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Stock Ideas Multi Bagger Stock Ideas Initating Coverage IDBI Bank (IDBI) ICICI Direct Report
Stock Ideas Multi Bagger Stock Ideas Initating Coverage IDBI Bank (IDBI) ICICI Direct Report 
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By Rick Pendergraft After an incredibly volatile week last week, economic reports continue to pour in this week. Nothing is as important as last week’s Fed meeting, but that doesn’t mean the markets won’t move based on the reports due out this week. |
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| Initating Coverage IDBI Bank (IDBI) ICICI Direct Report |
| Wednesday, 12 September 2007 | ||||||||
Aao sochein bada!IDBI Bank has transformed itself from a DFI to an active participant in the booming banking and financial services space.The amalgamation of United Western Bank with IDBI Bank has given the latter the muchneeded branch network to enhance its retail presence. This, coupled with the unlocking of value in its investments, is expected to lead to a surge in earnings. We expect earnings to grow at a CAGR of 19% over FY07- 09E to Rs 885 crore. We initiate coverage on the bank with an outperformer rating.
IDBI Bank ValuationsIDBI is expected to improve its core business gradually with NIMs expanding from 0.48% in FY06 to 0.74% in FY07 and further to 1.07% by FY09E. We expect RoE to rise from 10% in FY07 to 12.3% levels by FY09E, with the share of trading income declining and that of core NII increasing. At the current price of Rs 130, the stock is trading at 1.3 its FY09E ABV and 10.6x its FY09E EPS of Rs 12.2. Based on a theoretical book value multiple of 0.9x its FY09E ABV, the value of its core banking business comes to Rs 87 per share. Its huge investment portfolio is valued Rs 52 per share and subsidiaries at Rs 17 per share. Combining all the three, we arrive at a target price of Rs 156, an upside of 20% over a 9- 12 months timeframe. IDBI Company BackgroundIndustrial Development Bank of India Ltd (IDBI) is one of India's largest banks. It has played a significant role in the industrial and economic development of the country for over 40 years. Initially, it was a Development Financial Institution (DFI) and has now transformed itself into a full-service commercial bank. IDBI was established on July 1, 1964, by an Act of Parliament, as a wholly owned subsidiary of Reserve Bank of India (RBI), to catalyze the development of a diversified and efficient industrial structure in the country, based on the national priorities. Investment RationaleCore business to turnaround favourably…The recent merger of United Western Bank (UWB), coupled with the consolidation of IDBI Bank with DBI has positioned the bank favourably. It can now be an active participant on the on-going boom in the banking and financial services space. With this consolidation, IDBI will be able to focus more on its retail advances and deposits growth & reducing cost of funds by focusing more on growing low cost deposits thereby improving the NIM’s and the core business. Concentration on NIM's- A priority Dealer The area that requires immediate attention of the management is that of NIMs. To enhance NIMs, IDBI is focusing on garnering more low-cost deposits. The bank in the past has been working on this front where the NIMs have risen by 54%, up from 0.48% in FY06 to 0.74% in FY07.
