions implementation, leading to 29 new branches being set up. But this was at the cost of a 50 per cent increase in operating expenses. Despite that, the cost-income (ex-treasury) ratio improved substantially to 52 per cent for the quarter.

Mixed Business Growth

Through Q1FY10, IDBI’s business growth remained healthy at 41.6 per cent YoY. This was led by a 58.9 per cent and 25.4 per cent growth in deposits and advances respectively.

Risk & Concerns

Downturn to Drive NPAs Up

Any disappointment on the economic recovery front may lead to a surge in the bank’s non-performing assets (NPAs) as the bank has exposure to most industrial sectors and hence needs to make higher provisions. This, in turn, could affect the bank’s future profitability.

Unimpressive NII

IDBI’s net interest income (NII) was much less than expected. For the quarter, its NII stood at Rs 316.4 crore. This was significantly higher than the previous year’s quarter at Rs 90.6 crore. The reason behind this may be the possible change in the accounting policy for the recoveries.

Low CASA Ratio

The low-cost deposits as a percentage of the bank’s overall deposits are lesser than that of other government-owned banks, mainly due to the different focus of the entity in its role as a DFI. The peers (other public sector banks [PSBs]) have a current account and savings account (CASA) ratio in the range of 25-40 per cent while IDBI Bank’s CASA ratio is much lower at ~12 per cent.

Restructuring of Loans

During FY2009, IDBI Bank restructured loans worth Rs 3,131 crore and currently has applications for restructuring of loans worth over Rs 5,500 crore. Together these constitute over 8 per cent of the bank’s total outstanding advances. The rate is significantly higher compared with that of other PSBs who have restructured loans to the tune of ~1.5-4.5% of their total loans.

Valuation

Capital adequacy ratio (CAR) of the bank remains above the regulatory requirement of 12.3 per cent with tier-I CAR at 7.11 per cent. The same has improved vis-à-vis 11.57 per cent for the previous quarter, as the bank raised Rs 500 crore through upper tier-II bonds (15-year maturity; coupon rate of 8.95%).

IDBI Bank saw its earnings per share (EPS) grow on an annual basis from 12.3 per cent in FY07 to 15.7 per cent in FY08. Despite the severe slowdown in FY09 the bank grew by 17.8 per cent. It can be considered on dips.

ICRA

ICRA’s rich valuations don’t look expensive considering the high growth trajectory and robust fundamentals
CREDIT ratings agency ICRA has grown by leaps and bounds in the last three years. Though much smaller than the market leader, Crisil, the company is a prominent player in the rating industry. Since it is in the services industry, which does not require huge investment in fixed assets, its return on capital employed (RoCE) at 31% for FY 2009 is quite high.

BUSINESS:

Apart from credit rating, which accounts for a major part of the company’s revenues, ICRA is also into consulting and outsourcing services. There is great scope for growth in the ratings business in India for several reasons. Corporate bond market is highly underdeveloped in India. There are entry barriers in the form of brand name and expertise. And finally, there are just four big players in the industry—Crisil, ICRA, CARE and Fitch (India). The recent regulations of the Reserve Bank of India (RBI), according to which any company borrowing more than Rs 10 crore from a bank has to be rated, has given a fillip to ICRA.

Already its rating business is growing fast. ICRA’s rating revenues grew by 28% in June ’09 quarter. Indian companies require huge investments in projects and need to raise funds from various classes of investors to meet their needs. This will increase their dependence on the bond market. Through its subsidiary, ICRA Management Consulting Services (IMAcS), the company has also entered into consulting, wherein it provides services to companies in various industries such as banks, automotive, health and retail. Though last year the consulting business was affected by slowdown, it is set for a revival this year after the improvement in sentiment and increase in investments.

The company also has a presence in outsourcing services as well. In brief, the company has presence in a whole gamut of rating, consulting and BPO related businesses, which are the growth drivers of future.

FINANCIALS:

The company can grow its profits without substantial investments in fixed assets. For instance, its revenue has grown at a compounded annual growth rate (CAGR) of 40% in last three financial years. In the similar time frame the balance sheet grew at a CAGR of 25%. This is typical of companies, which are not asset heavy, wherein more returns can be earned from little investment. For this reason, RoCE has improved from 16% in FY 2006 to 31% in FY 2009. Moreover, the company has always been debt free, which results in better cash flows.

VALUATIONS:

The stock is trading at a price-to-earnings (P/E) multiple of 19.5 times.

Though, the valuations don’t look cheap, but factoring a high RoCE, it would look modest. The company is growing at a very fast rate — its profit jumped 73% in June ’09 quarter. Definitely, the valuation doesn’t look expensive in the context of growth trajectory. Historically, the stock has traded at very high valuations. For instance, in June 2007, the stock was trading at 45 P/E and then in December ’07, it was trading at a P/E of 40. This shows that the stock still has scope to catch up at current valuation.

