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8/13/2019 HSBC 09-10-13 India Diversified Financial Services
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abcGlobal Research
Niche consumer NBFCs still attractive,
despite macro slowdown, rising ratesPrefer sectors that are cash flow and
price sensitive: rural and housing financePrefer HDFC and LICHF, both OW rated;
upgrade SHTF to OW from N; downgrade
IDFC and PFC to N(V) and REC to N
Niche retail NBFCs remain attractive:Non-banking financial
companies (NBFCs) continue to be a space worth looking at,
despite a tough macro-environment and rising rates, as niche
consumer segments are still growing well. Two key sectors
rural and housing finance remain attractive. Urban housing
demand is steady due to affordability, income stability and
urbanisation and demand remains largely price and income
sensitive. Likewise, rural demand remains healthy, benefitting
from good monsoons, improving consumer cash flows, rising
income, and the wealth effect. Both segments have low interest
rate sensitivity. However, the commercial vehicle (CV) cycle
continues to be sluggish, while infrastructure issues, mainly
power, remain unresolved.
Little incremental impact on margins:NBFCs have
effectively managed their funding costs in 2Q, despite the
RBI raising the marginal standing facility (MSF) rate by
200bp. With the RBI reversing 125bp of this hike within the
quarter, NBFCs funding costs will ease. However, we
maintain our estimate of a 0-30bp margin decline for our
NBFC universe as the RBI has started hiking repo rates.
HDFC and MMFS best placed: HDFC (housing) and
MMFS (rural) are both well-positioned in their respective
sectors, with healthy profitability, good management and
conservative risk policies. LICHFs profitability has largely
bottomed out, while SHTF could see lower profitability due
to declining margins and rising asset quality risks. IDFC,
PFC and REC continue to be affected by the slow resolution
of power sector issues. A potential banking license could be
a further drag on IDFCs profitability.
Preferred picks: We continue to prefer HDFC, followed by
LICHF and SHTF (value buy). We remain N on MMFS,
whose strong fundamentals are offset by a rich valuation.
We downgrade IDFC and PFC to N(V) and REC to N as we
await the full resolution of power sector issues.
FIG
India Diversified Financial Services
India NBFCs
Remain selective
Indian NBFCs - Ratings and target prices
Company Bbg CMP* Rating(New)
Rating(Old)
TP(New)
TP(Old)
Potentialreturn **
HDFC HDFC IN 802 OW OW 1029 1007 30.0%LICHF LICHF IN 198 OW OW 236 243 21.1%Mahindra &Mahindra Fin
Services
MMFS IN 264 Neutral (V) Neutral 285 250 9.4%
ShriramTransport
SHTF IN 571 OW Neutral 706 723 25.2%
IDFC IDFC IN 95 Neutral (V) OW 101 129 9.8%Power Fin POWF IN 134 Neutral (V) OW 134 130 5.4%RuralElectrification
RECL IN 193 Neutral OW(V) 205 251 12.1%
**Potential return equals the percentage difference between the current share price and the target price, plusthe forecast dividend yieldSource: Company data, HSBC estimates, * prices as of 3rd October 2013,
9 October 2013
Tejas Mehta *
Analyst
HSBC Securities & Capital Markets (India) Private Limited
+91 22 2268 1243 [email protected]
Sachin Sheth *
Analyst
HSBC Securities & Capital Markets (India) Private Limited
+91 22 2268 1224 [email protected]
Todd Dunivant *
Head of Banks Research, Asia Pacific
The Hongkong and Shanghai Banking Corporation Limited
+852 2996 6599 [email protected]
View HSBC Global Research at: http://www.research.hsbc.com*Employed by a non-US affiliate of HSBC Securities (USA) Inc,and is not registered/qualified pursuant to FINRA regulations
Issuer of report: HSBC Securities and Capital Markets (India)Private Limited
Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it
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Valuation and risk factors
PE PE-based PB PB-based DCF Wghtd TP ___________________________________ Risks ____________________________ multiple TP multiple TP value (INR) Upside risks Downside risks
Weights 20% 50% 30%
MMFS 12.5 321 2.4 289 253 285 Improvement in asset quality Higher slippages due to monsoon vagaries,regulatory uncertainties, interest rateuncertainties
SHTF 9.0 664 1.7 772 624 706 Rigidity, higher slippages, regulatory risks
Weights 50% 20% 30%
HDFC 23.5 1147 4.5 999 853 1029 - Increase in competitive pressures couldslow business growth or impact margins;
Asset quality riskLICHF 8.2 248 1.4 245 208 236 Asset quality deterioration and prolonged
suppressed spreads
Weights 100%
PFC 0.6 134 134 Earlier than expected capex revival,lesser than expected asset quality issues
Increase in slippages, decline in margins
REC 0.9 205 205 Earlier than expected capex revival,lesser than expected asset quality issues
Increase in slippages, decline in margins
Weights 20% 50% 30%IDFC 8.0 100 0.9 100 102 101 Earlier than expected capex revival,
lesser than expected asset quality issuesWorse than expected asset quality andgrowth outlook
Source: HSBC estimates
Sector-wise analysis and outlook
Sectors Growth drivers Growth outlook Customer sensitivity Risks Rank
Housing Growing salaried middle class,increasing nuclearisation of families,rising incomes, home aspirations,increasing urbanisation, property prices
Growth has remained secularirrespective of the macro slowdown;Outlook remains steady with demandstill buoyant, buying behaviour ismore linked to prices and job securitythan interest rates
High sensitivity to prices andincome stability, lowsensitivity to interest rates
Low risk as 95%+ customers are stillfirst time home buyers; asset qualityremains one of the best among allsectors; however, its a AAA-equivalent lending and therefore lowyield, leading to lower RoAs
1
Rural vehicles Rising incomes, rising employment,growing wealth effect of gold and realestate, last mile connectivity resulting in
shift from savings to consumptioneconomy; leading to higher creditpenetration and higher sales of vehicles
