IRFC IPO: Minimal risks and reasonable pricing make the offer attractive

Priced at Rs 25-26 a share, IRFC's nearly risk-free model positions the initial public offering as a safe bet for investors

Indian Railway Finance Corporation, or IRFC, is a government-owned entity which caters to the railways ministry’s funding requirements. Set up as a non-banking financial company (NBFC), its position as a captive financier for the ministry differentiates IRFC from other state-run NBFCs such as Power Finance Corporation and Rural Electrification Corporation. The latter two fund central and state government projects, along with private power plants, making them vulnerable to stress in the sectors they cater to.

Being a captive financier and classified as an infrastructure finance company comes with several advantages, including a host of sops, which makes IRFC’s cost-plus model an efficient one.

Priced at Rs 25-26 a share, which values it at one time its FY21 estimated book value, IRFC’s nearly risk-free model positions the initial public offering (IPO) as a safe bet for investors.

Business model

IRFC has a strategic role to play in the railways ministry. Its primary business is to finance the acquisition of rolling stock assets — which includes both powered (electric) and unpowered vehicles, as mentioned in the standard lease agreement between IRFC and the ministry — leasing railway infrastructure assets and funding the national projects of the Union government. The company also lends to other entities under the ministry and the central government on a need basis. IRFC follows a leasing model for financing the rolling stock assets with a lease period of 30 years.

In the first 15 years, known as the primary lease period, the assets are leased at a weighted average cost of borrowing and a margin determined by the ministry in consultation with IRFC at the end of each financial year. The weighted average cost of borrowing is priced for expenses incurred by IRFC, including foreign currency hedging costs and forex losses (or gains) incurred in hedging costs by way of interest rate fluctuations.

In the secondary 15-year period, IRFC charges a nominal lease rate, following which the asset is transferred to the ministry — after 30 years.

Therefore, IRFC’s revenue growth hinges on the pace of additions in lease contracts.

In FY20, IRFC had financed 76 per cent of the rolling stock purchased and leased to the ministry and financed Rs 71,392 crore of Indian Railways’ actual capital expenditure (48.22 per cent of capex). IRFC derived 79 per cent of its revenues from lease rentals and 21 per cent as interest income, lending to other government entities. Catering to the railways ministry, which makes bi-annual payments to IRFC, there are virtually no non-performing assets — the highlight aspect for investors.

IRFC’s three-year average cost of borrowing is 7.03 per cent. While the company’s rating helps it access funds at lowest possible rates, Amitabh Banerjee, chairman and managing director of IRFC, says its operational strength also plays a major role.

However, being a cost-plus model, net interest margin at 1.4 per cent is significantly lower compared to other state-owned NBFCs at over 3.5 per cent. Likewise, its return on equity has historically been in the 11-12 per cent range, again significantly low compared to private NBFCs. Clearly, IRFC falls in the category of low-risk, low return, though its exclusivity offers steady state growth and returns.

Risk factors

IRFC’s cost-plus model works to its advantage as it enjoys multiple sops from the government such as exemption from minimum alternate tax, following Indian accounting standards on lease rentals, and more importantly, adhering to income recognition and asset classification norms under the Banking Regulation Act for asset classification. If these exemptions were not available, numbers may look different, though it’s highly unlikely these sops would be reversed as IRFC would continue to be a captive for the railways ministry.

Railways so far has been a strategic sector for the government. But a change in stand could alter the picture for IRFC. With the government largely in favour of privatisation, throwing the sector open for private players could reduce the monopoly of the railways ministry and IRFC.