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Sunday, June 18, 2000













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IDBI: Potential for price rise

Recommendation: Buy

IDBI's share price has long been flat. But, there have of late been some positive developments that may lower the risk of IDBI's loan portfolio. Sanjiv Shankaran looks at these developments and the implications for the IDBI's share price which may firm up.

THE STOCK of the Industrial Development Bank of India (IDBI) may hold some potential for upside because of indications that the risk associated with its loan portfolio may decline later. The IDBI stock, which is about Rs. 40, holds promise for investors looking at unconventional equity investments.

On the flip side, the constraint to capital appreciation in the share price may come from the unchanged stock market perception that poor quality loans on IDBI's balance-sheet show no sign of disappearing. With perception about the quality of loans being critical to stock price performance, a look at the changing environment in which IDBI is operating provides an idea of the FIs existing loan portfolio.


Large bad loans

In 1995, IDBI made a public issue of Rs. 130 per share. For investors this was an unhappy investment because the scrip seldom traded above the offer price of Rs. 130.

After trading close to the offer price for a couple of years, the share price declined markedly primarily because of the perception of risk contained in the company's loans; this was so for other FIs such as IFCI too.

Financial institutions lent, in the early- and mid-1990s, to manufacturing companies that were soon to be affected by the weak price trend in commodities such as steel and chemicals. On the heels of the declining commodity prices, many projects were rendered unviable. The outcome of these developments was that a significant proportion of FIs' loans turned bad.

IDBI's rising non-performing assets (NPAs) over the last few years revealed the problem of an increasing proportion of bad loans. From 7.78 per cent in 1994-95, about 13.4 per cent of IDBI's assets had become NPAs by March 2000.

The bad loans' problem had a major impact on IDBI's share price, because even as the NPAs of the FIs grew, the market perceived that the NPAs were underestimated. The general feeling indicated that the problem was bigger than what the financial statements revealed.

Thus, while the stock market valued IDBI's share value at about eight times the earnings per share (EPS) for a couple of years after listing, the stock market valuation declined to about two-to-three times the EPS as the NPAs grew. Currently, the scrip trades around 2.8 times the 1999-2000 EPS of Rs. 14.07.

The perception of risk about IDBI's loan portfolio is not surprising because the institution's biggest exposures were to industries affected by growing competition and declining price realisations of the late 1990s. Among these industries were the iron and steel, fertilisers, petrochemicals and cotton textiles.


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Will risk decline?

The key to an increase in IDBI's share price appears to be a change in the market perception of the risk attached to the company's loan portfolio.

In this context, there seem to be faint signals of an upturn in some sectors where IDBI may be confronted by large NPAs. IDBI's largest industry exposure is to iron and steel -- about 14.3 per cent of its total exposure.

Over the last few months, things have begun looking up for the steel industry. The most promising aspect has been the steady rise in steel price trends over the last six months. The global price of the different kinds of steel products has increased 10-30 per cent since December 1999.

The increase in steel price realisations, however, will not automatically translate into higher profits because input costs for steel producers have been increasing simultaneously. The steel price rise suggests that some of IDBI's steel exposures may have come through unscathed. This is a positive development compared to what the situation looked last year.

With a positive change in relation to risk, the most important determinant of share price valuation looks likely to improve. At the same time, there have been other changes which may have positive impact on IDBI's operations.

Towards becoming a supermarket

A significant development in the financial sector over the last few years has been the gradual disappearance of the barriers that separated different intermediaries such as banks, FIs and finance companies. There is a growing tendency for different kinds of intermediaries to directly compete with one another.

IDBI has so far shown little interest in getting into retail lending in a significant way. The only significant exposure to retail assets may be in the form of fund management for individuals. In this context, IDBI has formed a joint venture with the Principal Financial Group, US.

A clear change in approach has, however, emerged over the last couple of years. IDBI, which traditionally offered project finance, has begun to expand its range of products and services to protect its traditional business domain. In the words of the company, ``A complete financial solution to the clients is of paramount importance.''

In short, IDBI has joined the move to convert itself into a one-stop financial supermarket. But, unlike a few other financial intermediaries, it continues to focus on companies rather than target individuals.

Diversification of operations

Lending to infrastructure has assumed greater importance in IDBI's operations. In 1999-2000, the share of infrastructure assistance was Rs. 9,832 crores, that is, about 34 per cent of the total sanctions. In infrastructure, IDBI's funds largely went to electricity generation. By end-March 2000, its assistance to the power sector was 9.7 per cent of the total exposure.

Another area where IDBI has increased operations is short-term lending. In 1999-2000, IDBI's short-term lending increased from 22.5 per cent to 35.8 per cent of total assistance.

The increasing exposure to new areas may have not significant bearing on the company's profitability. Infrastructure, for instance, has its share of problems in the form of confusing and contradictory legislation, often resulting in delays. Short-term finance will perhaps only remain an adjunct to long-term lending, because banks with lower funds costs provide stiff competition in that area.

What the move into other areas will provide is a small diversification in revenue, too small at present to be considered significant. Revenue from short-term lending and other new products may perhaps play an important role in adding to the value of its existing mainline products.

Cost and capital

IDBI had the benefit of concessional finance till the early 1990s. Since then it has had to rely on the market for its resources. In that period, increasing competition in the financial sector has led to declining spreads (the difference between interest expense and income).

Against this backdrop, IDBI has begun to initiate steps to keep its cost of capital under check. Recently, IDBI exercised its option to call back some bonds issued in the high-interest environment of the mid-1990s. This move may only have a marginal impact on the cost of its capital, but is an indication of the thrust on cost control.

IDBI has decided to reduce its equity capital by Rs. 247 crores. The move, an attempt to shore up the share price, has been executed through the conversion of Rs. 247 crores of government equity into 13 per cent preference shares. As a result, the 1999-2000 EPS will increase to about Rs. 22.

The move as such may not have the desired impact of a sustainable improvement in the share price. More than capital, it may be the perception of risk and the ability to protect margins that will impact the share price. In this context, the changing scenario in the steel industry and IDBI's ability to control its cost of funds are the factors to watch.

Unconventional investment

IDBI's share price appears to hinge on the perception of risk and its ability to protect earnings. The faint signals of improvement in the steel industry are encouraging. As also the definitive steps to widen its range of products and services in order to protect the core business of term-lending. At the current price of about Rs. 40, there is the possibility of capital appreciation in the medium-term. However, the indicators are still faint. Investors willing to invest in unconventional stocks and take risks may consider investing in IDBI's stock.


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