Rural growth largely remainsdecoupled from macro slowdown,supported by ever-growing food
demand, higher MSPs andemployment schemes; growth invehicles likely to remain buoyant
Highly cash flow sensitiveand sentiments highlycorrelated to the monsoons
and agriculture, althoughdirect monsoon linkedbusiness is smaller
Monsoon risks remain every year asit affects not just incrementaldemand, but increases risks to
existing book asset quality; however,slippages are generally temporary
2
CV Industrial activity for large fleetoperators;Cash and carry consumables demandfor small operators
Faltering GDP and IIP growth andban on mining activities havesignificantly slowed down MHCVsales, where volumes have beendeclining for past few quarters;however, cash and carry related CVdemand and last mile connectivityrelated LCV sales are still growing
First time users and SmallRoad Transport Operatorsare borrower cash flowsensitive, however, largefleet operators are interestrate and IIP growth sensitive
Cyclical in nature and therefore,dependent on economic cycles; assetquality could see moderatedeterioration during downturn as peopleget out of business; however, chancesof subsequent recovery are good
3
Power India is a power starved country withannual supply shortfall at ~8-10%;however, generation capacity addition,fuel linkage and ability of state discomsto buy power are key drivers for the
sectors growth
Given India has one of the lowest percapita power consumption amongBRIC nations, long term growthoutlook remains promising; however,near term generation growth could
suffer due to coal and gas linkageissues, which will take time to sort out
Highly interest rate sensitivegiven the high leverageneeded to set up powerinfrastructure
Almost all recently operationalised andupcoming gas based projects arelikely to be restructured due to noresolution on gas supply; also thermalprojects could face coal supply issues
either due to shortage of supply fromCoal India or no PPA signed with thediscoms, which could lead torestructuring and some write-offs
4
Source: HSBC
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Stock scorecard
Growth Margins Asset quality Profitability Transparency, stability,visibility andmanagement quality
Valuations Verdict
HDFC Positive: Home salesremain buoyant, which willkeep HDFC's loan growthintact at 18-20% YoY;growth supported fromhome sales beyondmetros
Neutral: Likely to remainsteady at 2.2-2.4% rangewith support from a goodliability and asset mix anda well-matched ALM
Positive: Robust assetquality trend to continueaided by goodaffordability, first timehome and conservativecredit culture; GNPLs at0.7-0.8%
Positive:Expect RoA tocontinue in 2.7-2.8%range and ROA in 21-23%range over FY14-15e
Positives:One of the bestmanaged companies witha quality top management,prudence riskmanagement, stronggrowth and earnings'visibility
Trading at 4.1x PB and19.3x PE 12-monthforward; ex-subsidiaryvalue, trading at 2.4x PBand 11.3x PE inline withhistorical range; premiumustified considering stronggrowth and earnings'visibility
Good combination ofdefensive with returns
LICHF Positive:LICHF will alsocontinue to benefit fromthe steady home salesgrowth; we expect 20-22%
loan growth over FY14-15e
Neutral:Spreads atlowest level of 1.1%, havemostly bottomed out, evenafter considering higher
funding cost, marginalrecovery likely if MSFrates soften further
Positive:Robust assetquality trend to continuesupported by goodaffordability, first time
home purchases andconservative creditculture; GNPLs at 0.7-0.8%
Neutral:Expect low RoAof 1.3-1.4% and ROA of17-18% to continue, butlargely bottomed out as
margins have bottomedout
Positives:Presence inthe right sector, goodasset quality;Negatives:Poor earnings'
visibility due to uncertainmargins; averagemanagement
Trading at 1.24x PB and7.6x PE 12-monthforward, much lower thanhistorical averages,
probably reflectingmargins and earnings'uncertainty; upturn inmargins is the key catalystto rerate the stock
Value buy
MMFS Positive:Growing ruraleconomy coupled withhealthy monsoons thisyear to boost ruralspending; MMFS directbeneficiary of this; expectloan growth of 24-26%over FY14-15e
Neutral:High cash flowsensitivity of customersand low privatecompetition helping MMFSto pass on the rise infunding costs; however,imbalance in ALM tomarginally affect FY14NIM
Positive:Diversified loanbook across vehiclesegments coupled withgood monsoons, ruralspending by governmentand good cash recoveryefforts to support healthyasset quality; GNPLs at3.3-3.6%
Positive:RoA to declinemarginally from peak 4%levels to 3.7-3.8% due toslight margin decline andhigher credit cost; ROA toremain at 21-23% overFY14-15e
Positives:Presence inrural sector, strong topmanagement, prudencerisk management, stronggrowth and earnings'visibility for FY14,transparencyNegatives:Visibility linkedto monsoon vagaries
Trading at 2.6x PB and12.5x PE 12-monthforward, which are peakvaluations, investors havefavoured given strongearnings' outlook; webelieve stock is fullyvalued
Good defensive stock, butpriced to perfection
SHTF Negative:SHTF has beencautious on growth due toCV cycle slowdown overthe past few quarters;
growth mainly in theyounger used vehicles,growth to remain stable at15-17% levels
Neutral:FY14 to be thelast year of margin declineat 7.5-7.7% as SHTF isincrementally shifting to
high yielding older usedCVs; also with MSF ratereducing, fundingpressures have reduced,continue to price 20-25bpsmargin decline for FY14
Negative:Stressincreasing mainly in theindustrial category towhich SHTF has 20%
exposure; expect creditcost to rise in current fiscal
Negative:RoA to declineto ~3% from 3.3% due todecline in margins andhigher credit costs, but
likely to stabilise at thatlevel; ROA also likely todecline to 18-19% range
Positives:Niche businesssegment, marginsbottoming out, decentearnings' visibility
Negatives:CV cycleslowdown, slow growth,rising asset qualityconcerns, change inmanagement, somedoubts on riskmanagement
