NBFC STOCKS: Should You Add Them To Your Portfolio?

NBFCs have corrected sharply in CY18 after outperforming in the previous 3 to 5 years. Yogesh Supekar along with Amir Shaikh analyse the prospects of investing in NBFCs

Non-banking finance companies (NBFCs) have been on the radar of investors over the past few years. Indeed, many of the leading NBFC players have turned out to be multi-baggers, viz., Bajaj Finserv and Bajaj Finance. While the sector has been riding on decent growth trajectory over the past 3 to 5 years, it is worth looking at the sector afresh amidst increasing uncertainty in the financial markets. NBFCs, along with the broader markets, have taken a beating in CY18. NBFCs, apart from being an integral part of the Indian financial system, play an important role in nation-building by complementing the banking sector in reaching out to the unbanked segments of the populace in the country. The NBFCs

"Advances of the NBFC sector increased by 21.2 per cent and investments increased by 13.4 per cent. The PAT increased by 30.8 per cent in 2017-18."

"Banks’ funding to NBFCs increased 27 per cent during FY2018, while the banking system’s credit growth remained muted at 8 per cent for the period."

NBFC Stocks : 52-Week High–Low 

While there were nearly 493 stocks that touched their respective 52-week lows in June 2018, the increasing number of stocks that touched 52-week lows suggested that the broader markets are nearing their bottoms. Similarly, in the list of NBFCs having market capitalisation greater than Rs 500 crore, we find that the number of stocks touching their 52-week lows has increased manifold in the first half of July 2018. (refer table below). 

While most NBFCs touched their 52-week highs in January, many NBFCs touched their 52-week lows in the first half of July alone. This indicates the massive correction that has taken place in the NBFC stocks. The increasing number of stocks touching their 52-week lows in July also indicates that the prices of many of the NBFC stocks are bottoming out.

"Indian Accounting Standards (Ind-AS) is the new set of accounting standards notified by the Ministry of Corporate Affairs (MCA) in 2015. The standard was applicable from FY17 to companies having net worth of Rs 500 crore or more. 

However, NBFCs have been directed to prepare their books of account according to new Indian Accounting Standards (Ind-AS) from FY19. 

Due to convergence of Ind-AS to IFRS, the companies which are having zero coupon bonds, structured debt, preference shares on their balance sheet and a higher share of unstable fees and higher ESOP cost are likely to have adverse impact. 

This convergence is also likely to change the way companies do their business related to liabilities, employee compensation, structuring their loans and securitisation/assignment etc. 

Housing finance companies (HFCs) are well-poised for the changeover to new Ind-AS. On the other hand, corporate lenders are likely to face challenges."

Maket outlook

Rishi Kohli 
Chief Investment Officer & MD 
ProAlpha Capital

"Nifty has been climbing new highs and is expecting to touch a record benchmark of 12500. If the trend persists, exhibiting a continuous upward trend, Nifty can cross the mark in the coming 6 months. Meanwhile, the Midcaps have bounced back and seem to have been corrected and reinitiated brisk movements. In the present scenario, considering aspects from both the angles, Indian markets are on the way of finding its luster and a bounce is clearly on the cards"

Prasanna Pathak
Fund Manager - Equity
Taurus Mutual Fund 

"As of now, Mr. Market is happy to pay premium for NBFC stock"

What is your outlook on NBFC stocks? 

Currently, NBFCs are witnessing cyclical pressures with respect to their liability resources/profile. This time, however, the situation is peculiar in the fact that the demand pipeline remains strong for majority of them and most of the NBFCs have diversified businesses, competing against other financial institutions. For example, LAP is a product offered by banks, HFCs as well as other NBFCs. So, the segments with demand limits their ability to increase their yields. The availability of information about the basic credit profiles is also quite uniformly available. The better ones have developed good processes to assess the risk and mitigate it. So, to that extent, the entry barrier is low and the demand visibility is high. So, we feel it will be a “survival of the fittest” market. 

