5 reasons why IDFC is a medium term sell

Analysts say that though the stock will give good returns in the long term, it has peaked out in the short to medium term

IDFC opened sharply higher on news that the company has been given a in-principle approval for getting a banking licence. The stock has already moved up by 30 per cent over the last one month in line with the rally seen in banking and infrastructure stocks. There was also anticipation of the financial institution bagging a banking licence that was being priced in the move. 

 

With the uncertainty behind us, is banking licence really a positive for IDFC, which anyways is in the business of lending. Edelweiss believes that in the short to medium term there is pain in holding on IDFC though in the long term, the development is positive. By long term they mean after 2019.

 

Nilesh Parikh, Kunal Shah and Prakhar Agarwal of Edelweiss in their Impact analysis for IDFC say that the upside is capped in IDFC given the operational challenges in setting up a bank. Here are five reasons cited by Edelweiss justifying their stance.

 

1.IDFC will be impacted in the short term in order to comply with regulatory provisions such as maintaining SLR (Statutory Liquidity Ratio), CRR (Cash Reserve Ratio) and compulsorily giving loans as per the priority sector lending (PSL) which are both riskier and of low yields. 

 

2.Operational costs of IDFC will go up as it will have to open branches in Tier–5/6 cities which will be a costly affair and low yielding as raising sizeable deposits from such cities will be a difficult task. 

 

3.In an increasing competitive scenario, IDFC will face execution risk in acquiring and retaining talent as well as training the existing staff to perform banking functions. 

 

4.Increasing competition will also make it difficult for IDFC to scale its asset/liabilities base. Edelweiss believes that it will take IDFC at least 4-6 years to ramp up their operations. Edelweiss feels that these measures would bring down IDFCs Return on Equity (RoE) to sub-10 per cent levels which in any case is a modest 14 per cent. 

 

5.But the most important point as far as investors are concerned is that IDFC will have to bring down and cap its FII holding to 49 per cent from the present level of 53.5 per cent. If some of these FIIs refuse to sell in the market then IDFC will be compelled to go in for an equity dilution to the extent of 7-8 per cent. This would further lower the Return on Equity (RoE).