Trading at 1.4x PB and8.0x PE 12-monthforward, valuationslanguishing at Dec-11
lows, when mining issueoccurred, probablybuilding in rising NPLs andweaker profitability; webelieve asset qualityshould be broadlymaintained, given most ofits customers are in cash-n-carry business
Reasonably valued, someupside remain
IDFC Negative:IDFC hasclearly opted formaintaining asset qualityat the risk of slow growth.With capex revival stillsome time away andrefinancing opportunitieslimited , growth will largelyby muted FY14 - 15e
Negative:Lowerincremental disbursementsimply limited incrementalfunds requirement, whichwill limit the impact onmargins of rising rates.However with lowerflexibility on transmittingcosts, margins will declineby 15-20 bps over FY14-15e
Negative:GNPL hasremained fairly stable at0.32%; However, withinfra sector issues still farfrom resolution, defaults /restructuring will rise; Weexpect its GNPL to rise to2-2.5% over FY14-15e,especially from its gasbased exposure (2% ofthe loan book)
Negative:IDFCsprofitability is likely to beunder stress with pressurefrom all fronts growth,margins and asset quality;expect ROA to decline to2.5-2.6% and ROA to 12-13% - one of the lowestamong covered NBFCs
Positives:Good topmanagement,conservative risk cultureand good reportingtransparencyNegatives:weakeningvisibility and stability ofearnings' growth
Trading at 8.1x PE and0.9x PB , closer to all timelows; Capex revival andresolution of impedingissues in the infrasegment would be key forre-rating of the stock;Banking license could bea further drag on the stockin the medium term
Cheap valuations, butmany sector and bankinglicense uncertaintiesprevail
PFC Negative:Ex-TFM,disbursements growth hasslowed down significantly;State sector growing well,but private and centralsector growth slowingdown; We expect 5-7%disbursals growth and 15-16% loan growth overFY14-15e
Neutral:Expect risingrates to have limitedimpact on margins of ~25-30bps; PFC managingfunding costs through tax-free bonds (INR11.2bn in2Q) and cash-creditfacilities (INR 50bn in 2Q)from the banks and hasraised lending rates by50bps
Negative:Slow progresson reforms leaves a hostof pending issues to beresolved, increasing assetquality risks for PFC;outstanding restructuredbook at INR c120 bn ofloans to the IPPs
Negative:We expectROA to decline to 2.3-2.4% over FY14-15e,impacted by slowinggrowth, asset quality risksand unhedged forexexposures; ROA is likelyto remain at ~20%; Poorrisk managementpractices reduces comfortof reported earnings
Positives:Low exposureto IPPsNegatives:exposure toIPP growing; Poor riskmanagement practices,slowing growth, poorearnings' visibility;Uncertain growth strategyof former Chairman;Recent change ofChairman
Trading close to all timelow multiples of 0.6X PBdue to continuinguncertainties on powerreforms; Change ofChairman recently furtherfuelling uncertainty; Fullresolution of sector issuesand clear managementstrategy would be the keycatalysts for re-rating
Low valuations, but mayremain low due to lowcomfort on reportedearnings and sector notout of the woods
REC Negative:Ex-TFM, REC'sgrowth also likely toslowdown to mid teenswith growth largely comingfrom state sector gencosand discoms
Negative:Margins declineto be limited at ~20-25bpsas REC has raised INR35bn via the tax freebonds at 8.5% -8.7% andutilised the cash credit
facility from banks as wellas raised lending rates by50bps to limit the impactof spike in costs in thewhole sale market
Negative:Slow progresson reforms leaves a hostof pending issues to beresolved, increasing assetquality risks for REC;outstanding restructured
loans at cINR230 bn
Negative:We expectROA to decline to 2.6-2.7% over FY14-15e,impacted by slowinggrowth and asset qualityrisks; ROA is likely to
remain at ~22-23%; Poorrisk managementpractices reduces comfortof reported earnings
Positives:Low exposureto IPPs
Negatives:exposure toIPP growing; Poor riskmanagement practices,slowing growth, poorearnings' visibility;Uncertain growth strategyof former Chairman;Recent change ofChairman
Trading close to its all timelow of 0.9x PB , thoughhigher than its PFC due toclarity on growth strategy,hedged forex liabilities andbetter margins
Low valuations, but mayremain low due to lowcomfort on reportedearnings and sector notout of the woods
Source: HSBC
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Summary 5Focus on housing, rural 9Our stock picks 18Company write-ups 24HDFC (HDFC IN) 25LICHF (LICHF IN) 29MMFS (MMFS IN) 33
SHTF (SHTF IN) 37IDFC (IDFC IN) 41PFC (POWF IN) 46REC (RECL IN) 50Disclosure appendix 57
Disclaimer 60
Contents
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NBFC some niches deserveconsideration despite macroheadwinds
Indias macro environment remains challenging.With inflation stubborn and rates again on the
upswing, risks to growth have increased further.
Against this backdrop, we review NBFC stocks
under our coverage to identify if there are any
investment opportunities among these wholesale-
funded entities. We conclude that while growth,
margins and asset quality risks are increasing,
NBFCs that are focused on sectors where customers
are more sensitive to prices and own cash flows
and not sensitive to interest rates will outperform.
Rural finance from a savers to a
spenders economy
Indias rural economy has outperformed in the past
five years, amid the slowdown in the countrys
overall growth. Rising minimum support prices and
rural employment schemes have lifted rural
incomes, while rising gold and land prices have
spurred a wealth effect. The overall improvement
in sentiment has continued to boost rural spending.Going forward, a good monsoon this year and
national elections next year will further boost rural
consumer cash flows, which will continue to drive
demand. Rural customers are also more sensitive to
their own cash flows than interest rates, which
imply it has decoupled in the current macro
environment. Lastly, while asset quality risks are
high, in the current context, we believe these risks
are much less.
