Rally in NBFCs skating on thin ice; Piramal Enterprises biggest gainer

M-cap of top retail NBFCs has risen 19.4% in 2021, against 17.2% rise in Sensex and 12.8% rally in BSE Bankex

Retail non-banking financial companies (NBFCs) such as Bajaj Finance, Housing Development & Finance Corporation, Sundaram Finance, and Shriram Transport Finance continue to outperform the broader market and their bank peers on the bourses.

The combined market capitalisation of the top listed retail NBFCs reached a new high after it rose 1.6 per cent on Tuesday, against a 0.7 per cent rise in the benchmark BSE Sensex and 1.4 per cent rally in BSE Bankex, which tracks the market cap of the top 10 listed banks.

With this, the combined market cap of top 13 retail NBFCs has risen 19.4 per cent since the beginning of 2021, against a 17.2 per cent rise in the Sensex and 12.8 per cent rally in BSE Bankex.

The biggest gainer has been Piramal Enterprises. The company’s market capitalisation is up 93 per cent year-to-date (YTD) from Rs 32,243 crore at the end of December 2020 to Rs 62,242 crore on Tuesday. Other big gainers include Shriram City Union Finance (up 85 per cent), Sundaram Finance (up 41 per cent), Bajaj Finance (up 32 per cent), and Cholamandalam Investment & Finance (up 32 per cent).

Analysts attribute the NBFCs’ strong showing on the bourses to investors’ expectation of a faster-than-expected recovery in retail loan growth and NBFCs’ ability to grab the opportunity faster than banks.

“The rally in NBFCs is all about future expectations. After a disastrous FY21, when most NBFCs’ loan books shrank, investors expect a rapid rise in their loan book and earnings in second half of FY22 compared to banks,” says Shailendra Kumar, chief investment officer at Narnolia Securities.

However, contrary to expectations, NBFCs didn’t have a great start to FY22. The combined gross interest income of the top 25 listed NBFCs rose just 1.7 per cent year-on-year (YoY) in the June quarter (Q1FY22), while net profit was down 12.2 per cent YoY. Many NBFCs reported a decline in their loan book on YoY basis and a rise in the non-performing loans on their retail book.

While their combined gross interest income was the lowest in the last four quarters, net profit was the lowest in the last 16 quarters, with the exception of Q1FY21.

Many expect NBFCs’ earnings to remain under pressure for the rest of FY22 because of a combination of slower loan book growth and an incremental rise in cost of funds. “In the last few years, retail NBFCs grew very fast by taking away market share from banks. The process has now reversed and big banks are expected to grow faster, making it tough for non-bank lenders to outperform,” says Dhananjay Sinha, managing director and chief strategist at JM Finance Institutional Equity. He has been underweight on NBFCs for the last two months.

The industry also faces a margin squeeze because of a rise in cost of funds. This was already visible in Q1FY22. While NBFCs’ combined gross interest income was down 10.5 per cent quarter-on-quarter (QoQ) in Q1FY22, their interest expenses were down only 0.2 per cent and employee costs were down 7.9 per cent QoQ.

Many analysts see a valuation bubble in the segment fuelled by ample liquidity and low level of floating stocks. “The valuation of many NBFCs is in a bubble zone and has no relation to their earnings or balance sheet ratios. This greatly raises the downside risk for investors,” says G Chokkalingam founder and MD of Equinomics Research and Advisory.