Upcoming quarter is super important for IRFC. They are close to their internally set max leverage, we need to monitor if
They will respect minority shareholders and not dilute below book thereby increasing the leverage >10
Raise capital below book and destroy value for minority shareholders.
In case of 1, the upside potential will get rerated and IRFC can trade at premium to book. Incase of 2, not worth investing.
Agree.
But in their board resolutions, they increased borrowing limits but there has not been any inkling towards fund raise or leverage limits. It might be probable that they will securitize and take exposures off their books to grow
If they either do relax leverage limits or do securitization, with the kind of appetite MoR seems to have for borrowing…this is a risk free, high growth stock trading below book at low valuations
In Q4 concall, management mentioned they are yet to take a call on 10x leverage limit. But also mentioned they are willing to increase this 10x limit rather than going for new equity capital raise.
The audio recording of the transcript.
As an investor, the most I was concerned about is the 10X leverage limit which shall be breached in near future as the loan book is growing at far higher pace than equity book and I was worried that a fund raise may lead to dilution at lower than book value. However, I feel the con call had allayed most of the fears as
They said the leverage limit of 10 X is internal and they can raise it if they wanted as their CRAR was healthy. Although they had said the same during previous con call, the tonality this time was more definite and assuring as I feel they recognize the need to do it at some point
On being asked by someone, they said they are open to exploring INvits as a way to deleverage and hence grow book without breaching Leverage Limits
When I had asked them why they are not exploring securitization in lights of double benefit of
a) M2M gains amidst falling interest rates
b) Deleveraging
they indicated that they had done it in the past and shall explore at an appropriate time in the future
I had specifically point blank asked “In case your limit is being breached and you have two options of raising equity or relaxing limits, what would you chose”. The answer was affirmative that they would rather relax leverage ratio than raise new equity
Internal Notes
It being a PSU, securitization and InVITs although being great ideas require affirmative work and hence in the shorter term, it is more likely they will relax leverage limit. But the positive reception to these ideas is comforting as it is likely they will at least start to think along those lines as alternatives to dilution whenever limits are hit.
They said they had 3 years to reduce to 75%. It seems to me that they wont be in a hurry to achieve that or raise capital at depressed prices. They much rather show good profits and improve stock price before selling their stake or doing a capital raise
Disclosure: Invested
This is a super informative concall. Finally he gave a definitive answer on the leverage limit.
Over the past two months after listening to all PSU bank concalls, I have realised that these management don’t understand the minority value destruction when they raise T1 capital at below book value.
Despite many analysts tried to explain, they simply couldn’t think of it on analytical note. All they think of is, next year they need to do X business and they need y capital.
One should be able to understand that, trading below book is clear indication of shareholder don’t want you to grow. But, clearly these banks work for the nation and not shareholders.
In this case, Amitabh Banerjee seems like a great guy who have the ability to balance between the the equity dilution metrics as well as growth
Shareholders should make sure to send enough mails explaining why diluting below book destroys minority wealth thereby indirectly hitting the stomachs of his 13.5 lak shareholder and why leveraging and increasing the ROE numbers will give him premium valuation there by wealth for his shareholders.
Disclosure: no holdings, wanted to make sure they walk the talk before entering.
Someone can clarify this statement mentioned in the investor presentation for rolling stocks
In FY21, IRFC was entitled to a margin of 40 bps over weighted average cost of incremental borrowing
When they say “cost of Incremental borrowing”, does that mean whatever yield they get is based on rate at which they raise in current year. If that is so, how they manage the loans/debt they raised in previous year which are at higher rate.
For loans provided for projects and RVNL, they did not specify it as Incremental borrowing
In FY21, IRFC was entitled to a margin of 35 bps over weighted
average cost of borrowing
In line with expectations. After a Bumper Q4 2021, it is expected that disbursements will fall and the managemenet has already clarified that disbursements have a skew where a huge portion of disbursement is done in Q4 every year.
Need to monitor the guidance on dividends and book growth during con call. Initiatives such as INvits and Securitization are other things to monitor going forward
IRFC business model is to bring in equity and use it to leverage to 10X (current ceiling). And then do lease financing to MoR at cost of borrowing (CoB) plus margin of 30-50bps.
So say equity of 10 and leverage of 100 at CoB of 8%. Assuming entire fund 110 has been used for lease financing at 50bps margin; 110 would fetch a return of 8.5%. Earnings = 8.5% of 110 - 8.0% of 100 = 9.35 - 8 = 1.35. Again assuming no opex. RoE = 1.35/10 = 13.5% which is equivalent of CoB+(10+1)*50bps.
In Q1 21-22 IRFC has reported of RoE of 15.78% which seems very high. Even if CoB of all borrowings is 8%, RoE can not exceed 13.5%. How is the company able to get the 15.78%?
One reason I can think of is when the company borrows during a year say at 8.0% and enter into lease agreements for next 15 years at 8.50%. Funds borrowed would have different tenures. Say some borrowings matured in next 7 years and the company is able to refinance it at 7.0% while lease income remains fixed at 8.5%. This would result in extra income for the company. In the falling interest rate environment this can be a positive surprise but in case of increasing interest environment it can result in negative surprises.
What can be other reason for such a high RoE for the company in Q1 21-22?
