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A Quality Investment Target in Financial Sector of Bangladesh

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A Quality Investment Target in Financial Sector of Bangladesh Analyst: Abdullah Al-Rezwan, FRM [email protected] BRAC EPL Research IDLC Finance Ltd. Initiating Coverage Fair Value Estimate (December 2016): BDT 70.7 per share May 11, 2016 Sector: NBFI; Rating: OUTPERFORM A quality investment target in financial sector of Bangladesh Company Summary IDLC Finance (DSE: IDLC), founded in 1985 through a collaboration of 52-week Price Range (BDT) 42.1-66.0 IFC, DEG, Kookmin Bank, KDLC and several local sponsors, is the Current Price (BDT) [May 04, 2016] 55.9 largest NBFI in Bangladesh to provide a broad range of financial Dec 2016 Fair Value (BDT) 70.7 services with BDT 55.2 billion ($703.2 million) gross loans in 2015. While Price Return 26.5% the foreign shareholders took exit by 2009, the initial culture and ethos of Dividend Yield 4.5% transparency and accountability seem to have stayed within the Total Return 31.0% company. Being an NBFI, IDLC is inherently in a disadvantageous Number of Shares mn 251.4 position as it cannot take CASA deposits and hence, its cost of deposits Market Cap USD mn 179 is generally higher than that of its competitors i.e. banks. Even then, we Free Float 40.3% think IDLC stands out in the financial sector of Bangladesh because of Average Daily Turnover USD’000 (LTM) 407 its history of topnotch management and capacity of adaptability in Balance Sheet (BDT Mn) 2015A 2016E 2017E different economic environment. IDLC’s transformation from leasing Gross Loans 55,212 63,887 77,814 company to capital market centric institution to a largely financing entity Total Assets 73,434 80,227 90,758 is a testament to that. More importantly, IDLC’s superior growth Shareholders' Equity 7,786 8,655 9,879 trajectory was achieved without compromising the asset quality in SME Income Statement (BDT Mn) 2015A 2016E 2017E and consumer loans in last 6 years. The company is also well capitalized Net interest Income with 14.8% consolidated CAR in 2015. 3,418 3,594 4,473 Operating Profit We initiate coverage of IDLC with an OUTPERFORM rating with a 2,940 3,082 3,801 target price of BDT 70.7 per share for December 2016. With current Net Profit 1,459 1,498 1,853 price of BDT 55.9 (as of May 04, 2016), the fair price implies a price Growth 2015A 2016E 2017E return of 26.5%. Our estimated fair price implies a P/B multiple of Gross Loans 17.3% 15.7% 21.8% 2.05x over 2016E NAV and 1.80x over 2017E NAV. Considering the Total Assets 24.6% 9.2% 13.1% latest published NAV, the stock is currently trading at a P/B Net interest Income 18.3% 5.2% 24.4% multiple of 1.87x, which is lower compared to companies with Net profit 17.1% 2.7% 23.7% similar business and ROE profile like HDFC in India and DBH in Per Share (BDT) 2015A 2016E 2017E Bangladesh which are trading at 3.5x and 3.9x respectively. Other Adjusted EPS 5.8 6.0 7.4 key points from the investment thesis are as follows: DPS 2.5 2.5 3.0 Restated BVPS 31.0 34.4 39.3 In response to the stock market crash in 2010, IDLC radically Asset Quality 2015A 2016E 2017E changed its business and gained highest market share in mortgage Gross NPL (%) 3.8% 3.5% 3.1% market with leading market share in auto loans and second highest NPL Coverage (%) 58.2% 68.9% 80.3% market share in home loan market. Moreover, IDLC more than Valuation 2015A 2016E 2017E doubled its market share from 0.61% in 2010 to 1.29% in 2015 in P/B 1.80x 1.62x 1.42x SME financing market with a CAGR of 39.2% in last 6 years. P/E 9.6x 9.4x 7.6x Currently, SME and consumer loans consist of 34.8% and 34.7% of Miscellaneous 2015A 2016E 2017E gross loans in 2015 respectively. More importantly, IDLC’s capital NIM 5.7% 5.1% 5.7% market operations have largely grown out of the negative equity Cost to Income 35.9% 37.5% 35.8% margin loan issues whereas most banks and financial institutions ROE 20.4% 18.2% 20.0% are still grappling with this particular problem. Besides, given the ROA 2.2% 1.9% 2.2% new CEO, Mr. Arif Khan was an ex-commissioner of Bangladesh CAR 14.8% 14.8% 14.8% Security and Exchange Commission (BSEC), we expect him to Payout Ratio 43.1% 42.0% 40.7% closely engage, lead and scale up the capital market operations Figure: Price performance of IDLC since Jan’15 going forward. Overall, IDLC is well positioned to capitalize on the opportunities in the capital market as well as maintaining its growth momentum in SME. In 2013, IDLC recognized and restructured its problem exposure to capital market operations and took three important