We have identified two NBFCs - L&T Finance Holdings and IndoStar Capital Finance - as good long term bets at the current market price
The sell-off in non-banking financial company (NBFC) stocks has been at the centre of the recent market fall. NBFCs stocks nosedived following funding concerns.
While higher interest rates were anticipated in FY19, NBFCs were caught completely off-guard on shrinking and in some cases complete withdrawal of liquidity triggered by defaults of Infrastructure Leasing & Financial Services' (IL&FS) group companies. The impact of the same was felt on debt mutual funds. The resulting risk aversion and huge redemption pressure faced by mutual funds has raised concerns about how NBFCs will meet their funding needs.
While near term funding may remain constrained, we don’t see a liquidity crunch catapulting into a systemic concern.
In 2008, we witnessed a much worse carnage following the Lehman Brothers bankruptcy. In 2013 too , financial stocks plummeted following macro concerns and a sharp correction in the rupee. Many strong NBFCs not only survived both crisis but also managed to flourish. We see some companies emerging stronger from the current crisis.
The current scenario definitely calls for separating wheat from the chaff. Largecap names like Housing Development Finance Corporation (HDFC) gives us immense comfort and should form part of the investor’s core portfolio.
We ran through a long list of NBFCs to identify a couple of stocks that have been penalised by the market, but stand out in terms of business fundamentals and valuation. We also considered factors like parentage and the quantum and quality of liquidity cushion, which are the key differentiators in the current scenario.
We arrived at two NBFCs worth considering at this juncture. L&T Finance Holdings for its strong parentage and IndoStar Capital Finance for its compelling valuation and strong capitalisation. Long term investors with an ability to stomach some volatility could nibble into these stocks.L&T Finance Holdings: Strong parentage
We draw significant comfort from LTFH’s parentage as Larsen & Toubro (L&T) holds 64.01 percent equity in the company as on June 30. Support from L&T, especially on the liquidity and capital front is a key differentiator. L&T infused Rs 2,000 crore in the last round of capital raising in Q4 FY18, demonstrating strong commitment.
LTFH is a niche player with competitive advantage in the infrastructure lending segment. It has the ability to source funds at a cheaper rate compared to peers due to PFI (Public Financial Institution) and IFC (Infrastructure Finance Company) status.
The company’s consolidated loan book stood at Rs 86,571 crore as at June-end. It remains wholesale heavy with 53 percent exposure to infrastructure and corporate segment, which the management envisages to reduce to 50 percent of loan book by FY20.
The NBFC has done well and turned around after the new management took over the business in July 2016. The management redefined its business strategy to achieve top quartile return on equity (RoE) by FY20. The result of this focused strategy is very encouraging and reflects in improved return ratios with RoE increasing to 18.45 percent in Q1 FY19 from 9.78 percent in Q1 FY17.
The stock has corrected almost 44 percent from its 52-week high. Capital availability and access to funding will enable LTFH to garner a higher market share at a time when a large part of the NBFC space has been rendered weak due to liquidity woes.IndoStar Capital Finance: Trading below its trailing bookThe company listed in May, mobilising Rs 700 crore of fresh capital. Thanks to the initial public offer, its overall capital adequacy ratio (CAR) is a healthy 32 percent with Tier I CAR of 31.7 percent as on June 30. Large quantum of equity gives it an edge over peers in raising funds. Given the relatively smaller loan book of Rs 7,341 crore as on June 30, we don’t see concerns on growth, which will be supported by its healthy capital position.
IndoStar has an experienced senior management team and is sponsored by institutions of repute (Everstone Capital, Goldman Sachs and Baer Capital Partners). Also, the board consisting of eminent persons actively engaged in oversight of all aspects of the business. While the company is not backed by a big group, its professional and experienced management gives us a lot of comfort.
The company follows a conservative liquidity management policy of maintaining minimum 15 percent of net worth in liquid investments such as fixed deposits and liquid funds, including undrawn bank lines. Mutual funds have been an important source of funding so far. However, the NBFC’s policy of maintaining adequate liquidity mitigates the rollover risk to a large extent. It has established relationships with around 29 banks. Going forward, it is expected to increasingly tap bank borrowings. Its overall asset-liability position is cushioned by the favourable trend of repayments.
The stock has corrected almost 50 percent from its high as its limited history must have made investors jittery. IndoStar’s current market capitalisation is less than it Q1 FY19 net worth. From the long list of NBFCs that we track, the stock stands out for its compelling valuation as it is trading below its 12-month tailing book value at the current (October 8) market price of Rs 283.75. Its current valuation prices in the worst case scenario making it a good long term bet.Moneycontrol Research page