Upgrade IDFC Ltd to Buy post de-merger, de-rating of stock
IDFC Ltd de-merged into IDFC Ltd (holdco) and IDFC Bank (IDFCB) transitioning to IDFCB. The holdco has a 53% stake in IDFCB (IDFC Bank) and maintains stakes in AMC (75%), alternate assets (100%) and the securities business that it had prior to the de-merger. Interestingly, the holdco’s share of the bank (market cap of $3.4 bn) itself is worth $1.8 bn, ~30% higher than the holding company market cap of <$1.3 bn. We think this is a valuation anomaly, as: (i) the market appears to be assigning a negative value to its nonbank businesses; OR (ii) the market is giving a +50% discount to underlying constituents. We think this should correct. Hence, we upgrade IDFC to Buy with a price objective of R65.
IDFCB contributes 79% of total SOTP
We value IDFC at Rs 65, based on a SOTP (sum of the parts). In our SOTP, we value IDFCB at Rs 79/share; AMC and alternate asset businesses together are valued at R18/share, while IDFC Sec. is R3/share. We assign a 35% holdco discount. We think a holdco discount of more than 30-35% appears unjustified, given that IDFCB (biggest contributor) is listed and a tangible value can be ascribed to it. Moreover, there is value accretion from the nonbank businesses managing total assets of $11.3bn between them; the current discount (45-50%) suggests negative value is being assigned to non-bank businesses.
Transition to bank challenging, but bank can trade at 2x P/B
The transition to a bank will be painful, as it expands distribution and meets regulatory requirements, hurting its profitability (ROA (return on assets) at 1.2%. ROE (return on equity) at 12.4% by FY20). But it can arguably trade up to 2x P/adj. BV, having cleaned up its b/s; its share of infra loans will be 30% by FY20; EPS (earnings per share) growth at +30% (but off a low base); and Tier I of +15%. We have also initiated on IDFCB (IDFC Bank), with a Neutral and PO (price objective) of R70 (at 2x P/adj. BV).
Upgrading to Buy
IDFC Ltd. de-merged, as planned on 1 October 2015, into IDFC Bank and IDFC Ltd— both of which are listed. The erstwhile IDFC Ltd is now structured as a three-tier company with IDFC Ltd, the parent, having a 100% non-operating holding financial company (NOHFC)—and the NOHFC holding stakes in four subsidiaries—IDFC Bank (53%), AMC (75%), IDFC Alternatives (its private equity investment arm), and the proposed IDFC Debt Fund.
More importantly, IDFC Bank (IDFCB) will also no longer be an infra finance company, but will transform into a full-fledged bank, with the share of its infra loans falling to <30% by FY20. We separately overage on IDFCB with a Neutral (IDFC Bank), given the near-term challenges and headwinds it is likely to face during its transition to a bank.
The shareholders of IDFC Ltd (as of 9 October) got one share of IDFC Ltd and one share of IDFCB for every share of IDFC they held before the demerger. Majority of the assets of IDFC Ltd were transferred to IDFC Bank, including majority of its net worth. IDFCB commenced operations as of 1 October 2015.
Sum of the parts at Rs 65; 24% upside potential. From a valuation perspective, we had a price objective of Rs 140 on the erstwhile IDFC Ltd with an Underperform rating. Now there are two listed entities—IDFC Ltd (in its de-merged form) and IDFCB (that began trading in early November). After the de-merger, we arrive at a price objective of Rs 65 for IDFC Ltd, the holdco, using our SOTP analysis as shown, wherein we assign a 35% holdco discount.