Why Gruh Finance is going out of favour

The firm's cautious approach, particularly in loans against property, may keep a check on the pace of disbursement in FY17

When the Street was shifting its preference from large banks and non-banking financial companies (NBFCs) to their smaller peers in 2015, Gruh Finance was among the few to gain currency. While the stock didn't live up to its expectations last year (down seven per cent year-on-year), its valuations were hovering at 15x FY16 price-to-book. Notwithstanding this, analysts remained positive on Gruh in anticipation that swift loan growth due to its approach on smaller cities and its resultant impact on earnings to reflect on valuations. But September quarter results once again did not live up to expectations. Though there is little doubt on Gruh Finance's ability to expand its business in a profitable manner, analysts feel that the historical 30 per cent plus net profit growth and loan book may be difficult to replicate. A few data points that emerged from Q2 results such as slowing pace of disbursements and gradual compression of net interest margins (NIMs) apart from its valuations expanding to 12x FY17 P/BV (from 9X in April), thanks to the 37 per cent year-to-date gains, have led analysts to reconsider their stance. This comes at a time when investors are beginning to ascribe higher valuation to mid-cap stocks which offer promising growth opportunities.

Firstly, the cautious approach by Gruh Finance, particularly in the loan against property (LAP) segment may keep a check on the pace of loan disbursement in FY17. In Q2, loan disbursements inched up by a mere two per cent -- the lowest quarterly growth in the last four years. LAP accounts for 11 per cent of Gruh's total loan book. With this, NIMs at 4.06 per cent in Q2, were well below the FY14 peak of 4.5 per cent. There could be more downward pressure given the volatile net interest income growth (up 17 per cent year-on-year in Q2). Analysts at Motilal Oswal Securities, while downgrading their rating on Gruh from 'buy' to 'neutral', reduced the earnings per share (EPS) estimates for FY17-18 by 2 per cent, factoring in lower loan growth. Likewise, ICICI Securities also downgraded Gruh Finance from 'reduce' to 'sell'. "The stock trades at such a large premium to the 'right price' that even if business reality sticks to a rosy script of 25 per cent or more self-sustained asset growth, a five year holding period will reward a new investor with sub-par total returns," the brokerage cautions. Near-term outlook appearing bleak explains why very few analysts are bullish on the stock, while in 2014, over 75 per cent of analysts polled on Bloomberg had 'buy' recommendation on Gruh.