Smaller NBFCs may offer big returns

One of the reasons why the Street was sceptic about smaller non-banking finance companies (NBFCs) was whether their stocks were getting rerating ahead of fundamentals. The note ban period between November 2016 and January 2017 has addressed this concern effectively, and stocks such as Capital First, Repco Home Finance, Cholamandalam Investment and Shriram City Union are yet to catch up with their pre-demonetisation levels; Can Fin Homes is an exception and is up 16 per cent since November 8, 2016. The recent correction offers investors a good opportunity to accumulate these well-managed smaller NBFCs.

Despite the note ban, loan demand remained buoyant for most of them. In the coming quarters, experts believe that the relatively lower base would give them the competitive edge to grow faster (25 - 30 per cent) while some of the seasoned players such as HDFC, LIC Housing, Shriram Transport and Bajaj Finance could just about maintain the current growth levels of 17 - 25 per cent. Niche focus of these smaller players is another advantage. Most of them operate in Tier 2/3 cities, where banking network is thin. Therefore their diversified loan portfolio provides an opportunity to strengthen the MSME (micro, small and medium enterprise) market presence. Also, over the past few years, these NBFCs have significantly improved their underwriting skills to minimise the loan-loss risk. This is why despite the note ban experts believe that these NBFCs may not see a spike in non-performing assets (NPAs). While Can Fin Home may maintain the gross NPA ratio at less than one, Capital First numbers are seen at less than 1.6 per cent. Repco, Shriram City Union and Cholamandalam may maintain their gross NPA non-performing assets at three per cent or less. These are still near about the historic levels. Nonetheless, it needs to be seen if growth can be achieved without compromising on asset quality and profitability.

That said, going forward the Street will monitor if the smaller players can keep the cost of funds at check. Bond yields now at 6.98 per cent have shot up by 50 basis points in the past month - highest jump in the recent times. This can directly impact net interest margins by 20-30 basis points and poses as a risk particularly for Cholamandalam, Capital First and Can Fin Homes which have 40 - 50 per cent exposure to the bond market. On the positive side, Sebi has recently enhanced limits for mutual fund investment into bonds of housing finance companies by 50 per cent; a move which would improve low-cost liquidity by Rs 55,000 crore for the industry.

With these positives adding up, analysts estimate that fundamentals may start cushioning the valuations from FY18.