The resilience of NBFCs has been proved again recently. Catering to the more informal part of the economy, GST and demonetisation had a larger impact on the NBFCs. But they have come out strongly. So, we tend to believe that despite the regulatory and market challenges, most NBFCs have been nimble/agile and have sustained through the challenges.

How are valuations for NBFC stocks?

Most of them have not recovered yet from the fall seen post-GST and demonetisation. So, it’s a mixed bag. The valuations look high for the better performing NBFCs, which have demonstrated a very high level of consistency and agility. But, as of now, Mr. Market is happy to pay the premium. 

Are you happy with Q1FY19 results so far?

Only two large ones have reported numbers till now. Both Bajaj Finance and L&T Finance have reported satisfactory numbers. Both are highly diversified and their loan growth continues to show healthy traction on a consolidated basis. The asset quality remains stable and margins are stable. So, overall, it’s a healthy start for the results season. 

One important regulatory change that has happened this quarter is the implementation of IND-AS accounting standard. This has led to some volatility. With IND-AS implementation, the probable losses have been upfronted and steady-state return ratios will be reflected from the current fiscal. 

How do you expect Q1FY19 results for NBFC stocks?

On the growth side, most NBFCs will be a mark ahead of the banking system average growth. The margins could stagnate and may show pressure going ahead as the system rates rise. Companies with more diverse liability profile will be better equipped to withstand the margin pressure. The asset quality is expected to behave generally well for most of them. So, while the Q1FY19 results should be strong fundamentally across, but headline could be volatile on account of IND-AS. For the housing finance companies specifically, the competition is heated and the pricing power is very limited. The real estate is also yet to pick up pace and hence we remain cautious. Valuations are, however, not heated. 

Nitasha Shankar
Sr. Vice President and Head of Research
Yes Securities

"NBFC valuations are stretched at the current levels"

Will NBFCs surprise on the earnings front in Q1FY19?

Non-food credit has grown at a healthy pace, albeit owing to a favourable base effect on account of demonetisation. In addition to this, favourable trends in consumer finance, auto numbers, as well as positive traction in affordable housing segment would help drive the topline for most of the NBFCs lending to these segments. However, the rising cost of borrowings can pose a threat to the NIMs. We believe that housing finance and consumer finance companies could yield positive surprises in the ongoing earnings season. 

Should an individual investor shift to NBFC stocks from PSU bank stocks?

We have been underweight on PSU banks for a while owing to the concerns related to asset quality, recapitalisation woes and weak business models. On the other hand, investors could certainly consider NBFCs in the affordable housing and consumer financing segments. 

How are valuations looking for NBFC stocks?

Valuations are stretched at the current levels. However, we believe that the capital markets would see volatility in the months leading up to the state and general elections. Therefore, any dips could provide a good opportunity to accumulate quality stocks in the NBFC segment.

Where to focus in the NBFC space? 

We find that the RoEs for the consumer finance companies are higher than the RoEs for HFCs. HFCs on an average are reflecting a couple of percentage points higher RoEs when compared to transport finance companies. Investors can hunt for opportunities in HFCs and consumer finance compani

Conclusion 

NBFCs are expected to gain market share owing to the stress on public sector banks. The digital disruption among the micro, small and medium enterprises is on the rise and NBFCs adopting advanced analytics solutions and technology may do well in terms of improving their market share. 

The NBFCs are expected to perform in line with estimates in Q1FY19. The results for the likes of Bajaj Finance and Shriram Transport, which are consumer-facing lenders, have been better-than-expected. 

Looking at the prospects for the NBFC sector going forward, there is a good case for investors to include NBFC stocks in the diversified portfolio. 

Investors can focus on HFCs that are witnessing growth owing to affordable homes and also identify opportunities in consumer-facing lending businesses. With heavy bouts of selling in mid-caps and small-caps in H1CY18, several NBFC stocks have shed their gains accumulated in 2017. 

Investors should scout for those stocks where the growth and fundamentals are intact, while the stock prices have fallen more than warranted. 

Definitely, there is potential for growth in the NBFC space, but the valuations should not be ignored by long term investors.