Where are the opportunities?

M.V.S. Santosh Kumar

Stocks of non-banking finance companies (NBFC), which took a massive hit during the credit crisis, have rebounded smartly from their lows in March 2009. Taking stock today, which segments of the business appear overheated and which offer further investment opportunities? Our analysis suggests that while infrastructure financing NBFCs offer growth opportunities and their housing finance counterparts may deliver stable growth, investors should also book profits in some of the segments that have run up too far.

Benign liquidity conditions, regulatory support by RBI , revival in the economic activity boosting credit demand and improving asset quality benefited NBFCs immensely. Additionally, the capital raised over the last year and a half also helped some of them reduce leverage .

Apart from rising economic activity, banks' wariness to lend to some segments of borrowers worked in favour of these NBFCs. Securitisation also revived, augmenting their fund raising base.

Our analysis showed that 24 NBFCs with a market capitalisation of more than Rs 1,000 crore, gained between 123 to 1400 per cent from the March 2009 lows, with the majority of stocks trebling in value and almost the entire universe outperforming the broader market.

However, investment companies such as Tata Investment Corp, JSW Holdings and Network 18 Media, given the underlying stocks' under- performance, continue to trade below their January peaks. Here, we review NBFCs spread across three major segments (infrastructure, mortgageand asset financing) and take a look at their stock performance vis-a-vis business growth, current valuations and growth prospects.

Infrastructure financing Power Finance Corporation (PFC), REC and IDFC are the largest listed players in the infrastructure financing space and are among the better performing stocks as the demand for credit from infrastructure did not cool off over the last two years despite overall slowdown in capex activities. The stock of IDFC, however, hasn't gone back to its January 2008 peak levels, as its loan book grew the slowest and has very high business linkages with equity markets which hasn't entirely revived.

The loan books of IDFC, PFC and REC grew at annual rate of 10 per cent, 24 per cent and 30 per cent respectively over the two-year period ended March 2010, leading to an annual net profit growth of 22 per cent, 39 per cent, and 52 per cent respectively. Apart from rising loan book, fall in interest rates, shrinking corporate spreads and high liquidity also led to cost declines and consequent improvement in margins for these NBFCs.

As of June 2010, cumulatively, these three NBFCs' loan books grew at 7.5 per cent sequentially, indicative of the high demand for infra-loans. The current price-to-book value of PFC, REC and IDFC are close to three times, re-rated from the March 2009 lows of 1.1-1.5.During this period, IDFC and REC raised capital, despite which they are trading at such a high price-book value. Going forward, with a major chunk of Rs 20,00,000 crore of funding requirements yet to be met in the 11th Five Year Plan (2007-12) and another Rs 41,00,000 crore projected to be spent in the 12th Plan , the loan book growth may continue to be spectacular. The asset-liability management of these NBFCs will also be better in future as they are allowed to raise long-term resources at lower costs thanks to their infrastructure financing status. In our view, investors can hold on to these stocks with a two-three year horizon for good returns.

Mortgage financing

Among the housing finance company stocks, HDFC, LIC Housing Finance, Dewan Housing and Gruh Finance have all climbed above their January 2008 peaks. To revive the housing loan segment, regulations such as re-financing and interest subvention were introduced and, as the economy revived, housing demand improved steadily, especially as property prices and rates of interest were low.Housing finance companies maintained their market share over the last two years despite stiff competition from banks. The total loan book of major housing finance companies expanded by 20 per cent annually in 2008-10, when scheduled commercial banks' home loan growth was in single digits.This may come as a surprise as many banks came up with teaser loans, but the growth in the loan books of some banks led to fall in the others, reducing the pressure on housing finance companies. They also maintained margins despite pressure on yields (due to teaser loans) as they brought down operating costs and cost of funds.