Housing finance still the best
In our view, housing finance remains the best
sector to be in due to its apparent immunity to the
macro slowdown; affordability and job security,
along with property prices, are the key growth
drivers here, not interest rates. Increasing growth in
first and second tier cities further supports growth
in this segment. This sector also has the lowest
asset quality risks as most customers are first-time
buyers and the credit culture remains conservative.
Commercial vehicle finance slowing
Although the CV space does not face any
particular structural issues, its cyclical nature and
close linkage to industrial activity make it more
vulnerable to the economic slowdown. Given the
current industrial slowdown and mining ban,demand has come off significantly in the past few
quarters and it is probably at its lowest point in
Summary
Niche consumer NBFCs remain attractive, despite tough macro
conditions; housing and rural finance stand out
Rising rates to have limited impact on margins of most NBFCs;
HDFC and MMFS best placed fundamentally
We prefer HDFC, followed by LICHF and SHTF (value buys) and
MMFS; our least preferred stocks are IDFC, PFC and REC
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recent history. The exception has been LCVs,
where demand remains healthy due to growth in
last-mile connectivity in the hinterlands. In terms
of sensitivity, first-time users (FTUs) and small
road transport operators (SRTOs) are more cash
flow sensitive than large fleet operators, which are
likely to be more sensitive to interest rate and
industrial activity. In terms of asset quality,
NBFCs catering to the cash-and-carry CV
operators are less prone to credit risks, than those
financing fleet operators.
Power sector issues unresolved
The infrastructure space, especially power, remains
our least preferred sector, as structural issues there
are unresolved. While some progress has been
made on coal supply issues (tariff revisions by
distribution companies (discoms), fuel supply pass-
through to name a few), speedier resolution to
power sector problems has yet to be seen. Issues
like PPA signing by discoms and FRP signing bystate governments have not progressed and
continue to get delayed, thereby leading to poor
visibility on growth, asset quality and earnings.
Not only is incremental growth likely to slow
drastically, the asset quality of upcoming and
recently completed projects is also under question.
The infrastructure space is also largely interest rate
sensitive as most projects are built with a substantial
debt burden. Ongoing delays in the execution of
projects are leading to a substantial increase in
interest cost burden for many private sector players.
Given the problems related to coal supply, gas
supply, fuel cost pass-through and PPAs not
signed, we expect c.19GW of projects could be
restructured, of which 20% could eventually be
written off due to low capacity utilisation. In
addition, c.32GW of projects are under
Comptroller and Auditor General (CAG) scanner
and at risk of default.
Similarly, discoms total historical loss of
INR1.2trn is yet to be restructured under the
Financial Restructuring Package (FRP) package,
leading to significant uncertainties on asset quality.
HFC and rural finance best
sectoral play
Overall, on the parameters of growth, sensitivity
and risk, the housing finance sector stands out
given end-customers (a salaried class with c95%
first-time home buyers) secured nature ofcollateral lending and secular growth witnessed
historically. Rural buoyancy, amid a good
monsoon, bumper harvest and increasing income
levels, makes rural financing our next most
preferred pick. Risks to growth, asset quality and
sensitivity to interest rates make infra financing
the least preferred.
HDFC and MMFS, best stocksfundamentally
On growth, prefer HDFC, LICHF and
MMFS
HDFC and LICHF have seen steady secular
growth in the past decade through economic
cycles, and we believe they will continue to do
reasonably well over the next few quarters.
MMFS, a rural play, has also grown well and
diversified its loan book. With a good monsoon
and stable rural incomes, MMFS should continueto do well in the next few quarters.
SHTF has seen slower growth amid the slowdown
in the overall CV demand cycle, although its
AUM are still growing 15-17% annually as it is
focused on used CVs, which are achieving better
sales than new CVs. This growth level should
continue in the near future.
IDFC has seen and will likely continue to see a
significant slump in growth due to a lack of newcapex, extreme management caution and a lack of
refinance opportunities. PFC and REC should also
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see barely single-digit growth in disbursements, as
private sector disbursements slow, well-rated
central Public Sector Utilities (PSUs) migrate to
banks and power sector issues remain unresolved.
On margins, most do well, despite
recent spike in rates
Most NBFCs have managed to limit the impact of
the recent spike in rates by using their cash-credit
limits and liquidity on the balance sheet, while
IFCs have also raised tax-free bonds to managefunding costs.
HDFC remains the most insulated on margins,
given its superior Asset Liability Management
(ALM) structure, good asset mix and balanced
liability profile.
MMFS has also largely limited the impact of
margins, though with the RBI starting to raise
repo rates, it could see a 25-30bp impact on
margins in the current fiscal year.
LICHFs margins remain subdued at 1.1% and are
likely to remain so in the current fiscal year due to
funding cost pressures, though they could improve
slightly in the next fiscal year.
SHTF has seen margins slide from 8.5-9% to
7.8%, and we expect them to slide further to 7.5%
in the current fiscal year, though incremental
growth in the older used CVs will lift yields,
which will protect incremental margins.
IDFC should see 10-15bp margin decline due to
rising funding costs, though low incremental
growth should limit funding requirements and
therefore margins. PFC and REC have seen their
margins remain resilient, though we expect a
marginal drop given they are at historical high
levels and rates in the system are rising.
Asset quality avoid IFCs
HDFC and LICHFs asset quality remains strong
by virtue of the segments that they cater to. Our
view on their outlook has not changed, while
MMFS should see relatively stable asset quality as
the rural economy continues to do well. SHTF
could see some rise in NPLs as the CV demand
cycle remains weak.
IDFC, PFC and REC are most at risk of ongoing
issues in the power sector and therefore, risk to
earnings is significant for these stocks.
Overall, HDFC and MMFS remain fundamentally
the best NBFCs with quality management,
transparency, prudence, growth and earnings
visibility. SHTF and LICHF come next, while
IDFC ranks poorly on fundamentals, though it has
a good management team, in our view.