Hi Naman,
I can only think of two possibilities
However, on call they explicitly mentioned that they are doing high cost debt refinancing and not securitization. So, like you had predicted, it should be the 2nd one
@p12srirampp - thanks for your inputs. I agree securitization will also result in higher RoE. It seems like there is something more going on. Even if we were to consider the benefit of refinancing of higher cost debt with lower cost debt, numbers do not add up. 2.5% of excess RoE on 31.03.21 equity of 35,900 cr would be ~900 crores. And say 1.5% is the benefit of reduced interest rate at the time of refinancing then that would mean refinancing of ~60,000 crores of debt which seems to be too high. It seems like there is more going on. I suspect that accounting of project assets pre commencement lease - interest income is creating some noise. May be 2020-21 AR would have some answers.
All the quarters/years with high RoE will have equivalent quarters/years with low RoE (may be even 10%). If the street is not enthused with 15.78% RoE, then they would not be at all happy with RoE of 10%. That time may be great buying opportunity. I do not think they will end the year 2021-22 with RoE any higher than 13.5%.
They have specifically mentioned that company does not have any interest rate risk hence
during rising interest rate scenerio company shouldn’t be facing downcycle which also implies that no upcycle during lower interest rate ,
I feel there should be another reason except refinancing which explains higher ROE
Thanks Vyom. I see from where are you coming. In their AR and Prospectus, the company did mention that they do not have any interest rate risk but in the context of borrowings having floating rate of interest or hedging costs etc. They have not specifically mentioned that interest rate risk in relation to refinancing of debt is also passed onto MoR. But I agree with you that in the true spirit of business model costs/benefit arising due to refinancing of debt should be passed on to MoR. I hope they have robust accounting mechanism to identify this (considering fund and borrowings are fungible) and are following it. But we can not be sure unless confirmed by the company or the management explicitly about this.
What you have highlighted is very important fact and I hope someone ask this question to the management in the next concall.
Agree, there is something more to it, that we are not able to figure out. 15.5% RoE does not makes sense, until it can be proved how this number is arrived at.
Based on your comment, I thought reinvestment at lower rates is causing the jump in RoE, but after going through DRHP, it looks its related to the way lease agreement is structured. See below:
According to above, entire principal and Interest amount is recovered during 1st leasing period of 15 years. Then what is the use of Secondary leasing period?
According to above, there is some nominal rate charged in second 15 year period. How much? I could not find anywhere.
Let me know if you find some clarity over it
In the secondary period of 15 years the company charge Rs. 100,000. I am sure about it but do not remember in which document it is mentioned. With such a small amount it may not make such a large impact in the P&L. I think this method was used to match the lease period with the economic life of the asset so as to structure the arrangement as a finance lease.
Thanks for the response. Let me know if you remember where you saw these details.
Coming back to original question, then this is not the answer to the question of where the 15.5% RoE is coming from.
Based on the latest annual report, I see most of the bonds raised by IFRC are for 15 year term. As you said, it does not looks like raising funds at lower rates while maintaining same interest rate for Indian railways, is the source of high RoE.
Overall, at 8% average cost of debt (which is on higher side, ideally it will be lower) and 10 times leverage with 0.4% spread, one cannot make more than 12% (8 + (0.4*10)) RoE in best case scenario. The puzzle still remains to be answered.
Other negative points that I see:
With such a small spread (0.4%), the company will have to lend incremental 1 Lakh Core, to generate additional profit of Rs 400 Cr. Irrespective of huge demand for Capex in Railways, Realizing high profitability and RoE looks very difficult for IFRC.
If Interest rate drops in market, RoE will further reduce, as IFRC cannot change the Spread (0.4%).
True but what you are getting is a business which trades @ a pe of 5 maybe lesser at current levels with no risk of npa
For the growth part, the company from 2016 to 2021. has increased loanbook from 108000cr to 377000cr ,in the last 3 years they are adding almost 80000 to 100000cr eyery year in the loan book(source screener) with the current objective of government to build dedicated freight corridors this number is only going to increase .
at this current rate i dont see the loan book @ 700000 cr in the next 5 years you will be getting a stock @ under 2.5 pe and a divdend yield of 8 to 10% all with the backing of the government for the next 15 years.
Can anyone confirm what happens to the rest of the profits that are not paid as dividends ?looking at balance sheet i see the the difference between the loans and advances and borrowings keep increasing ,are profit used to lower the borrowing?,Another thing i have noticed is interest spread are increasing YoY is paying borrowing with net profit the reason for this.
One of the things we have assumed for this leverage discussion is they can grow their loan book at 25% easily. Railways have some required Capex. Government provides some part of it through budget while the rest is done through external borrowings. IRFC has become 70% of the external capital outlay for Railways. I know there is a lot of capex allocated to railways for next decade. However, once they become majority of Railway’s capital outlay, I don’t think they can grow much fast. If IRFC grows a 25% for next 3 years, and Railway’s external capex grows at 10%, IRFC becomes 100% of railway’s capex. Even lending to other PSUs won’t matter since the scale they have already reached. The growth will have to slow down. I think that’s where market is pessimistic along with PSU tag.
25% for next 3 years itself is not possible. Till this year, project assets are under moratorium, so there is no run down in AUM, hereafter we can see rundown here and definetly it will reach saturation point where new loans match with retiring loans.
You are correct. This is debt product, but instead of holding PFC, REC, Coal India, this is bit safer option until, Railway babus bowl a googly
Yeah, you’re right. People are overthinking about leverage and how will they manage their superb growth with 12% ROE. I think even if the growth came, it’s easy for them to breach the internal leverage ceiling. And the only way insane growth will come is if government reduces budget for railways substantially. Otherwise, we don’t have enough growth opportunities. It seems safer, but they could be more directly affected due to any policy changes, that’s why I have made a bucket of tail-enders including PFC, REC and IRFC in my portfolio.
