Bajaj Finance bets on HFC hive-off and festive demand

Hive-off will boost returns; better discretionary demand to aid consumer finance business

Bajaj Finance’s share price is on the rise, thanks to continued strength in its core business of consumer durables financing (about 40 per cent of the total assets under management) and expectations of better demand in the ongoing festive season.

Besides, the company's plan (announced last month) to hive off its housing finance (HFC) business into a separate company, registered under the National Housing Bank (NHB), will bring multiple benefits. Not surprisingly, its stock made a new high of Rs 2,812.85 on October 1 and has outpaced the BSE Sensex and most of its peers in the past month.

First, Bajaj Finance's cost of funding is likely to reduce, given that the HFC will also be eligible to get refinancing from NHB, as well as for external commercial borrowings (ECBs). Second, an HFC can maintain tier-I capital of less than 10 per cent as against above 12 per cent required for Bajaj Finance. The HFC would also be eligible for tax benefits under section 36(1) (viiia), which would improve profitability.

“Setting up of a separate housing finance company is likely to enhance Bajaj Finance’s return on equity from the home loan business from eight per cent under the NBFC structure to about 23 per cent under the HFC structure,” says Sampath Kumar, analyst, IIFL. He expects Bajaj Finance to post a 25 per cent earnings and 30 per cent assets under management compound annual growth rate (CAGR) over FY14-17.

Bajaj Finance also enjoys strong asset quality, with gross and net non-performing assets ratios of 1.13 per cent and 0.27 per cent, respectively. This trend is likely to continue. The company plans to focus on the SME (small and medium enterprises) segment and cross-selling products to existing borrowers, besides expanding reach to include more rural areas.

A slower than expected economic recovery and intensifying competition in the housing finance, retail and SME finance segments are potential risks. The strategy of launching new products (such as doctor loans and lifestyle loans) regularly has paid well.

In this backdrop, most analysts remain positive on the company. But, the recent run-up to Rs 2,695 (BSE closing) currently, means the stock trades at 2.4 times the FY16 estimated book value, much higher than its historical average one-year forward price/book ratio of 1.3 times. Thus, long-term investors could await a correction.