IPO analysis: Indian Railway Finance Corporation

IPO Rating - Invest with limited exposure

About the issue

The government-owned Indian Railway Finance Corporation (IRFC), the dedicated market borrowing arm of the Indian Railways under the Ministry of Railways (MoR), is entering the capital with its initial public offering of equity shares of the face value of Rs 10 each. Through this issue, the company aims to raise around Rs 4,633.33 crore at the upper band while at the lower band, it will raise around Rs 4,455 crore. The price band of the issue has been fixed at Rs 25 to Rs 26 per equity share of the face value of Rs 10 each.

The total number of shares for sale is 178.2 crore, out of which, 118.8 crore is a fresh issue and 59.4 crore is offered for sale by the Government of India. The net proceeds from the fresh issue are proposed to be utilised for augmenting the equity capital base of the company to meet their future capital requirements arising out of growth in their business as well as for general corporate purposes.

About the company

IRFC is a dedicated market borrowing arm of the Indian Railways. The primary business of IRFC is financing the acquisition of rolling stock assets, which includes both powered & unpowered vehicles eg. locomotives, coaches, wagons, trucks, flats, electric multiple units, etc. The MoR is responsible for the procurement of rolling stock assets and also, for the improvement, expansion & maintenance of project assets. IRFC is responsible for raising the finance necessary for such activities.

The company is registered with RBI as an NBFC (systematically important), classified under the category of an 'infrastructure finance company'. Over the last three decades, IRFC has played a significant role in the capacity enhancement of the Indian Railways by financing a proportion of its annual plan outlay. The company follows a financial leasing model to finance the rolling stock assets. The period of the lease with respect to rolling stock assets is typically 30 years, comprising a primary period of 15 years, followed by another 15 years of secondary period. For all the rolling stock assets acquired during a financial year by Indian Railways, the company enters into a lease agreement with the MoR, following the close of each respective fiscal. Lease rentals include the value of the rolling stock assets leased by the company to the MoR in the relevant fiscal year, the weighted average cost of incremental borrowing as well as a certain margin, all in accordance with the terms of the standard lease agreement. In the fiscal year 2020, the company was entitled to a margin of 40 bps over the weighted average cost of incremental borrowing for financing rolling stock assets and a spread of 35 bps over the weighted average cost of incremental borrowing for financing project assets.

And for the next 15 years, they received a nominal amount of 1 lakh every year, during which, IRFC recovers the entire value of the asset and some extra. At the end of the lease term, MoR buys the assets for Re 1 as a formality.

The Union Budget has proposed a capital expenditure of Rs  1,61,000 crore for the Indian Railways for the fiscal year 2021, which was higher than the capital expenditure of Rs  1,48,064 crore in FY20.  The extensive expansion plans of the Indian Railways in the future will involve significant financing, and as a primary financing source for the Indian Railways, the company’s operations will increase significantly. In FY20, IRFC financed Rs 71,392 crore, accounting for 48.22 per cent of the actual capital expenditure of the Indian Railways. In FY18, FY19, FY20, and 1HFY21, it financed rolling stock assets worth Rs 18,669.86 crore, Rs 24,055.08 crore, Rs 33,544.10 crore and Rs 10,816.4 crore, respectively.

Diversified sources of funding, the highest credit ratings, and strategic relationship with the MoR have enabled the company to keep the cost of borrowing competitive. In addition to equity infusion from time-to-time by the Government of India, long/medium-term sources of funding include taxable and tax-free bond issuances, term loans from banks/financial institutions, external commercial borrowings, internal accruals, asset securitisation, and lease financing. The company has a diverse base of investors from whom it raises funds through the issuance of bonds in domestic and international bonds. The cost of borrowing was 6.82 per cent, 7.09 per cent and 7.27 per cent in FY18, FY19, and FY20, respectively along with 3.91 per cent & 3.55 per cent (non-annualised) in 1HFY20 and 1HFY21, respectively.

Financials

IRFC’s total revenue from operations increased by 19.33 per cent from Rs 9,207.9 crore in FY18 to Rs 10,987.4 crore in FY19 and by 22.15 per cent to Rs 13,421.9 crore in FY20 and was Rs 7,384.8 crore in 1HFY21. In FY18, FY19, FY20, and 1HFY21, its net profit was Rs 2,001.46 crore, Rs 2,139.9 crore, Rs 3,192.1 crore and Rs 1,886.84 crore, respectively. The company follows the cost-plus pricing model for financing to other PSU entities, which typically provide for a relatively higher margin. In addition, low overhead, administrative costs, and high operational efficiency have resulted in increased profitability.

In addition to strong financial growth, the company boasts strong financial ratios. It has no bad assets represented by non-performing assets. For every rupee that it lends to the company, it manages to recover interest and principal.

Valuation and recommendation

At the upper price band of Rs 26, the issue is asking price-to-book value of around one time after considering the issue. This is at the same level where REC is trading. Nonetheless, what differentiates IRFC from others is its low-risk business model. It will not give you extraordinary profit growth; however, its profit is likely to grow steadily, given the monopoly that it has in its business. Looking at the huge capital expenditure required by Indian Railways, we believe that the company will keep growing its business at a healthy rate, and hence, you can invest with limited exposure and do not expect blockbuster listing gains that we have witnessed recently.