RBS on Aditya Birla Nuvo

RBS initiates coverage on Aditya Birla Nuvo with a `Buy’ rating and target price of Rs 1,050 per share. ABNL has a presence in a wide range of financial services, such as life insurance, asset management, non-banking financial services, wealth management, retail broking, private equity and insurance advisory. Birla Sun Life Insurance is the sixth-largest private life insurance company in India based on April-January ‘10 weighted new received premiums. Birla Sun Life Mutual Fund is the fifth-largest asset management company, with about Rs 68,100 crore of assets under management. The gross domestic savings rate increased from 23% in FY01 to 32.5% in FY09, with household financial savings forming a large part of that.

In addition, about 61% of the population is of working age. The target price is made up of:

1) the financial services group (insurance, asset management company and the listed AB Money Ltd)

2) the telecom business; and

3) the manufacturing businesses. Recently, the government announced its intent to consider giving banking licence to the private sector and NBFCs, subject to RBI approval. ABNL’s management has said that the group will apply for one.

BAJAJ Auto Finance

Bajaj Auto Finance is likely to post a higher growth in the next fiscal considering a rebound in the two- and three-wheeler market

BAJAJ Auto Finance, the non-banking finance company of the Bajaj Group, has smartly changed its business model over the years. The company was primarily into financing of two-and three-wheelers; as such disbursements formed 60% of total business in FY06. Over the past three years, the company has ventured into personal loans, small business loans and loans for durable goods, as well. As a result, the share of auto loans in the total disbursements slipped to 32% in FY09. Today’ given its lesser dependence on auto market, the company is less exposed to the slowdown in the auto sector than earlier.

In FY08, when the slowdown in the auto market started, the company’s net profit fell by 56% year-on-year. The next year was a mixed-bag. The two-wheeler industry had seen its nadir in FY08. So on a lower base, FY09 appeared to be better, as the profit jumped by 65%. However, the company was yet to recover entirely. Despite high growth, absolute profit couldn’t bounce to the levels of FY07. Apart from that, the situation remained grim for finance companies in FY09, as economy slowed down and interest rates shot up due to monetary tightening.

Come FY10, the company seems to be on a recovery tide. The profit has more than trebled in the nine months ended December 2009. The recovery has come on the back of a revival in the non-banking financial companies (NBFC) sector. Even as banks struggled to extend loans, NBFCs posted much better results in December 2009 quarter.

The recovery in the sector has rubbed off even Bajaj Finance as deployments in all segments surged manifold. The disbursements of twoand three-wheeler loans grew by 58% in the nine months ended December 2009. In the same period, the disbursement of small business loans was thrice that of the corresponding period last year.

It is expected that the company will continue to post high growth in the next fiscal as well. The automobile sector moves in cycles. So if the past two years were marred by slowdown, it is expected that the next fiscal will signify the recovery. Besides, there are other encouraging signals, like growth in industrial production (IIP) that touched 11.7% recently after falling to zero in December 2008. Any kind of recovery in the economy will bring fruits to the finance providers as well.

VALUATION

Given a tremendous improvement in financials, the company’s stock price has shot up by more than five times since the start of current rally on March 2009. In the same time, the benchmark Nifty has gone up by 90%. Clearly, the stock has been an outperformer. The surge in stock price has also stretched the valuations, as the stock is trading at 13.7 times its trailing 12 months’ earnings. However, there is a scope for price to further go up. First, the company is on a high growth trajectory.

Two- and three-wheeler market moves in cycles and the recovery has started. It is expected that the good run will continue even in FY11. Second, the stock is still far away from its all time high price of Rs 529 per share that it reached in March 2006. So it makes sense for long-term investors to consider exposure to the stock at current level.

HDFC

HDFC is facing stiff competition from state-run banks.With the P/E at a high, it may be a good idea to exit at the current price point
HOUSING Development Finance Corp, better known as HDFC, is the biggest housing loan provider in India. In fact, its success is so unparalleled that its name has become synonymous with housing loans in the country. It is also one of the most consistent performers in India Inc. For instance, its profit growth remained in the range of 20-25% in six years from FY 2002-2007. As a result, its stock has become darling of investors be it retail, high net worth individuals or foreign institutional investors. However, state owned banks; particularly State Bank of India (SBI) has upped the ante on housing loans, which has intensified the competition.

BUSINESS

India is a country with acute shortage of dwelling units. This shows that housing loans will continue to be a growth business in many years to come. Moreover, housing loan is secured lending. Unlike unsecured lending such as credit cards, the risk of non-performing loans is much lower in mortgage business. The logical conclusion from these facts is that HDFC - being the largest mortgage player - is set to grow in future. But the competitive landscape has dramatically changed. In the good days of boom, it was ICICI Bank, which was the closest competitor of HDFC in terms of housing loans.

Today, public sector banks are coming out with attractive schemes for prospective borrowers. For instance, country's largest bank, SBI, has offered home loans at 8% per annum interest rate to new borrowers. The bank has met with such success that it has become the largest home loan provider in terms of both numbers of homes and volumes.

