IREDA: Up over 500% from IPO price, ICICI Direct chooses it has ‘high conviction pick’ – 3 key reasons why

Giving positive returns for 3 straight months till June, the Indian Renewable Energy Development Agency (IREDA) has been chosen as a ‘high conviction pick’ by ICICI Direct. It said that IREDA is at the inflection point of the renewable revolution in India.

The brokerage assigned a ‘buy’ call to the stock with a target price of ₹250, implying a 28 percent upside in 12 months.

"Given the government’s focus on the renewable sector, we remain positive on long-term growth prospects which will aid long-term sustained growth in AUM. Thus, we assign a Buy rating on the stock with a target price of ₹250, valuing the business on a DCF basis assuming a discounting rate at 12 percent and terminal growth at 6.5 percent," said the brokerage.

The stock has seen exceptional performance this year, surging nearly 90 percent year-to-date in 2024. In the last three months (April-June), it jumped over 43 percent. However, earlier, it had dropped 17.5 percent in February and 9.4 percent in March, but in January 2024, it soared almost 77 percent.

Following its IPO in November 2023, IREDA became the second PSU to enter the primary market in recent years after Life Insurance Corporation (LIC). Priced at ₹32, IREDA's shares have surged over 509 percent since then. The ₹2,150.21 crore IPO included a fresh issue of up to 40.32 crore shares and an offer for sale (OFS) of up to 26.88 crore equity shares.

Incorporated in March 1987, IREDA is India’s largest pure-play green financing NBFC engaged in promoting, developing and financing renewable energy and energy conservation projects. IREDA is a public financial institution (GoI stake at 75%) under the administrative control of the Ministry of New & Renewable Energy and categorised as a Systemically Important Non-Deposit taking Non-Banking Financial Company by RBI.

Investment Rationale:

Expanding Opportunities and Government Focus: As per the brokerage, India ranks as the third-largest energy producer and second-largest consumer globally. The country's electricity demand has been steadily rising and is projected to grow at a CAGR of 4.8 percent from FY24 to FY27, reaching a peak demand of 277 GW by FY27. As of December 2023, India's installed power generation capacity stood at 428 GW, with renewable sources contributing approximately 40 percent (172 GW) and the government aims to increase renewable capacity to 500 GW by FY30, requiring investments totaling ₹24.43 lakh crore, noted ICICI.

Given the lengthy gestation period of renewable projects limiting traditional bank financing, specialised power financiers like IREDA are poised to play a crucial role, it said. Given IREDA's focus on financing the RE sector, business growth is expected to remain healthy at 25-30 percent CAGR with market share expected at 29 percent in incremental financing in FY24-30E, thus touching an AUM of ₹3.5 lakh crore in FY30E (as given in the plan to achieve Maharatna status), it forecasted.

Competitive Borrowing Advantage: As a non-deposit-taking NBFC, IREDA predominantly sources its borrowings domestically, constituting about 81 percent of its borrowings as of March 2024. Backed by a 75 percent Government of India stake and holding the highest “AAA” rating, IREDA secures long-term borrowings at competitive costs, bolstering margins. Despite a predominantly floating rate loan structure (94.3 percent floating vs. 62 percent fixed), which could exert pressure in declining rate cycles, consistent growth in AUM and top credit ratings are anticipated to support Net Interest Income (NII) growth at a CAGR of 26 percent from FY24 to FY26, said the brokerage.

Operational Leverage and Profitability: ICICI further pointed out that continued robust growth in AUM, projected at approximately 30 percent CAGR from FY25 to FY26, is expected to enhance profitability through operational leverage. While margins may face near-term pressures, operational efficiencies, and stable credit costs are forecasted to sustain profitability growth at around 20 percent CAGR. Return on assets may experience slight near-term compression but is anticipated to recover to 1.9-2 percent over the medium term, it predicted.

Valuation

"Given the story of sustainable growth amid opportunity in the renewable sector, long-term business growth should remain in focus instead of focusing on 1-2 years forward performance. Given the government’s focus on increasing the capacity of renewable energy and the relatively smaller balance size of IREDA, we remain positive on business growth prospects from a long-term perspective, thereby aiding AUM. Expect AUM growth to sustain at 30 percent CAGR in FY25-26E coupled with steady RoA at 1.8-2 percent," said the brokerage.

ICICI has valued IREDA at a premium compared to peers, owing to IREDA’s relatively smaller size which could result in sustained healthy business growth amid the company’s prominent focus on green technology and the government’s focus on building incremental capacity of renewable sources and improving energy efficiency.

ICICI notes several key risks for IREDA, including the potential impact on margins due to a high proportion of floating-rate lending. Regulatory changes could also pose risks, and the unseasoned loan book warrants vigilance for potential asset quality concerns. Additionally, concentration risks related to geographical and borrower exposure are highlighted as significant risks for the organisation.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.