High Debt Hampers Disbursements, Diversification Could Reduce Credit Risks

Key Takeaways

• High debt-equity ratio hinders disbursements, posing challenges to revenue growth and requiring strategic adjustments for financial stability.
  
• Expanding beyond traditional sectors could increase credit risks, affecting net margins and sustainability of earnings trajectory.
  
• The company's strong financial foundation, strategic leadership, and diversification efforts could enhance growth, stabilize margins, and support robust revenue streams in the long term.

Catalysts

Engages in leasing of rolling stock assets, railway infrastructure assets in India.

• IRFC has not made any disbursements in the last six quarters due to a high debt-equity ratio. This pause in disbursement suggests impending challenges in revenue growth if these conditions persist.
  
• The company is making plans to lend beyond the Indian Railways, such as engaging with NTPC for the logistics sector. However, the diversification into non-traditional sectors could lead to higher credit risks, potentially affecting net margins.
  
• IRFC's plan to fund sectors linked with railways and logistics without precise targets could imply uncertainty in revenue forecasts, especially if the strategies are not well-executed or if market conditions become less favorable.
  
• Despite having a weighted cost of capital lower than peers, the slim spread (35-40 bps) on existing railway lending might not sustain similar profitability if comparable margins are not achieved in newer sectors. This could challenge the company’s ability to maintain its earnings trajectory.
  
• As IRFC transitions to a more conventional NBFC model with potential ventures into infrastructure funding, concerns might arise regarding its ability to maintain its 0 NPA status, impacting future earnings and net margins if default rates increase.

Indian Railway Finance Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Indian Railway Finance's revenue will grow by 1.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 97.6% today to 97.7% in 3 years time.
• Analysts expect earnings to reach ₹68.5 billion (and earnings per share of ₹5.22) by about December 2027, up from ₹65.1 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.2x on those 2027 earnings, down from 33.1x today. This future PE is lower than the current PE for the IN Diversified Financial industry at 18.2x.
• Analysts expect the number of shares outstanding to grow by 0.11% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 19.25%, as per the Simply Wall St company report.

Indian Railway Finance Future Earnings Per Share Growth

Risks

• The appointment of a new CMD with extensive experience in railway finance and infrastructure may lead to strategic initiatives, boosting the company's growth and stability in revenue and earnings.
  
• A steep increase in the company's assets under management highlights IRFC's capability to handle large-scale projects, which may enhance future revenue and maintain net margins if similar growth opportunities continue.
  
• The company has a low weighted average cost of capital compared to peers, potentially leading to improved profit margins as it leverages its balance sheet for future endeavors.
  
• Diversification into other logistics and infrastructure sectors beyond railways could provide new revenue streams and growth opportunities, potentially increasing future earnings and stabilizing net margins.
  
• IRFC's strong position in low-risk, zero-NPA railway business provides a stable financial foundation, which could support robust revenue streams even amidst expanding its reach to other infrastructure projects.

Valuation

• The analysts have a consensus price target of ₹50.0 for Indian Railway Finance based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be ₹70.1 billion, earnings will come to ₹68.5 billion, and it would be trading on a PE ratio of 16.2x, assuming you use a discount rate of 19.3%.
• Given the current share price of ₹164.91, the analyst's price target of ₹50.0 is 229.8% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.