ValuePickr Forum

IRFC - A Zero NPA NBFC

The Indian Railway Finance Corporation is an NBFC with the objective of financing Indian Railways. It was founded in 1986 and IPOed last month.

  • Market Cap ₹ 32,475 Cr.
  • Enterprise Value ₹ 266,751 Cr
  • Current Price ₹ 24.8 (ipo price: ₹ 25)
  • Stock P/E 8.80
  • Book Value ₹ 23.7
  • March 20 revenue: ₹ 13,838 Cr and PBT: ₹ 3,692

Whom does it lends to:

  • Majorly it acquires rolling stock assets and then leases it to the Ministry of Railways(MoR). The lease terms between IRFC and MoR are revised every year.
  • It also finances other PSUs like RVNL.
  • The borrowing target is also provided by MoR at the start of the year.

How does it borrow:

  • Long term issuer rating is AAA by Crisil, ICRA, Care. Baa3- by Moody’s.
  • From Domestic and International markets. Though domestic contribution is > 80%.
  • term loan from LIC (biggest lender), banks and other institutions, Sale of bonds, internal accrual and asset securitization.

Promoters: Its a PSU with the GoI’s holding at 86%. 14% is public.

Historic performance:

  • 3yr revenue growth cagr: 15% 3yr profit after tax growth cagr: 58%
  • current ROCE 5.93% ROE 13.2%

Future Growth Drivers: Govt of India’s ambitious 100 trillion Rs planned infra investment (national infra pipeline 2019-2025). Railways should get a good chunk of it. (new locomotives, tracks, electrification etc) and that would be needed to be financed.

Pros

  • 0 NPA since 1986. Prospects of any NPA in future is really slim because MoR get its fund from the union budget.
  • High credit rating results allows them to borrow at good rate. This can help them negotiate with MoR for better terms.
  • Number of employees: 26. IMO the chances of fraud/scam reduces if the number of employees are low. Obviously employee cost also remains low.
  • Risks relating to damage to Rolling Stock Assets as a result of natural calamities and accidents are passed on to the MoR.
  • Foreign currency risk is also passed down to MoR.
  • Good historic performance.

Cons

  • PSU.
  • Only one client. But that client is MoR.
  • Final say on margins is with MoR and is decided every year. This is a big risk IMO.
  • No stock based incentive to KMP. Also the KMP remuneration is very low in comparison to PAT. (< 0.5%). Whats the incentive to the management to give their hearts out??

Bottomline:
I believe the Company is trading at cheap valuation and shouldn’t be considered just a dividend company when there is a strong railway infra push by the government which will directly translate to higher borrowing via IRFC. Though i can’t get my head around as to why is a PSU making big bucks out of govt’s pockets.
Looking forward to insightful opinions from fellow Valuepickrs!!

Disc: Tracking. Not yet invested.

References:
2020 AR
HDFC coverage
groww blog

4 Likes

Thanks for your analysis. Could you also tell what’s the dividend policy of the company.

Adding couple.of reasons for not investing:

1.Massive growth ahead in excess of 25%+ over next decade. But ROEs are hardly 12% & leveraged capped at 10× despite high capital adequacy.
So, inorder to facilitate this excess growth they need to dilute every 2 years. Now, if they dilute below book value, that will lead to reduction in book value, eps etc and it’s a vicious cycle.

  1. Long run cost of debt always goes down, in next 10 years cost of debt in India will.move down to 3- 4% this will mean ROE for this company at hardly 7% ish( unless they start funding private sector at higher spreads). Incase they decide to diversify to Pvt sector, I wonder why will it trade more than its book considering its peers PFC & REC and the bulk loans, NPAs they have in Pvt loan books.

  2. Infact, apart from.the.business model. This company consists of hardly 35 people raising funds for the goverment. So, paying 30kcr valuation only for purchasing a low risk debt model where we know that it’s prone to disruption due to fiscal policies(pricing spreads, forced dilutions etc) for hardly 10-12% compounding doesn’t seem very attractive.

9 Likes
  1. The concerns about Leverage Capping at 10X is legit but the management has confirmed on con call that it is an internal guideline and is not restrictive. They can choose to do away with the gearing limits.

