NBFC stocks ride on licence hopes

Even as the markets are taking a breather and the Sensex has shed over 200 points over the past three days, non-banking financial company (NBFC) stocks have run up on news flow related to the issue of fresh banking licences by the Reserve Bank of India (RBI). Stocks went up largely on speculation. Past history indicates RBI has been choosy on licences, so the markets are likely to feel disappointed, going ahead.

Vaibhav Agrawal, VP Research, Angel Broking, says, “Looking at safeguards like diversified shareholding of promoter companies, we expect RBI to dole out only three to four licences, to be handpicked from several contenders.” Experts suggest players like L&T Finance, IFCI, LIC Housing or Bajaj Finserv could be front runners for these. Nevertheless, RBIs decision to issue licenses would determine competitive intensity in the banking sector and lead to consolidation in the long run.

A positive move
RBI’s discussion paper has suggested that NBFCs, which are already under its purview, could be issued licences subject to conditions. As a bank, preferred NBFCs would get access to a low-cost deposit base, besides enhancing their client base in the form of small enterprises.

Says Abizer Diwanji, Head of Financial Services, KPMG, "It makes sense for diversified conglomorates (Aditya Birla Nuvo) or financial services companies (Edelweiss, Bajaj Finserv) to get into banking, as it will complete their bouquet of services." In addition to building up scale in terms of branches and mobilising deposits, a banking licence would give them access to the forex market, custodial services and PDs (primary dealers), which otherwise they have to apply to separately. For companies that predominantly cater to a semi-rural base, a banking licence is handy, as all they need to do is to convert or extend some of the operations into deposits. Collection ability (for companies such as Shriram Transport Finance) and reach in these areas are their biggest strengths.

Growth pangs
The issuance of banking licences to NBFCs is positive. Experts warn it would become tough to compete with established banks unless NBFCs seek out a niche in the long term. With urban markets competitive, RBI’s financial inclusion plans to expand operations in unbanked territories would mean the new entrants would need to make capital infusions. RBI could also look to raise capital requirements for new banks. It is now Rs 200 crore, with a prescription to raise it to Rs 500 crore initially. Players like Shriram Transport and LIC Housing look reasonably capitalised, as the new capital raised would amount to 14 per cent and 15 per cent of their respective net worth.
 

HOW THEY STACK UP
	CMP (Rs)	% chg *	EPS (Rs)		P/BV (x)		P/E (x)
			FY10	FY11E	FY10	FY11E	FY10	FY11E
IDFC	178	-2.8	8.0	9.1	3.3	2.6	22.1	19.5
Reliance Capital	763	0.6	27.8	29.0	2.4	2.2	27.4	26.2
Shriram Transport Fin	736	4.1	37.9	52.9	4.7	3.5	19.5	14.0
LIC Housing Fin	1,225	1.9	71.9	91.7	3.5	2.8	17.0	13.3
Bajaj Finserv	480	10.6	1.9	NA

5.7

 NA

256.0

 NA

M&M Finan Serv6172.631.242.33.63.119.914.7 IFCI592.39.3 NA 1.4 NA 6.3 NA  Sundaram Finance4920.140.0 NA 1.7 NA 12.3 NA  JM Financial352.90.6 NA 1.6 NA 57.5 NA  Future Capital2930.63.2 NA 2.5 NA 90.4 NA  SREI Infrastructure Fin911.37.57.91.3

 NA 

12.011.5 *Over August 10, 2010  E: Estimates                                                                                         Source: Bloomberg, capitalline

In the medium term, in a hardening interest rate environment, NBFCs’ higher cost of funds compared to banks could hurt them on margins.

On the valuations front, NBFCs are quoting at an estimated two-three times book, cheaper than several private sector banks, but at a premium to state-run banks (trading at one to two times) that have access to low-cost funds.

Stocks to watch
While RBI’s move is certainly positive for