We are adjusting our fair value estimate for IDFC to Rs 90 per share, after taking into account the recent demerger of IDFC Bank (which Morningstar does not cover) and our lowered near-term expectations for IDFC.
Our valuation implies a price/book multiple of 1.5 times our fiscal 2016 book value estimate. IDFC will hold 53% of the bank’s equity, with 47% of bank profits flowing to minority shareholders. After adjustments, the book value per share for IDFC drops to Rs 61, from Rs 100 pre-demerger, as Rs 39 per share in book value flows to the bank’s starting balance sheet. We retain our no-moat rating, as we believe the bank will take more than a decade to build a substantial deposit franchise that will provide it with cost advantages.
It was strategic for investors to buy IDFC pre-demerger, and presently the stock trades at a discount to our fair value estimate. The catalysts for the stock price to meet our fair value estimate could take a while to materialise.
IDFC Bank captures many of IDFC Limited's future growth prospects, and is still in the startup phase. We are, therefore, changing our fair value uncertainty rating for IDFC to very high.
We also reduce our near-term expectations of profitability. We now incorporate higher provisions in the first two years of the bank’s existence as the loan book transitions from its current infrastructure focus to a more diversified portfolio.
Our 5-year provisions/average loans ratio has increased to 1.4% from 0.8%. We also assume increased technology spending as the firm looks to reach out to the masses using technology. Our cost/income ratio for 2016 is 27%, versus 17% before, as we believe technology spending will be front-ended. Furthermore, since the bank will take some time to generate a low-cost deposit base, we reduce our net interest margin forecast to 3.0% from 3.3%. As a result of these changes, our 5-year forecast average returns on equity fall to 12%, and average returns on assets fall to 1.5%.