  2. The current gearing is at 7.5X. Even if we are to assume 10X as a restrictive limit, it means, as on today, it can increase book by 33% without any dilution. That means, at 12.5% RoE and assuming 25% book growth, it still has 1-2 years before those limits are hit

  3. With its policy to pay out 30% PAT as dividend, I dont see any other way for the company except to ease its artificially set leverage limits. There is no advantage the government gets either to set its limits at 10X. I dont forsee they doing a dilution every year to meet its artificially set gearing limits

  4. Even if such a dilution were to happen, I dont see why anyone should buy Govt treasury at 6.5% when the same credit exposure to the government here is giving you 12.5% RoE and earnings yield. That should help dilution to happen at a fair price

  5. The receivables can always be securitized and sold to foreign investors chasing yields. The current book seems to have a 8% INR yield. Assuming 5% hedging costs, it is still 3% USD returns which is attrractive to many investors and for investors who might want to bet on the collapse of the dollar amidst unprecedented printing

  6. Just flipping the funnel, the receivables can be securitized and sold to the very same Indian banks who are lending to IRFC. By this they can have the same exposure but move from Non Zero Risk weight exposure (IRFC) TO Zero Risk weight exposure (MoR) in a regulatory arbitrage

So, Yes, the concerns of dilution are valid but there are a host of solutions to grow without ever needing to dilute if the management decides to explore (by securitization or easing gearing)

If I were IRFC what I would be doing is put a Goldman Sachs hat, securitise the loans and sell to investors in Europe/US who are vying for yields. This allows IRFC to capture a quick profit and reduce gearing. Hence can grow without any equity infusion

Basically twist the model from NBFC to that of an investment banker. (I see the IRFC business as an Investment banker who is helping its client raise many as opposed to an NBFC that borrows money and spreads risk among multiple clients)

Even if the government does not do any of the above, I am happy to earn a 12.5% earnings yield on an FD like risk which pays me 4% (Not counting pvt banks here as they are not exactly safe as seen in a big bank last year)

The book by end of this financial Year is set to grow to 3.8L Cr as per con call. This means the PAT will likely be close 1250 Cr per quarter => 5000 Cr annualized PAT and growing…just the jump in annualized PAT should increase stock price by 25% in next 1 year if we assume P/E shall remain constant

More on this post which I wrote a few weeks ago

6 Likes

Nice points.

Extracts from your post:

  1. Leverage can move from 10× limit to 25× limits.

  2. Securitization

  3. Risk weight arbitrage.

5.High P/B dilutions due to host of reasons.

My counter view:

  1. Leverage limits revision to 25× or even above 10× is not an easy decision.
    China has done this before and it is also possible with current rules. But, what about the critisism of hiding excessive debts in Quasi sovereign entities & ratings there after ?. Not so easy.

  2. I haven’t seen any securitization deal at 7% yields till now. IRFC spread is hardly 30 bps over cost of funds. Note that cost of funds are very close to sovereign debt due to the backing.
    Maybe, this can be a way but I don’t see any compelling reason apart from the promoter not willing to dilute.
    In this case I don’t think promoter is that concerned about dilution.

  3. High P/B dilution is a tough affair. IRFC book value is at 27 bucks and it is already trading at discount. I don’t see any reason why dilutions will be at higher level as yet. Would be very interested to see high P/B dilutions.

  4. Major point: equity pricing risk + dilution risk is the major disruptor for returns in this stock.

Instead if you take 30 year fixed sovereign debt and reinvest one might make more without volatility.

You’ll have locked in debt at higher rates for longer tenure for eg: you’ll find many AAA sovereign debt paper at 10%-12% yields from 2000s.

same will be the case in 2030s and 2040s, 7-8% will be premium yeild.

  1. At some point, IRFC used to get .5% spread later it was revised to 0.3% again it was increased. This type of revisions will void all our higher roe assumptions.

  2. Having dividend in play will make the equity price upside to 5-6% on a straight line basis, but incase valuation derating we will endup having 0 stock price returns for maybe 5+ years.