Even as HDFC saw its price-book value expand from 2.5 to 5 times, it was LIC HF, Dewan Housing and Gruh Finance that enjoyed the highest re-rating. The re-rating of LIC Housing and Dewan Housing was due to their non-metro focus, which improved their market share in the total loan book. Loan book growth was at 31 per cent and 45 per cent compounded annually over the two years ended March 2010. Over the years, not only have the volumes increased, but also the ticket size of loans, boosting the overall loan book size of the housing finance companies.Going forward, the demand for loans may improve given the 2.47-crore unit shortfall in housing expected in Eleventh Plan. According to Crisil estimates, mortgage loans from NBFCs and banks will grow at 14.7 per cent compounded annually over the five years ending FY15.

Our preferred picks in this segment are HDFC (diversified business income across various segments of finance) and Dewan Housing (low valuation and improving presence , thanks to tie-up with banks). Investors can book profits in LIC Housing and Gruh Finance, which are trading at stiff valuations, limiting the upside.

Asset-Financing

Auto financing companies were hit the most during the fall, because of their high dependence on growth in vehicle sales, which headed south during the latter half of FY-09 and early FY-10. However, the rebound also has been spectacular, thanks to stimulus efforts. Sundaram Finance, Bajaj Auto Finance and Mahindra Financial Services benefited from the revival in the vehicle sector.

Commercial vehicle (CV), two-wheeler and car volumes grew 38 per cent, 26 per cent, and 26 per cent for the year ended March 2010 after a muted performance a year ago. Bajaj Auto Finance saw its loan book grow by 94 per cent in the last 15 months after a slowdown in 2008-09.Similarly, Sundaram Finance and Mahindra Financial, which saw moderation in 2008-09, have improved their loan book growth for the year-ended March 2010.The current price-to-book value of Mahindra Finance, Bajaj Finance and Sundaram Finance stands at 2.2 to 3.5 times, up from 0.3 and 1.4 times the value in March 2009.The Society of Indian Automobile Manufacturers estimates that car and utility vehicle sales will grow at 13 per cent in the current year with CV sales growth moderating to 19 per cent and two-wheeler sales increasing to 9-10 per cent as the base effect kicks in. With the rate of growth getting normalised, the upside in these stocks may moderate. Investors can hold on to Sundaram Finance and Bajaj Finance.

 

Rising competition

Shriram Transport Finance (STFC), Manappuram General Finance and the recently listed SKS Microfinance are all trading at a high valuation premium to other NBFCs due to lack of peers for such businesses in the listed space.These three have a presence in very high margin (albeit risky) businesses and make margins of more than 8 per cent.STFC is a commercial vehicle financier but predominantly finances used vehicles, in which it is almost a monopoly in the organised space.SKS and Manappuram, despite facing competition from their peers have advantages of scale as well as a first-mover edge in certain geographies, helping them attract more borrowers and keeping the high growth rates ticking.

STFC is up 218 per cent since its March 2009 lows and 92 per cent from the January 2008 market peak, while Manappuram ended up being the star performer amongst the large NBFCs, with more than 900 per cent in gains since March 2009 and 777 per cent gains from market peaks. SKS, which listed in August, has already gained 35 per cent in the last 45 days.The current price-to-book values of STFC, Manappuram, and SKS are 4.2, 7 and 5.5 times respectively.The loan book growth for STFC, Manappuram and SKS during the last two-year period was 22 per cent, 222 per cent and 101 per cent respectively.Given their current valuations they have to clock exceptionally high growth in earnings over the next few years to justify these prices.Despite huge untapped potential left in these segments, competition is also on the rise.In addition, there are individual business risks relating to vulnerability to a downturn and asset quality due to a low-income focus. Therefore, it is safer for investors to stay away from these stocks at this juncture.Overall, we continue to be bullish on infrastructure financing companies, thanks to their growth prospects, and on investment companies such as Bajaj Holdings, Tata Investment Corp, JSW Holdings as they are trading at significant discounts to their investment book value.