This was achieved with a help of impressive growth of 72% (FY06) and 67 % (FY07) in deposits. We expect the bank to register healthy growth of 32.3% and 28.5%in deposits in FY08E and FY09E on account of changing resources mix from borrowings to deposits mobilization, which in turn will reduce the cost of funds (which we expect it to be at 6.81%in FY08E and 6.79% in FY09E) and enhance the NIMs. The shift in resources mix was clearly evident from the resources mix of FY06 and FY07. Going forward, we expect the bank to maintain a 3:2 ratio (FY09E) in favour of deposits, thereby taking the deposits base to Rs 73,723.2 crore, implying a CAGR of 30% through FY07-09E. We also expect CASA deposits to improve from FY07 levels of 25.2% to 28.4% in FY09E.This increase will be contributed by the addition of branches and retail deposits of UWB. Trust On Growth in Retail advances-Ensuring Better Yields Being a former DFI, IDBI has leveraged its position in the corporate lending side of the business. In FY06 and FY07, retail advances constituted 16.2% and 15.7%of its lending book. Going forward, the goal is to achieve 30% retail and 70% corporate lending mix. So one can easily understand the xposure of the bank’s lending book towards corporate sector (even advances to priority sector forms a low proportion of the advances book). As a result of this, the bank had lower yields on advances, which stood at 6.75% and 7.12% in FY06 and FY07 respectively. Now with the integration of UWB which will enhance the retail coverage, we expect the bank to shift focus on garnering more retail loans which will have favorable impact on the yields and thereby the NIMs of the bank, but still we expect IDBI’s loan book to be heavily tilted towards the corporate lending. We expect advances to grow at a CAGR of 21% over FY07-09E to Rs 91,959.2 crore. We expect yields on advances to improve to 8.09% by FY09E because a thrust on growing retail advances will help the bank to earn higher yields as compared to yields from corporate lending. Rising fee income to suppliment core business In FY06, trading income was very high at Rs 703 crore against Rs 335 crore in FY05 as it offloaded a bulk of G-Sec. In FY07, however, trading income was again in the range of Rs 314.1 crores. It has got an SLR book of just 13%, which is fully in HTM category and hence less MTM losses expected due to interest rate risks going forward. Also, the increasing focus of the bank on core business would ertainly lower the ratio of trading gains to total income. Non- interest income as a percentage of net income has declined from 77% in FY06 to 61% in FY07 and is expected to further decline to 51.8% by FY08E and 49% by FY09E due to comparatively higher contribution of core net interest income. We expect overall non-interest income to grow at a CAGR of 16% over FY08 - 09E, excluding the effect of one-time sale in fixed assets in FY07. Recently, the bank has forayed into insurance, a high growth, through a joint venture with Fortis. The bank has so far received the principal nod to flag off the venture and we expect this business front to add value to the bank in future. The bank is also planning a foray in the asset management business, which will boost non-interest income as well. All set to meet the new BASEL II challenge This is one front where IDBI is in a comfortable spot. The current holding of the government stands at 53%. The bank has been able to maintain a healthy CAR ratio for FY06, which stood at 14.28% hereas the same as per Q1FY08 results was one of the best among the PSU banks at 14.4%. Also there is scope for the bank to raise further capital by way of perpetual Tier I and Tier II capital of Rs 1,200 crore and Rs 4,088 crore respectively. Going forward, we expect the bank to maintain a reasonable CAR of 11% in FY09E. Turnaround in industrial sector to improve the asset quality Upsurge in industrial activity, especially in the steel sector, in the last couple of years has helped IDBI to improve its asset quality due to increasing recoveries from the bad loans that were accrued. The GNPA and NNPA levels for FY07 declined to 1.97% (2.12% in FY06) and 1.16 % (1.07% in FY06, this has gone up due to the inclusion of the NPAs on account of consolidation of UWB) respectively. Going forward, we expect the recoveries of bad loans to continue which will bring down the NPAs to 0.80% in FY08E and 0.50% in FY09E. Also the loan loss coverage ratio is expected to move up to 58.8% in FY09E. SASF (Stressed Asset Stabilisation Fund) Bonds yielding no returns IDBI had earlier transferred bad loans of Rs 9,000 crores to SASF and had in return received bonds from government, which don’t yield any returns. As and when recovery is made that much funds become available to IDBI as resources that are available for funding balance sheet. As of March 2007, the outstanding balance in IDBI’s SASF bonds was Rs 7,366 