Rankings based on key performance metrics
HDFC LICHF MMFS SHTF IDFC PFC REC
RoA 3 7 1 2 5 5 3ROA 1 6 1 4 7 4 1Prudence 1 4 1 3 5 7 6Transparency 2 5 1 4 3 6 7Earnings
visibility
1 4 2 3 5 6 7
Earningsstability
1 4 2 3 5 6 7
Managementquality
1 5 2 3 4 6 7
Points 10 35 10 22 34 40 38Overall rank 1 4 2 3 5 7 6
Source: HSBC estimates
Valuations: Prefer HDFC,LICHF
We prefer HDFC (OW); valuations (19.3x PE and
4.1x PB, 12-mth forward) remain in line withhistorical multiples and fundamentals. This is
followed by LICHF (also OW) at a 7.6x PE and
1.2x PB, where margins and therefore earnings
have bottomed out and growth remains healthy.
While fundamentals are not likely to improve this
year, we expect margins to start rising next year,
which should act as a catalyst for LICHF to rerate
from its current low valuations.
At an 8.0 x PE and 1.4x PB, we believe SHTF has
corrected more than what is warranted by its
fundamentals. Recently, the stock has also reacted
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negatively due to the resignation of its CEO. We
believe the current stock price is a good entry
point for long-term investors. We therefore
upgrade our rating to OW, but reduce its EPM
value after lowering growth forecasts.
We like MMFS from a fundamental point of view
but consider the stock fully valued at a 12.5x PE
and 2.6x PB. However, given the likely strong
harvest and stable rural incomes, we think it is a
good defensive stock. We raise our targetmultiples to 12.5x PE and 2.4x PB, but remain
Neutral, adding the volatility flag.
IDFC has corrected significantly, especially after
the Board recently reduced the FII limit.
However, given its low growth and drag on
profitability over the medium term, in case it gets
the banking license, we do not expect its multiples
to rerate much from current levels. We therefore
downgrade the stock to N(V).
As for PFC and REC, although some progress is
being made on power sector reforms, a host of issues
still need to be resolved. We note a lack of clarity on
reform implementation. We do not think the stocks
will rerate until power sector issues are resolved. We
downgrade PFC to N(V) and REC to N.
Overall HDFC, LICHF and SHTF remain our
preferred picks and MMFS is a good defensive
play. IDFC, REC and PFC remain least preferred.
Indian NBFCs - Ratings and target prices
Company Bbg CMP Rating (New) Rating (Old) TP (New) TP (Old) Pot return
HDFC HDFC IN 802 OW OW 1029 1007 30.0%LICHF LICHF IN 198 OW OW 236 243 21.1%Mahindra & MahindraFin Services
MMFS IN 264 Neutral (V) Neutral 285 250 9.4%
Shriram Transport SHTF IN 571 OW Neutral 706 723 25.2%
IDFC IDFC IN 95 Neutral (V) OW 101 129 9.8%Power Fin POWF IN 134 Neutral (V) OW 134 130 5.4%Rural Electrification RECL IN 193 Neutral OW(V) 205 251 12.1%
Source: Company data, HSBC estimates; Prices as of 3 October. Potential return equals the percentage difference between the current share price and the target price, plus the forecast dividendyield
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A reality check
With the economy slowing further in 1Q, inflation
still elevated and interest rates up significantly,
NBFCs have been a tough space to be in, giventhat most are niche players and wholesale funded.
In light of this, we attempt to identify the
preferred investment themes among rural,
housing, CVs and infrastructure (mainly power)
and pick stock winners within the NBFC space
based on the relative strength of the sectors and
stock-specific fundamentals.
We believe the relative outperformance of the
sectors is driven by:
Growth drivers and outlook
Customer sensitivity to borrowing
Risks to asset quality
Rural the most buoyant
Rural finance shift from savings to
consumption economy to drive growth
Rural has been the single most important sectorand has remained buoyant over the past five years.
While urban centres and industrial activity have
shown slowing growth, rural buoyancy has been
an important driver of consumption growth due to
rising incomes and the wealth effect. Factors such
as consistently rising Minimum Support Prices
(MSP) and rural employment schemes (e.g.,
Mahatma Gandhi National Rural Employment
Guarantee Scheme) have increased rural incomes.
Rural wages on the rise The income effect
1%
5% 6%8%
11%
16%
18%20%
18%
0
50
100
150
200
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
0%
5%
10%
15%
20%
25%
Average daily wage rate in rural India for men(INR)
y-o-y growth(RHS)
Source: RBI, HSBC
Focus on housing, rural
We conduct a cross-sectoral review, attempting to rank most-to-
least preferred sectors, followed by top NBFC picks
Rural and housing sectors continue to promise good growth and
profitability; CV cycle at the bottom, but visibility low
Power sector, though in better shape than last year, has
unresolved issues
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MSP on the rise = Rural buoyancy and income effect
0
500
1,000
1,500
2,000
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
Paddy MSP Wheat MSP Coarse Cereals MSP
Source: CIEC, HSBC
Similarly, our channel checks suggest that rising
prices of gold and land the two core assets that
rural people own have led to the wealth effect,
making rural people feel richer and improving the
broader rural sentiment, which has induced people
to shift from savings to consumption.
Gold prices have risen exponentially = Wealth effect
0
10,000
20,000
30,000
40,000
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
Gold prices (INR)
Source: CIEC, HSBC
Growth outlook for rural sector
Along with the above, we believe two additional
factors will keep the rural economy buoyant for
FY14-15:
Good monsoons this year along with higher
MSP will further boost rural incomes
General elections by May 2014 will further
boost spending in rural regions, which will
drive consumption
Overall, the rural theme is relatively decoupled
from domestic and global macro uncertainties and
therefore remains an attractive space. Gold loans
and vehicle finance are two sub-sectors that one
could consider in terms of the rural theme.
High cash flow sensitivity
Spending behaviour in the rural segment is more
linked to income and wealth levels and sentiment
(which is a function of agricultural production
levels) than to changes in interest rates. High
interest rates in a year with a good monsoon will
not deter rural people from borrowing for an asset
purchase. In essence, they are more cash flow
sensitive than interest rate sensitive.