Other top PSU banks are also offering housing loans at attractive rates. In fact, today PSU banks offer lowest rates for housing loans. No doubt HDFC is feeling the heat. Moreover, PSU Banks have adopted modern practices such as core banking solution (CBS), improved their culture by instilling customer-focused approach at branch level, hired young workforce and introduced incentive based compensation structure. These changes have radically changed the competitive landscape in banking and finance space.

HDFC, however, has an upper hand due to its relationships with many builders across the country and its valueadded services to potential home buyers like qualitative information about builders and projects. Its staff also tends to be aggressive in courting prospective customers, while state-run banks mostly rely on walk-in customers.

FINANCIALS

HDFC’s performance has slipped a few notches in the last few quarters. In fact, in the December ’08 quarter, its net profit fell 2.3% year-on-year. Though profits soared 20.7% in the June’09 quarter, still the performance is lacking on some parameters. For instance, the growth in advances has come down to a mere 8.4% in the June ’09 quarter from 31% a year ago.

It is clear that the company is finding it difficult to maintain the growth rates. Plus, the competition has intensified over last year.

Moreover, the cost of funds for banks is much lesser because 30-40% of their deposits are CASA (current account and savings account) in nature. And because such deposits provide better liquidity than term deposits, banks offer extremely low interest rates. On the contrary, the cost of funds for HDFC is high because it is a non-banking finance company (NBFC) and cannot mobilize CASA deposits. For instance, in FY 2009, the cost of funds for SBI stood at 5.9% compared to 9.7% in case of HDFC. (Refer the chart below for comparison of cost of funds between HDFC and SBI over last five years). With higher cost of funds, HDFC cannot match the interest rates offered by PSU Banks on home loans.

VALUATIONS

The stock is trading at 30 times its trailing twelve months standalone earnings. The adjacent chart shows price to earning multiple (P/E) at various points in last six years. It is clear that only once in last six years that valuations were higher than what is prevailing now. And that happened in last months of year 2007. Those were the days of great Indian bullrun, when the company was growing by leaps and bounds.

The point here is that HDFC is facing strong headwinds in form of stiff competition. However, it seems that stock market has not captured it. On the contrary, the current rally has pushed the stock price bit too far. There is no doubt that HDFC will continue o grow due to its expertise in mortagge business. But, the growth rate may not be as high as invetsors have become used to. Later or sooner, stock market will factor this into valuations. It would be wise for long term investors to sell the stock or at least reduce exposure.

LIC Housing Finance

LIC Housing Finance has been able to efficiently manage all kinds of risks during testing times and has strong fundamentals. Long-term investors can accumulate the stock at its current level

WE HAD recommended LIC Housing Finance as a stock idea on June 23, ’08. The stock has lost nearly 22% since then. We feel this is due to the overall bearish phase in the market, wherein even the Nifty has lost close to 30% during the same period. Hence, LIC Housing Finance’s stock has outperformed the broader market. We think the company is the one of the best-managed non-banking finance companies (NBFCs) in the country and long term investors can accumulate the stock at its current level.

BUSINESS:

LIC Housing Finance provides housing loans mainly to individuals. It is the second-largest housing finance company in the country after Housing Development Finance Corp (HDFC). Its balance sheet size has nearly trebled in the five years from FY03-08. During this period, it has been one of the fastest growing NBFCs. This is due to the strong economic growth seen in India and the rising level of disposable incomes, which has fuelled the demand for housing loans. Also, since last year, LIC Housing Finance has stepped up its promotional activities, which has improved its share in housing loans from 5% to 7%. This is commendable as much larger players like HDFC and commercial banks, which have a significant presence in housing loans, dominate this market. Since the beginning of the current financial year, the financial sector has been facing the brunt of rising interest rates and slow disbursements. LIC Housing Finance has been able to weather the storm, which is visible from its growth in interest income. The company’s interest income grew by more than 30% year-on-year for the six months ended September ’08. In fact, even its disbursements were up 30% during this period, which is in line with its performance last year.

NBFCs typically face delinquency risks, which surface during times of a slowdown, when borrowers are not able to make the interest payments (EMIs) on their loans. LIC Housing Finance’s net non-performing assets (NPAs) stood at less than 1% of its net advances as of end-September ’08, compared to 1.65% a year ago. This shows that the company’s quality of loan book has improved tremendously in the past one year and it has been efficient in managing delinquency risks.

The company is also efficient in managing liquidity risks. This is evident as the proportion of assets maturing in one year is similar to the proportion of liabilities maturing within one year. This aspect is extremely vital as NBFCs which have financed long-term assets through short-term sources of finance face tremendous pressure in a scenario of tightening liquidity. Hence, it is clear that LIC Housing Finance has been able to efficiently manage all kinds of risks during testing times.

VALUATIONS:

The stock is trading at a price-to-earnings (P/E) multiple of 3.9 times. Hence, the stock appears to be cheap considering its high earnings growth, as its net profit in the past 12 months has grown by more than 40%. Though it is a known fact that in the case of finance companies, the stock trades at a lesser multiple than earnings growth, we feel this is overdone in the case of LIC Housing Finance, as the P/E multiple is just a fraction of its earnings growth.

We think the market has already factored in a worst-case scenario for all NBFCs, including LIC Housing Finance. The company’s current low valuations appear to be attractive for long-term investors, as LIC Housing Finance’s stock price has fallen as much as that of other NBFCs, even though its fundamentals are much better than theirs.