crore from which we have factored recovery of Rs 6500 crores and Rs.6000 crores in FY08E and FY09E respectively. Investment book – a hidden jewelIDBI has got a huge investment portfolio of quoted and unquoted equity stocks. It could unlock value from these hidden jewels and boost profitability. We have tried to get IDBI’s list of investments in companies where it holds over 1 per cent stake.The current market value of quoted investments comes to Rs 1,768 crore. There are high growth and turnaround companies like IDFC, IFCI, Reliance Petroleum, Indraprastha Gas, Gujarat State Petronet Ltd, etc. On an unrealized gains basis, the value of these investments is Rs 528 crore. Unquoted equity investments valued at Rs 2,034 crore and unrealised gains are expected to be Rs 1302 crore. All these valuations are based on stocks disclosed by IDBI. There will be many other stocks in which IDBI will be holding <1% stake and have not been disclosed. We have valued individual unquoted equity investments on an EPS or net worth basis. We have taken the cost of equity investments, quoted and unquoted based on discussions with management. We have analysed value of investments in three ways: 1) At estimated total realizable value from sale quoted and unquoted investments giving Rs.52 per share of IDBI, 2) Estimated unrealizable gains per share giving Rs 25 per share of IDBI and 3) An average of the above two giving Rs 39 per share of IDBI. However, as we know only partial investments and not overall investment book we use the first method to value investments. Value unlocking from subsidiaries too …IDBI has four wholly owned subsidiaries – IDBI Capital Market Services Ltd (ICMS),IDBI Homefinance Ltd, IDBI Gilts Ltd and IDBI Intech Ltd. IDBI is planning to sell a 26% stake in IDBI Capital to strategic investor. In FY07 and FY06, IDBI had done buy back of 1 crore and 3.2 crore shares of IDBI Capital at Rs 58 and Rs 27 per share respectively, giving us some sense of future valuations. We have estimated IDBI Capital’s value based on the UTI Securities stake sale to Standard Chartered and the recent IPO of Motilal Oswal Securities Ltd. Valuing IDBI Capital at a very conservative Rs 58 per share, translates into a value of Rs 870 crore. However, we have valued the company at 3x its networth of Rs 362 crore, which is more than a 50% discount to Motilal Oswal Securities IPO price, giving us a value of Rs 1,088 crore. It converts to a pricing of Rs 70 per share of IDBI Capital, a 20% premium over its earlier pricing. We have to however consider the fact that PD business has been transferred from ICMS to IDBI Gilts. IDBI Capital has also expanded its broking business with new retail investment portal and started PE fund also. So we believe the valuation at Rs 70 per share of IDBI capital is justifiable which equates to Rs.15 per share of IDBI Bank. IDBI Capital had a total income of Rs 40.8 crore in FY07, down from Rs 125 crore in FY06 mainly on account of the transfer of PD business and some trading losses. It had a networth of Rs 362.7 crore as of end FY07. IDBI Home Finance is also growing gradually with a total loan book of Rs 2,146 crore as on FY07. Net profit increased 60% y-o-y to Rs 23.1 crore in FY07 from Rs 14.4 crore. We have valued home finance business at 1x its current networth of Rs 160 crore giving a value of Rs 2 per share of IDBI. IDBI Intech had also made a net profit of Rs 6.5 crore in FY07, however its operations are very small and hence we have not considered it and IDBI Gilts in our SOTP valuation. Risk and ConcernsEconomic downturn to increase NPAsAny downturn in the economy may lead to a surge in NPAs as it has exposure to most industrial sectors and thereby requiring more provisioning to be made. This can impact IDBI’s future profitability.Investment portfolio gains linked to capital market volatilityIDBI quoted equity book is exposed to market risks and any adverse movement in capital markets may affect the expected valuation and earnings from investment portfolio.Hardening of interest ratesFurther hardening of interest rates may affect the bank and the sector as a whole as pressure on cost of funds will continue.IDBI Bank ValuationsIDBI is expected to improve on its core business front gradually with NIMs expanding from 0.48% in FY06 to 0.74% in FY07 and is estimated to rise to 1.07% by FY09E. We expect RoE to rise from 10% in FY07 to 12.3% levels in FY09 with share of trading income declining and that of core NII increasing.At the current price of Rs 130, the stock is trading at 1.3x its FY09E ABV and 10.6x its FY09E EPS of Rs 12.2. Based on a theoretical book value multiple of 0.9x its FY09E ABV, the value of its core banking business comes to Rs 87 per share. Its huge investment portfolio is valued at Rs 52 per share and subsidiaries at Rs 17 per share. Source : ICICIdirect
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