Federal Bank

Federal Bank has emerged as one of the fastest growing banks in the last three years. Investors are advised to consider exposure to the stock for the long term
Beta 0.8
Institutional Holding 70.1%
Dividend Yield 1.6%
P/E 8.4
M-Cap Rs 4143 cr

Federal Bank is the country’s fourth-largest private bank by balance sheet size. This oldgeneration private bank was set up at Travancore (modern-day Kerala) in 1931, six decades before the bigger newgeneration private banks came up post-reforms. A major chunk of its business is concentrated in the south and Kerala contributes almost half to its loan book. The bank has 624 branches in 24 states and is now increasing its presence in neighbouring states like Tamil Nadu, Andhra Pradesh and Karnataka. A market capitalisation of just over Rs 4,000 crore and a balancesheet size of Rs 39,000 crore make Federal Bank one of the smaller banks in the country, but it ranks high on many key parameters. The bank’s net interest margin (NIM) — which is a measure of spread between the cost of borrowing and yield on loans — was 4.1% in 2008-09, the highest reported by a small bank. Only Kotak Mahindra Bank and HDFC Bank fare better on this count. In fact, the bank has maintained an NIM of about 3.5% for seven years now.

Federal Bank has managed to reduce its non-performing assets (NPA) to one of the lowest within a decade. Its net NPAs formed 0.3% of net advances in 2008-09, bettered by only three other banks. In contrast, the bank was struggling with higher NPAs at the start of this decade as these unrecovered loans formed 10% of its advances in 2000-01.

A dose of capital infusion in 2007-08 improved the bank’s capital adequacy ratio (CAR) to 20.1%. As per the Reserve Bank of India norms, banks have to maintain a minimum CAR of 9%. This shows that Federal Bank has a sufficient capital base. However, the capital infusion has resulted in dilution of return on equity (RoE), which fell from 21.3% in 2006-07 to 12.1% in 2008-09. At the current levels of CAR, the bank does not need to raise capital like other banks and no further dilution is expected in near future. Federal Bank’s net profit has risen at an average rate of 30% in the last three financial years, making it one of the fast-growing banks in the country.

A diversified loans portfolio places the bank in a better position to tackle economic slowdown compared to its peers. Loans to corporate, retail and small and medium enterprises segments comprised 37%, 31% and 32% of the total loan portfolio in 2008-09. In the last five years, the bank has increased the share of retail loans in total lending. In 2003-04, retail loans formed only 19% of the loan book.

In a country that continues to face a shortage of housing units, Federal Bank’s strategy of focusing on home loans can not be better timed. In FY 2009 housing loans formed 59% of retail loan book. In fact, secured lending like mortgages helps maintain high asset quality.

The bank also holds 26% stake in life insurance company, which is a joint venture with IDBI Bank and Fortis Insurance Co.

CRISIL

Bank loan rating, customised research products and growing international advisory business has benefited Crisil. Tightening international liquidity acts as a windfall gain

CRISIL is the market leader in research, rating and advisory businesses. It has posted impressive results for 2008 (it follows Jan-Dec FY). Its performance got a fillip from the Reserve Bank of India (RBI) too, because as per one of its directive, companies borrowing more than Rs 10 crore from the banks have to be rated. Investors can consider an exposure in the stock for the long term.

BUSINESS:

Crisil’s business can be broadly divided in three segments:

• Research,
• Rating and
• Advisory.

Crisil Research provides products related to research on several industries. The last few years witnessed a large number of new entrants in different industries thus boosting the company’s research business.

It has also tapped the market of outsourced research through its subsidiary, Irevna, which provides support to financial institutions worldwide. Crisil Rating is the largest agency in its business in India. It rates a wide spectrum of organisations, like insurance companies, mutual funds, state government, urban bodies, small and medium enterprises (SME) and non banking financial companies (NBFC).

Crisil Risk and Infrastructure Solutions take care of the advisory part of the business. It acts as an advisor to various agencies on policy, infrastructure and energy. The financial institutions have realised the importance of adequate measures to ascertain and manage risk. Crisil has tried to tap this market by providing risk solutions in the form of risk management services, consulting and software products.

Crisil is the market leader in its business segments. Its market share in bank loan rating is 50%, while its share in other bonds stands at 65%-70%. Even in research space, it is the biggest player as it offers reports across wide spectrum of industries. The sector expertise and the subject knowledge help it in factoring a premium in pricing.


FINANCIALS:

For the year ending December 2008, Crisil’s total income increased 30.5%, while profit after tax grew by 68% over last year. Another interesting trend was that the manufacturing companies are again using bond ratings to raise finance through debt. This is because the liquidity in the international market has been squeezed making the route of external commercial borrowings and foreign currency convertible bond extremely tough.

Corporate India did not do all that well in 2008, however, the performance of Crisil’s research business was unfazed. This is because the company has a large base of subscription-based products. Moreover, it released timely reports on current issues like the impact of global meltdown in India. Similarly, advisory business also continued to do well. Despite rising government deficit, the company’s domestic advisory business was not affected as most of the projects are in urban areas, where the funds are committed for long term. The company has seen growing proportion of international business and projects with agencies like Asian Development Bank.

In the short run, the company is expected to face headwinds in the form of lesser outsourced business for Irevna due to global financial crisis. Moreover, the retail loan market is witnessing slowdown thereby impacting the securitisation, which in turn has affected the structured finance business. However, in the long term the outsourced research part of business is expected to do well especially after the dust settles down around the ownership of financial institutions worldwide.

VALUATION:

The stock is trading at a price to earning multiple of 12.1 times. The earning growth has been much higher than the valuation. This shows that the stock is available at attractive valuations. Moreover, its nearest competitor ICRA is trading at a P/E of 13.1 times. Crisil’s stock is available at lower valuation despite of being the market leader in the industry, which further shows that the market is not factoring the fundamentals entirely into the price.