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SmartInvestor. Infrastructure lending company IDFC's stock after rallying 8.7% in initial trading closed 2.2% at Rs 125 on Thursday even as the company was among the only two (out of 25) to get a licence (Wednesday evening) to set up a bank. While the 36% share price gains since beginning of March is partly responsible for the fall, IDFC is also expected to witness slower growth in its balance sheet and earnings, and pressure on its return ratios in the initial 2-3 years of setting up the bank, say analysts. Since the focus will now shift to successful transition to a bank, the stock may remain under pressure in the near-term. However, most analysts remain optimistic from a long-term perspective given the management's proven track record. "Though in first and second year of incorporation, RoEs (return on equity) will be dragged down, it is a long term positive as it offers cheaper funding options for a large scale lender. Citing the banking story, we are raising our target multiple to 1.3 times FY15 estimated adjusted book value, leading to a revised target price of Rs 150," says Kajal Gandhi of ICICI Securities. Subramanian Iyer of Morgan Stanley Research, however, says, "This is a long term positive as it reduces risk. However, stock performance over the next 12-24 months will likely be weak as profitability will come under pressure." Valuation is expensive in the context that RoE is less than cost of equity. By FY20, we expect RoA (return on assets) to decline to 1% from 2.9% (FY13) for IDFC. Longer-term gains depend on execution, adds Iyer. Out of the 15 analysts polled by Bloomberg in March 2014, eight have a Buy, six a Neutral and one a Sell rating on the stock. Their average target price stands at Rs 127 an upside of just 1.3% from Thursday's closing price. Currently, IDFC trades at 1.1 times FY15 estimated book value. In the initial years, IDFC will need to comply with the banking license requirements (in 18 months), which come with its challenges. IDFC will have to change the company structure, but, more importantly, it will have to reduce FII shareholding from 54% currently to 49% in the existing listed company (IDFC). Also, the non-operating financial holding company (NOFHC) will have to reduce its shareholding in the bank to 40% in the first three years. This can lead to dilution of book value, depending on the price it is able to get from investors. A premium pricing would, however, result in good gains for existing investors of IDFC. However, Gandhi says, "The easiest route is to give NBFC (IDFC) shareholders proportional shareholding in the NOFHC, though it may require RBI nod. IDFC will have to expand its branch network with 25% of these in rural areas (low ticket, less profitable) as well as maintain Statutory Liquidity Ratio (23%) and Cash Reserve Ratio (4%). These along with priority sector lending (PSL) norms will put IDFC's profits under pressure and RoA and net interest margin could halve to 1.3% and 2% respectively, over the next 2-3 years, say analysts. To reduce the regulatory impact of CRR, SLR and PSL, balance sheet size may also see some pressure. "We expect lDFC's core infrastructure loan book to decline by 10-15% over the next 2-3 years; however, overall loan book is likely to increase due to incremental lending towards priority sector. RoEs will fall to 8% in the first two years and gradually increase to 15 per cent by FY20," says Nischint Chawathe of Kotak Institutional Equities. Chawathe expects net profit to decline to Rs 1,300 crore in FY15 compared to Rs 1,900 crore estimated for FY14, but others like MOSL analysts expect a marginal increase in profits. Apart from enabling IDFC to diversify its loan book, a banking license will provide access to low-cost CASA deposits, improving cost of funding albeit in the long run. Infra sector accounted for 85 per cent of its loan book of Rs 54,552 crore as on 31st December 2013. While IDFC can leverage on its strong corporate relationships, it will be operating with lower capital adequacy norms which in turn will lead to higher asset (loan) growth, boosting RoEs in the longer run. "We will be raising our fair value estimate of IDFC from earlier level of Rs 134 to factor in banking license approval. We are quite optimistic about the firm?s future prospects with the license in hand," says Suruchi Jain, Equity Research Analyst, Morningstar India. AdvertisementsIntroducing the new 11th generation corolla altis. Building a Global Enterprises-India. 28 APR-01 May 2014. Make New Beginnings design a Neo Life. Rajiv Gandhi Equity Saving Scheme. FacebookTwitterGoogle +YoutubeRSSCopyrights © 2014 Business Standard Ltd. All rights reserved. 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