Identifying the Indian Apple-Part 4
The Non Banking Finance Companies (NBFC’s) can be categorized into segments based on their lending activities. NBFCs provide personal, home, vehicle, consumer durables, holiday, equity and equipment finance. NBFC’s cater to the retail and corporate sector. To a large extent the activities of NBFCs overlap bank activities, but NBFC’s can reach out to markets where banks cannot go. Examples where NBFC’s are stronger than banks are commercial vehicle finance and micro finance. NBFC’s such as Shriram Transport Finance are leaders in commercial vehicle financing while there are many private micro finance companies that are lending to small borrowers in towns and villages across India. The biggest micro finance company SKS Microfinance started out with a bang but ended with a whimper with its share price losing over 90% in value as most its loans turned sour.
Home loan companies such as HDFC and LIC Housing Finance are categorised as NBFC’s while institutions such as PFC (Power Finance Corporation) and REC (Rural Electrification Corporation) come under the NBFC category. Many of the NBFC’s own asset management companies, brokerage firms and insurance companies. HDFC and Reliance Capital are majority owners in their asset management and insurance ventures.
Product manufacturers such as Tata Motors, Mahindra & Mahindra and Bajaj Auto have NBFCs to provide finance for their customers to purchase their vehicle. There are NBFCs for providing loans against gold. Muthoot Finance and Mannapuram Finance are two gold loan companies that have grown fast over the last few years with growth of over 800% and 6000% respectively over the last five years.
The NBFC sector as a whole is highly fragmented with over 10,000 NBFC’s operating in the country. The question is “are there any NBFC’s that have “Apple” like traits where the potential market size is large and the markets have not full factored in an explosive growth in a stock?”
Are there potential “Apples” amongst NBFC companies?
On a broad macro level India presents a large market for NBFCs. Consumer credit at around 40% of GDP is much less than over 100% of GDP for countries such as Taiwan and Malaysia. Insurance penetration is low with 80% of population not covered by insurance. Mortgage to GDP ratio at around 9% of GDP has a long way to go as compared to 20% in China and over 40% in Hongkong. However given that NBFC’s compete with banks in many areas and are restricted by geography or market segments, only a few NBFC’s can truly take full advantage of the growth opportunity in India.
The NBFC’s that are shortlisted in Table 1. for future potential have one of the following characteristics of a) amongst leaders in a segment b) national presence c) best in class technology to deliver services and reach out to a wider audience.
Bajaj Finserve looks to be the most attractive in terms of pricing of the stocks listed in Table 1. The company is a holding company for its Finance and Insurance business. However, holding companies usually receive lower valuations in the market and a price to book value of around 2 is not cheap.
HDFC is expensive at 5 times book and despite its leadership and brand value, the stock will struggle to generate high returns.
Muthoot Finance, a leader in gold loans has issues of corporate governance and has come under regulatory scrutiny. The stock will struggle under higher regulatory supervision.
Shriram transport is expensive in both price to book terms and in terms of market capitalisation to sales ratio. The company operates in one area of financing that is second hand commercial vehicles and it will struggle to widen its presence to other areas.
Technology for deliver is used the most in insurance business and both Bajaj Finserve and HDFC have large insurance businesses. The reach of the insurance players is much higher than the reach of standalone NBFC’s.
Bajaj Finserve at Rs 690/- is the best buy in the NBFC universe, though it is not a potential “Apple” in the making given its nature of a holding company. The stock is expected to generate around 50% returns over a medium term period once insurance business starts picking up. The upside for the stock could also come from a banking license as and when RBI decides to release more licenses. A rerating of the stock to around 2.5 times price to book will generate the 50% returns. The risk to the stock is a continued downturn in the economy leading to slower loan growth and falling insurance premium growth.
In the next issue we will look to the IT sector for any potential “Apples”.