Backed by rising income and wealth levels, auto
sales, one of the largest assets purchased in rural
areas, have shown significant buoyancy in the
past five years. As a proxy to this, below we show
a chart of Maruti car sales over the past few years
in rural areas. Similar buoyancy can been seen in
FMCG sales, which have been considerably more
in rural areas than urban centres and LCV demand
from last mile connectivity (as per our channel
checks). All of this points toward higher
sensitivity of demand to the customers cash flow
than interest rate movements.
Tractor sales jump in 1QFY14 - leading indicator of ruralhealth
-40%
-20%
0%
20%
40%
60%
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
Tractor sales (YoY)
Source: SIAM, HSBC
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Maruti sales growth in rural centres outstrips urban growth
0%
20%
40%
60%
80%
100%
FY09
FY10
FY11
FY12
FY13
-50%
0%
50%
100%
150%
Rural sales Non Rural Sales
Growth Ex Rural (RHS) Growth - Rural (RHS)
Source: Company data. HSBC
Asset quality seasonality
associated, but no imminent risk
Rural businesses are cash flow dependent, which
in turn is seasonal in nature. The asset quality
cycle follows a similar trend a case in point is
the asset quality of MMFS, which deteriorates in
1H and then improves in 2H every year.
Asset quality MMFS
0%
2%
4%
6%
8%
10%
12%
Q207
Q407
Q208
Q408
Q209
Q409
Q210
Q410
Q211
Q411
Q212
Q412
Q213
Q413
Gross NPL Net NPL
Source: Company data, HSBC
Thus the performance on the asset quality front is
more closely linked to the patterns of cash flow
and income generation than to activity on the
macro front. In the current environment, with
above-average monsoons and bumper harvest
expectations, the cash flow cycle is expected to
remain robust, which suggests improving asset
quality in the latter half of the year.
Housing finance seculargrowth continues
Indias housing finance sector has historically
shown resilience in the face of economic
upheavals. Increasing urbanisation, a rising
middle class, rising income and the increasing
comfort of borrowers to take on debt have been
long-term growth drivers for this sector. With the
housing loans to GDP ratio in the vicinity of 10%,
we believe the potential for growth in this sectorremains intact.
Housing loan growth still resilient
0%
10%
20%
30%
40%
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
Hom e L oan Grow th S CB Loan Gro w th - HDFC
Loan Grow th LIC HF Sy stem Credit grow th
Source: Company data, HSBC
While the economic slowdown, combined with
high property prices, has slowed sales in metro
areas significantly, especially Mumbai and the
National Capital Region (NCR), our discussions
with the banks/NBFCs suggest smaller,
underpenetrated centres are doing well as the
slowdown has not yet threatened the job security
of the salaried class, who make up the majority of
home loan seekers. Also, most of the demand has
been driven by a large base of government
employees, as well as the IT, financial and other
service sectors. Most of these have remained
healthy, barring some job losses in the financial
sector. Further, our channel checks suggest that
the first and second tier cities are becoming more
important in driving overall growth. The IT sector
has started witnessing a rebound, thereby
improving sentiment in this segment. Overall we
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expect housing finance growth to remain resilient
at 15-17% as buying behaviour is driven more by
property prices and job security than interest rates.
Asset prices more sensitive than
interest rates
Purchasing a property is a long-term, possibly
once-in-a-lifetime, event for many so its demand
is driven more by prices and affordability than the
borrowing rate to finance the purchase. Below we
see very little correlation between the change ingrowth rates versus the change in repo rate (the
proxy of prevailing interest rates).
Growth vs repo rates Very low correlation
0%
10%
20%
30%
40%
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
Hom e L oan Grow t h SC B Loa n Gr ow th - H DF C
Loan Grow th LIC HF Repo Rate (RHS)
Source: Company data, HSBC
Home loan growth has remained fairly stable over
the past few years, despite rates moving
significantly in both directions. Therefore,
financiers with a diversified presence across India,
like HDFC and LICHF, could sustain current
growth over the coming years.
Asset quality as good as ever
With collateral-based lending, a relatively
conservative credit culture and 95% of home sales
being to first-time buyers, housing finance is the
least exposed to asset quality risks. The strong
asset quality of HDFC and LICHF over the years
reflects the relatively low risk nature of lending inthis sector is, albeit at lower returns.
Gross NPLs No spikes
0.00%
0.50%
1.00%
1.50%
2.00%
FY08
FY09
FY10
FY11
FY12
FY13
HDFC LICHF
Source: Company data, HSBC
Despite property price rise, affordability has remained constant on the back of rising disposable income
5. 3 4.7 4. 3 4.7 5.0 5.1 5.1 4.5 4.7 4.8 4.6 4.75.1
0
510
15
20
25
30
35
40
45
50
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
0
2
4
6
8
10
12
P rope rty C ost (INR La cs) A nnu al In com e (IN R Lacs ) R HS Afforda bility
Source: HDFC FY13 company release, Affordability = Property Prices/ Annual income
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CVs heading toward thebottom but LCV still bright
Demand for MHCVs is closely correlated to
growth in the economy in general and to industrial
activity more specifically (see chart below). So it
is no surprise then that MHCV sales declined 23%
y-o-y in FY13. However, within this segment:
Passenger vehicle (i.e., buses) sales have not
been affected.
Goods transporting vehicle sales have not
slowed down much.
Most of the slowdown has been seen in the
infrastructure and construction related segment
and this is mainly due to the mining freeze.
IIP vs CV sales Close correlation
-40%
-20%
0%
20%
40%
Mar-09
Jul-09
Nov-0
9
Mar-10
Jul-10
Nov-1
0
Mar-11
Jul-11
Nov-1
1
Mar-12
Jul-12
Nov-1
2
Mar-13
Jul-13
-20%
-10%
0%
10%
20%
CV sales (MoM growth) IIP (MoM growth) RHS
Source: Bloomberg, SIAM, HSBC
Banks and NBFCs believe mining activity will
resume over the next few months, which couldrestart demand for MHCVs in 2HFY14. But this
is still uncertain.