  3. I’ve tried enough to model these risks for longer term projections. I felt, this risk is simply not worth it.

3 Likes

I think we do not disagree on the facts here but see it panning out differently. For me, IRFC is a good return on a risk adjusted basis where Risk is like an FD with additional upside to manifest if some of the things I said were to pan out. Some points

  1. I don’t think leverage is limited to 25X. It can theoretically be anything given that RW is zero. Also, the IRFC borrowing is a very small percentage of the overall government external debt. The extent of impact of “hiding” such borrowings on credit rating may be miniscule

  2. The spread is a function of the prevailing interest rate market. A lower spread means lower earnings but it also means higher P/E as money becomes cheaper. The spread has broadly followed the interest rate and hence there is a natural hedge for valuation

Like i said, i think we dont disagree on the reading of the stock but what the future holds

2 Likes

Please advise if story still Holds good for averaging.Share price is only going down and trigers for upmove are also limited considering govt divestment of 11% in next 2/3 years.

Has GOI declared disinvestment for IRFC ??? Is that the reason the price has been dropping ?

IRFC has declared its shareholding pattern and HDFC has invested a good chunk. Surprisingly, LIC has not yet invested and may contemplate investing at current levels.

1 Like

whats the reason for price decline

  1. Might be fear reduction in Govt spending on railway infra due to spending on Covid
  2. It is PSU, so valuation will definitely be cheap and hover in these area. Only after the result and seeing AUM growth, there might be some growth in price

Also just like rvnl there will be stake dilution at higher prices leading to price correction so in a bull markets market might favour high cagr stocks

does anyone knows approx total dividend yield…since they have given interim dividend we can expect a final one too

@Nimit , thank you for starting this post.

@manikya_saiteja_gund and @p12srirampp , wonderful reading your discussions. They’ve been really insightful and cover most of the issues.

The way I’ve been thinking about it is (and I haven’t made up my mind yet) - I guess this whole thing comes back to are you looking at yield or are you looking at stock appreciation.

The trajectory appears to be as follows:
They still have another 30% space to raise money (borrowings) after which they would have to dilute equity (management has also stated this is a possible option during the concall). This would probably be done/announced in the present FY itself given the demand for funds vs the balance sheet space.
Since the working is relatively simple, an increase in debt and 0.38% or some such figure (weight Sovereign at 0.4% + others at 0.35%) to understand revenue helps bring some visibility.

The dilution price would determine if it’s accretive to the rest of us or not. (if there’s a slight premium (likelihood is low), it helps us. If it’s at a discount, well, that may be a problem). Also given the nature of the business (compulsory 30% payout YoY, the 70% will barely make a difference with the passage of time, and high double digit AUM growth), dilution may be more frequent than desirable if they want a significant portion of the government’s business coming here.

Multibagger? Probably not. Yield? The purchase price will be the most important factor that will determine long term yield (needs to be able factor in dilution issue, etc.). That price is probably far lower than what it is trading at right now.

It’s a wonderful business and an addition to my watchlist, but I’m still thinking through the above.

A simpler way would be to look at full year EPS and take 30% of that. (the other is 5% of networth (whichever is higher as per policy) but this is a good enough proxy).

1 Like

IRFC is getting an exception from DIPAM from this dividend rule. Only in 2021 due to IPO fund raise DIPAM denied the exception.

Key monitorable for me to enter into this company:

  1. Company expanding its gearing > 10 - this removes the dilution angle.

  2. Slow growth i.e AUM growth ~= % increase in BV. - decreases the requirement for dilution.

  3. P/B value below .5-.6 - gives decent margin of safety.

  4. Dividend yield at 30% or 5% NW without exception from DIPAM.

Having (1 or 2) , 3 , 4 in play will make this stock attractive in terms of risk reward for a conservative investor.

1 Like

Only possibility where IRFC doesn’t want to raise fresh equity and if they want to grow at 25% aum growth and provide dividend with a margin of 38 bps , they have to leverage themselves at at least 25x.

For a 38 bps margin company, 10x leverage is a joke

If you see last 10 years for capital raising, they infuse capital almost every year and pay dividend every year.

FY Fresh Capital Raised(Crores) Dividend including tax(Crores)
10 291 117
11 511 100
12 750 116
13 600 116
14 632 128
15 543 213
16 2400 182
17 0 668
18 0 281
19 2854 452
20 2500 241
Total 11081 2614

This AUM growth fueled by heavy capital raise and if they stop capital raise and cap their leverage ratio, then aum hardly can grow by 4-5% per year

1 Like