IRFC is the dedicated market borrowing arm (NBFC) of the Indian Railways. The primary business is financing the acquisition of rolling stock assets, which includes both powered and unpowered vehicles, for example, locomotives, coaches, wagons, trucks, flats, electric multiple units, containers, cranes, trollies of all kinds, and other items of rolling stock components as enumerated in the Standard Lease Agreement (collectively, Rolling Stock Assets), leasing of railway infrastructure assets and national projects of the Government of India (collectively, Project Assets) and lending to other entities under the Ministry of Railways, Government of India (“MoR”).

The MoR is responsible for the procurement of Rolling Stock Assets and for the improvement, expansion, and maintenance of Project Assets. IRFC is responsible for raising the finance necessary for such activities.

As of September 30, 2020, it had 26 permanent employees.

Cost of Borrowings was 6.82%, 7.09%, and 7.27% in Fiscals 2018, 2019, and 2020, respectively, and 3.55% (non-annualized) in the six months ended September 30, 2020, respectively. (Stable cost of funds)

Issue Details

Dates – January 18 to January 20, 2021

Price – Rs 25 to 26

Issue Size – 4633 Cr (3089 Cr Fresh issue + 1544 Cr Offer for Sale)

Issue Objectives – The proceeds from the fresh issue will be utilized to augment the company’s equity capital base to meet business future growth requirements and to meet general corporate purposes. The offer for sale money will not be received by the company.

Lot – 575 Shares

Lot Value – Rs 14950 at the upper band

Market cap post listing – 33976.8 Cr (1188 Cr fully paid up existing shares + 118.8 Cr fresh issue of shares multiplied by Rs 26)

Upon completion of the Issue, the GoI will control approximately 86.36% of their paid-up Equity Share capital.

Fun Fact

Business Model

They operate on a cost-plus based model. They receive lease rentals which include the value of the Rolling Stock Assets leased by them 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, which they enter with the MoR for leasing of Rolling Stock Assets subsequent to the end of the relevant fiscal year.

The margin is determined by the MoR in consultation with IRFC at the end of each Fiscal. In Fiscal 2020, they were entitled to a margin of 40 bps over the weighted average cost of incremental borrowing for financing Rolling Stock Assets. In Fiscal 2018, the margin for financing Rolling Stock Assets was reduced to 30 bps from 50 bps in Fiscal 2017. There can be no assurance that the margin determined will be favorable for IRFC.

Credit Ratings

They have been accorded ratings of ‘AAA’ by CRISIL, ‘ICRA (AAA)’ by ICRA, and ‘CARE AAA’ by CAREeach with respect to the debt program. International credit rating agencies such as Moody’s have rated Baa3 (Negative) while Fitch, Standard & Poor’s, and Japan Credit Rating Agency have rated them BBB- ‘Negative’, BBB- (Stable) and BBB+ (Stable).

Risks

They are the dedicated market borrowing arm of the Indian Railways. The vast majority of revenue is generated from leasing Rolling Stock Assets to the Indian Railways. Lease income, interest on loans and pre commencement lease interest income together represented 99.75% and 99.87% of their total revenue from operations in Fiscal 2020 and in the six months ended September 30, 2020, respectively. Their business and revenues are substantially dependent on the policies of the MoR and operations of the Indian Railways.

The Indian Railways faces significant competition in the transport sector from other means of transportation such as transport by road, sea and air.

Litigations –

The composition of IRFC’s Board of Directors is not in compliance with the requirements of the SEBI Listing Regulations. Currently, the Board of Directors comprises of six directors, out of which two directors are whole time directors (including the Chairman and Managing Director), two directors are nominee directors of the GoI and two directors are independent directors. Accordingly, the composition of the Board of Directors is not in compliance with the applicable provisions of the SEBI Listing Regulations. Accordingly, in order to be compliant with the applicable corporate governance requirements of the SEBI Listing Regulations, IRFC is required to appoint two additional independent directors. (For which they have told the MoR)

Financials

Balance Sheet MetricsThe Balance sheet size is quite huge but that is justified given it is the dedicated arm for the Indian Railways. Lease receivables are quite high at 53% but again justified as they deal with the government, so the big receivables is a given.

P&L MetricsNothing out of the ordinary as such, Topline and bottom line growing.

Valuation & Conclusion

At upper price band of Rs 26, the issue is priced at an 8.18x P/E ratio and 0.97x P/BV ratio. While this may look affordable, it comes at a cost.

The biggest risk for the company is the cost-plus based Standard Lease Agreement with the MoR that has historically provided them with a margin over the weighted average cost of incremental borrowing determined by the MoR in consultation with IRFC at the end of each Fiscal.

In Fiscal 2018, the margin for financing Rolling Stock Assets was reduced to 30 bps from 50 bps in Fiscal 2017. While the margin has been constant at 0.40% for FY19 and FY20, there is no guarantee (IRFC has said it themselves) that it’s going to stay the same. The risk is that if the Indian Railways gets a lesser budget (or any other reason), they may try to squeeze their many vendors and subsidiaries for every last rupee which will see IRFC get impacted.

Therefore, taking into account all of the above, we recommend giving this company a pass if you are thinking about IRFC as a portfolio stock for the long term.

In the short term the GMP is 1.25 Rs , representing 5% premium which may translate into a premium listing. For the short term, please take your own judgement.

On the JST IPO scorecard system, we rate this company a 4 out of 10.

Schedule 1 – Management interview (CMD, Amitabh Banerjee) with CNBC TV 18 on 13th Jan Morning – Takeaways

Privatization of routes to impact them? Not really as more rolling stock will be required which IRFC can help out with. Got the mandate to finance that also.

Big ticket freight corridor project? Dedicated Freight Corridor (DFC) is coming up (Eastern freight corridor is up and running, other parts will also come online), so rolling stock will be required for the same.

Within 3 years, will get the Government shareholding to 75% (86.36% post IPO still with government)

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