LCV sales are holding onto growth, in the mid-
teens compared to a 2% decline in overall CV
sales in FY13. LCV demand continues to be
driven by last-mile connectivity in rural regions,
mainly for cash-and-carry and FMCG and for
ferrying rural people to nearby areas due to lack
of a public transport system.
Moreover, we note that the rural economy has
been doing well for the past five years, essentially
decoupling from the greater economy. With
industrial activity not likely to pick up any time
soon and the rural segment aided by the monsoon,
we expect LCV sales to continue to grow steadily,
while visibility on MHCVs will emerge only in
2HFY14.
CV financing is cash flow sensitive
CV segment uptake is fragmented in terms of end
use, with LCV demand driven more by last-mile
connectivity and growing cash-and-carry business
volumes. This, plus increasing freight rates, has
ensured steady cash flows, which can boost
demand for LCVs.
In contrast, MHCV sales, which are driven by
industrial activity, have faltered due to weak IIP
leading to weakening cash flows despite freight
rates rising steadily. In general, FTUs and smallroad transport operators (SRTOs) are more cash
flow sensitive than large fleet operators, which are
likely to be more sensitive to interest rates and
industrial activity.
Freight rates are a significant driver of
profitability and thus asset quality
Asset quality in the CV segment is dependent on
the profitability of the fleet operators while the
FTUs and SRTOs are more cash flow sensitive.Though diesel prices have been on the rise and
thereby increasing the cost of operations for the
LCV most resilient
-40%
-20%
0%
20%
40%
60%
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
CV LCV MHCV
Source: SIAM, HSBC
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fleet operators, freight rates have risen in line to
compensate for the increasing cost, keeping the
operators profitable.
Freight rates
1.49
1.51
1.53
1.55
1.57
1.59
Dec-0
9
Mar-10
Jun-1
0
Sep-1
0
Dec-1
0
Mar-1
1
Jun-
11
Sep-1
1
Dec-1
1
Mar-12
Jun-1
2
Sep-
12
Dec-1
2
Mar-13
Jun-1
3
(Rs/tkm)
A verage freight rat es
Source: Crisil, HSBC
However, as industrial activity slows, business
volumes could shrink, thereby increasing the risk
of large fleet operators facing stress. Hence the
segment could witness a moderate deterioration in
asset quality
Infra finance structuralbottlenecks
While the long-term growth potential of the
infrastructure sector remains promising with a
need to add more power generation capacity to
address the chronic power deficit and the
requirement for better road and other physical
infrastructure, the near-term outlook for the sector
(especially power) is clouded by structural
bottlenecks. See our reportIndian Power and
Banks: Progressing towards value discovery,
dated 12 July 2013. Delayed clearances, problems
in acquiring land, lack of coal supplies for power
production, lack of gas, and the financial ill health
of the state discoms are among a host of issues
that have stunted the sectors growth.
Over the past 12 months, there has been progress
with the central government trying to resolvevarious issues, including restructuring discoms
debt, expediting clearances for projects, securing
coal supply through fuel supply agreements
(FSAs), creating new bidding guidelines, and
introducing tariff relief for low-tariff PPAs. Also,
the discoms have been raising tariffs regularly for
a couple of years now to reduce financial losses.
Progress made, but much remains to
be done
The recent Cabinet Committee on Economic
Affairs (CCEA) ruling allows projects with coal
linkage from Coal India with PPAs to pass-through increased costs by allowing them to raise
tariffs. This is likely to benefit about 5.5GW of
power projects. However, loans to projects where
PPAs have not yet been signed (8,335MW) are at
risk of impairment amounting to an estimated
INR348bn.
However, the decision regarding the pass-through
mechanism for power producers using imported
coal with PPAs being signed still needs to be
resolved. The Central Electricity Regulatory
Commission (CERC) has appointed a panel
headed by HDFC Chairman Deepak Parekh to
make a recommendation on tariff increases.
Should these projects be allowed to raise tariffs,
then we would expect their positive returns,
however small, to be sufficient to service debt.
The bulk of these projects have PPAs signed.
For the projects without PPAs signed (totalling
2,940MW), we estimate impaired loans of
INR141bn. There is a risk that the arbitration
panels decision could lead to litigation, thus
delaying relief for even those projects with PPAs
in place. Projects which use both domestic and
imported coal and have not signed a PPA are
expected to remain in limbo as we do not expect
any fresh signing of PPAs.
Gas-based projects most at risk
Total private sector gas-based capacities are about8GW. These projects are close to completion, but do
not have sufficient gas supply to operate and, even
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where gas is available for operational plants, they
face difficulty in selling power since their average
tariff is expected to go up significantly after the new
natural gas pricing policy. The future of these
projects is uncertain. In fact, most developers have
suspended their unfinished gas projects regardless of
how close to completion they are.
Overall, we estimate c.19GW of power capacity is
at risk of restructuring or defaulting over the next
couple of years. In addition, the CAG-related coalblock allocations could put at risk another
upcoming 33.2GW of power capacity.
Power projects at risk
At risk (MW) Probabledisbursals
(INRbn)
Domestic coal-based projects withpartial PPAs and no fuel pass-through
8,335 348
Imported coal-based projects withpartial or no fuel pass-through
2,940 141
Gas-based projects at risk 7,968 273CAG related risk exposure 370Risky exposures of PFC and REC 143Total 19,243 1,275
Source: HSBC estimates
Uncertainty over discoms continuing
The revenue gap carried by discoms has been a key
area of concern, with average sale prices not
enough to meet the average cost of supply. This has
led to total losses of about INR1.2trn with major
losses coming from the discoms of the seven key
states Uttar Pradesh, Tamil Nadu, Rajasthan,
Andhra Pradesh, Haryana, Punjab and Madhya
Pradesh. However, in the last two years,
incrementally, the situation has improved after
almost all states raised tariffs in FY13. To tackle
the losses, the central government has finalised a
FRP for these states, whereby short-term debt up to
31 March 2012 will be restructured, with 50% to be
taken up by state governments by issuing bonds
and the balance 50% to be restructured by banks.
