IDFC, Shriram Trans, LIC Hsg top NBFC picks: Kotak

Nischint Chawathe of Kotak Institutional Securities believes that non-banking financial companies (NBFC) have an advantage to their net interest margins owing to the recent decline in the interest rates for AAA rated bulk borrowers.

In an interview to CNBC-TV18, he said that companies like IDFC in the infrastructure finance segment, Shriram Transport in auto finance and LIC Housing Finance in the housing finance segment would be his top picks in the NBFC sector. These companies have a conservative approach to their business and have buffers on their balance sheet.
Speaking on gold loan NBFCs, he said that sector will see a muted growth as the management of many firms are waiting for gold prices to stabilise. Once that happens, the companies would expand furthermore. Also read: ICRA explains: How NBFCs will gain from banking licences
Below is the edited transcript of his interview to CNBC-TV18. Q: There is a lot of interest in the non-banking financial companies (NBFC) space because of the impending banking licenses etc. But I was reading your note where you believe that the recent decline in interest rates for high-rated bulk borrowings provides an upside bias to the net interest margins on many of these NBFCs. Can you just take us through what your top picks are in the NBFC space itself and the rationale behind it?
A: Within the NBFC space in the infrastructure finance companies we like IDFC and in the auto finance segment we like Shriram Transport and in the housing finance space we would prefer to look at LIC Housing Finance.
The logic is very simple, you are seeing two things playing out – one is that the interest rates are declining, as I had highlighted in the note that bulk borrowing rates have comedown very sharply for AAA rated and high quality borrowers. It is almost a 100 odd basis point (bps) over a period of last three months.
The interest rates for the AA rated borrowers, which would essentially be the auto finance companies; which are also not in the AAA, are not very low as well would have come down by around 50 odd bps. So, there is still some way to go out there. But even they are benefiting from decline in interest rates.
The second theme is the fact that we are not really very excited or we are not looking at any speedy recovery in the system. So we would want to be cautious and we would want to look at players like IDFC, which continue to have conservative approach towards their business, and have buffers on their balance sheet. At the same time, as and when the economy turns around, and the infrastructure sector picks up, these companies will be able to ride on that.
These are the two broad themes or thought processes according to which we are really placing our top bets. Q: What about the gold finance companies? Do you manage to look at them particularly Manappuram if you have a view on that, especially the earnings that went by for Q4 FY13 because there was an opinion that maybe worst is over for Manappuram in terms of loan-to-value (LTV) ratios etc. and maybe it could be just one more quarter of pain and then we see some amount of stabilisation in terms of earnings. Do you have a view on that?
A: We don’t have coverage on Manappuram, but broadly looking at the gold loan sector what I can say is that for any particular NBFC there is a very high linkage to the underlying asset class. This is obviously more so for single product NBFC, so when compensating variation (CV) prices come down, somewhere you have an implication on CV finance companies.
In a very similar manner when gold prices are volatile and come down there is going to be some impact on gold loan companies as well. Given the fact that gold prices are very important for this business, it is important from hereon to have a very strong call on gold as to which side gold is really going to move; that will give investors a lot more confidence as to what can happen to the businesses.
Currently, as I understand even the managements of many of these entities are not really very confident and they are waiting to see the gold prices stabilise and after which they will take a call with conviction as to how they want to expand and scale up.
So, at this point of time, the entire gold loan NBFCs would be looking at growth, but they would be looking at muted growth. Nobody is really looking at aggressive or fast expansion. As far as the impact on asset quality is concerned I think that’s again going to be a function of how gold prices are going to move.
So, we will need to really wait and watch on that.
_PAGEBREAK_ Q: You have a sell call on HDFC. Can you take us through that? What are your expectations in terms of home loan rates? How much would they decline because of the competition that we are seeing and its effect? How would you approach something like HDFC now?
A: The issue is like this that interest rates – bulk borrowing rates are coming down very sharply. This can play out in three ways – one, the bulk borrowings rate comes down, the borrowing cost for housing finance companies comes down and this is something that the housing finance companies retain for themselves and their margins expand.
The second alternative is that they really pass on the benefit of lower margins to their customers and they gain market share or they are basically able to grow business at a faster pace.
And the third option is where you will see everybody really cutting down the rates and that is the point of time where most of the benefit will be passed on to the customers and there will not be much left for either the banks or the housing finance companies.
So my point is that given the fact that there is severe competition out there either the option second or third option could play out rather than a first option where we are saying that margins will just kind of stay with these guys.
When and what extent the interest rates come down, is a very difficult call to take. There will be multiple dynamics involved. However, looking at the fact that there is so much of competition and there is no growth elsewhere in the financial system everybody will want to do this business, you will see a downward pressure on home loan rates.
As far as HDFC is concerned I think the biggest issue here remains that the stock is very expensive. Yes, historically it has traded at high multiples, but clearly today the valuation multiples are closed to its all-time peak levels. This is the reason the margin of safety for the stock is much lower than what it was in the past. Q: A question with regards to the NBFC space in terms of playing it from a possible banking licence and say something like an L&T Finance Holding – is that a strategy that you would be recommending to investors to take a call on a company which would possibly have likelihood of getting a banking licence at this point?
A: No, it is not that L&T Finance or any of the stocks don’t have a possibility of getting out there. But we will still want to wait and watch. Things are quite hazy. We still really don’t know how the earnings will play out over the next three or four years. So, I will not really want to put some of these things in my financial modules.