strategic decisions. Firstly, IDLC recognized its negative equity margin lending portfolios as NPL and stopped accruing interests. Secondly, IDLC started a campaign to incentivize its negative equity customers to regularize their accounts through fresh equity injection. Thirdly, leveraging on investment research and better management capacity, IDLC engaged with the negative equity portfolio customers and liquidated significant portion of negative Source: DSE, BRAC EPL Research, May 2016 IDLC Finance Limited (DSE: IDLC; Bloomberg: IDLC:BD) May 11, 2016 equity portfolios and realized direct losses in the process. These three decisions have helped IDLC decrease NPL of margin lending portfolio from 63.3% in 2013 to 27.5% in 2015. More importantly, margin loans have come down from 30.0% of the gross loans in 2009 to only 2.9% in 2015. IDLC’s superior business and financial performance was amply helped by the leader- ship and management prowess at the helm. The last two CEOs, Mr. Anis A Khan and Mr. Selim RF Hussain, were both among the better CEOs in the financial sector and helped transform IDLC during challenging period in financial sector. The current CEO, Mr. Arif Khan, is very well-known in the financial service community and policy offices and has a lot to offer in terms of taking the company to the next stage of growth and development. Summary of Valuation We have used 3-stage Dividend Discount Model (DDM) and Justified P/B multiple to cal- culate our fair value estimate for IDLC. With 50.0% weight given to each of the methods used, the weighted average valuation for IDLC is BDT 70.7 per share. We have utilized 3-stage DDM model to calculate fair value of IDLC. For the 1st stage (2016-2020), we have provided explicit forecast for the next 5 years. With 13.5% Cost of Equity and assumed growth in shareholders’ equity of 12.0% and 8.0% respectively in 2nd (2021-2026) and 3rd stage (2027-2031) respectively, our DDM model calculates target fair value of IDLC to be BDT 63.5 per share. To calculate justified P/B multiple of IDLC, we have taken the estimated average ROE for next 5 years which is 20.4%. The long-term growth rate is assumed to be 8.0%. All these lead to justified P/B multiple of 2.3x for IDLC. By multiplying justified P/B multiple by our forecasted Net Asset Value (NAV) of IDLC at the end of 2016, we have derived target fair value of IDLC. Our justified P/B valuation method indicates that the target fair value of IDLC is BDT 77.9 per share. Our weighted average fair value estimate of BDT 70.7 per share implies P/B multiple of 2.05x and 1.80x based on 2016E and 2017E NAV respectively. Major risks to our valuation IDLC declared on February 26, 2015 that the BoD has recommended to issue rights shares at 1R:2 (1 Rights share for every 2 Ordinary shares held) at an issue price of BDT 20.0 each subject to the approval by the shareholders and regulatory authori- ties. If IDLC gets regulatory approval, it will be difficult to maintain the current ROE profile of the company which will lower the valuation level of the company. While it is unlikely that political violence will resume in near future, things remain murky in the political front and likely to remain so going forward. We have assumed slower growth and increased our NPL forecast for the election year in 2019. Howev- er, if the political unrest continues and lingers for a longer period than expected, that will strain our valuation. IDLC’s consumer loan basket is essentially driven by home loan portfolio. Given the stiff competition in recent times, we assumed 5.0% growth in home loan portfolio for 2016. However, we expect IDLC and other major NBFIs in this segment to dominate in long term. If private sector credit growth does not pick up, banks may continue to focus in this segment, which can hurt IDLC’s prospect in this segment even beyond the short-term. We expect the current CEO to scale up the capital market operations. Under such scenario, if equity market performs poorly, the volatility of the equity market will affect the earnings of IDLC. 2 IDLC Finance Limited (DSE: IDLC; Bloomberg: IDLC:BD) May 11, 2016 Overview of IDLC Corporate profile and transformation history IDLC was established as the first Leasing Company in Bangladesh in 1985 through the collaboration of International Finance Corporation (IFC) of the World Bank, German Investment and Development Company (DEG), Kookmin Bank and Korean Development Leasing Corporation (KDLC) of South Korea, the Aga Khan Fund for Economic Development, the City Bank Limited, IPDC of Bangladesh Limited, and Sadharan Bima Corporation.
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