However, barring Tamil Nadu and Rajasthan,
other states have yet to sign the FRP. Banks
funding will likely remain low and incremental
PPAs are unlikely to be signed by the states as
they are still not out of woods. In such a scenario,existing generation capacities will operate at sub-
optimal levels, while IPPs will slow the pace of
commissioning new projects, which could lead to
significant restructuring by banks and IFCs over
the next few quarters. Also, many large promoters
like Lanco, GMR and GVK are sitting on
significantly leveraged balance sheets, which
increases the risk of default if the government
does not resolve the issues in time.
Given these issues in the power sector, we expect
new capex will be postponed, which is already
resulting into muted sanctions growth, implying
slowing disbursements growth going forward. All
this suggests that the revival of the sector is some
time away, though we are moving in that direction.
Pro forma impact of risky power sector exposure
(INRbn, FY13) PvtGencos
SEB Total Pvt Genco% of totalexposure
(FB+NFB)
Risky /power
exposure
Total riskyexposure
Write-off/Total
exposure*
Write-off/PAT
(tax adj)
Write-off/BV
REC 166 - 166 13% 40% 5% 0.70% 24% 6%PFC 193 - 193 12% 40% 5% 0.70% 24% 5%
Source: HSBC estimates , *Write-off assumed at 20% of risky exposure
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High interest rate sensitivity
The capex-intensive nature of infrastructure
projects places a substantial debt burden on the
project owners. Interest cost, therefore, is a
significant determinant of the profitability and
viability of a project. The interest cost has
assumed greater significance in the current
environment given power projects are
underutilized, which hurts their profitability. The
decade-low interest coverage and fixed asset
coverage ratios and high debt/equity ratio for
some of the biggest names in infrastructure (GVK
Power, JP Associates and GMR Infrastructure) is
a clear indication of stress. High leverage, coupled
with rising borrowing costs, raises financial risks.
Interest coverage at all-time low for major infra players
0
12
3
4
5
FY07
FY08
FY09
FY10
FY11
FY12
FY13
LANC O INFR A GM R INFRA
G VK POWER & IN FR JP Associate
Source: Bloomberg, HSBC
Embroiled in asset quality worries
Infrastructure projects are most exposed to asset
quality risks owing to multiple issues, including:
delays in project execution, underutilization and
fuel shortages. The key ratios, like debt/equity and
fixed asset coverage, for some of the infrastructure
companies point to acute financial stress.
Debt/equity ratio on the rise
0
2
4
6
8
10
FY07
FY08
FY09
FY10
FY11
FY12
FY13
LANC O INFR A GMR INFRA
GVK POWER & IN FR JP Asso ciate
Source: Bloomberg, HSBC
A significant number of projects is likely to come
up for restructuring in the power sector over the
next few quarters.
Overall, the nature of lending (secured), and
clientele make housing finance the least exposed to
asset quality risks. In the current scenario of vibrant
agri and rural growth, the rural financiers should see
improvement in asset quality and remains our
preferred sector after housing finance. Infrastructure
finance is most exposed and least preferred with a
higher potential for defaults and restructuring.
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Summary of state discoms financial health and our analysis of their ability to call for new bids and initiate a capex programme
State ____ Outstanding loans (INRbn) _____Revenue gap
(INRbn)Revenue gap Case I Capex likely
FY11e FY12e FY13e FY14e exists Bids likely
1 Andhra Pradesh na na na 0 No Yes possible Possible2 Bihar 101 111 122 3.5 Yes No No3 Chhattisgarh 19 35 55 4.6 Yes Not likely4 Delhi 41 46 54 NA NA Not likely5 Gujarat 24 30 33 0 No Not likely Yes6 Haryana 150 184 222 0 No Not likely No7 Jharkhand na na na 0 No Yes possible Yes8 Karnataka 48 53 59 0 No Yes possible Yes9 Kerala 11 17 19 4.1 Yes Not likely Yes10 Madhya Pradesh 111 149 199 0 No Not likely No11 Maharashtra 82 117 157 0 No Yes possible Yes12 Punjab 168 179 200 0 No Not likely No13 Rajasthan 31 54 112 12.8 Yes Not likely No14 Tamil Nadu 241 300 388 NA No Yes possible No15 Uttar Pradesh 243 270 300 0 No Not likely No
Total 1,268 1,543 1,921 25
Source: HSBC
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Having looked at various sectors, we compare stocks
under our coverage based on growth, margins, asset
quality, profitability, and valuations.
Growth HDFC, MMFS andLICHF emerge as winners
Most sectors saw reasonable growth up to FY12.
However, with macro and industrial activity
faltering post FY12, along with the mining ban in
FY12, sectors like CV have slowed significantly.
Accordingly, SHTF has consciously reduced its
growth since FY13. Also, emerging structural
issues in the power sector meant that whiledisbursements were continuing against pending
sanctions, incremental sanctions have reduced.
As a result, IDFC has already seen a significant
slowdown in growth, while PFC and RECs
growth has been cushioned by state sector capex.
Incrementally, we expect disbursements to grow
at a single-digit rate for PFC and REC, which will
slow growth to a mid-teens rate over FY14-16e.
Compared with these stocks, HDFC and LICHFs
growth has remained resilient and should remain
so in the foreseeable future. MMFS is the bestway to play the rural theme, which remains one of
the key growth sectors. Over the past five years,
MMFS has not only grown well, it has done so
with diversification and reduced direct linkage
with agriculture. Going forward, the growth
outlook for MMFS looks fairly buoyant, with the
exception of CV and to some extent cars.
Our stock picks
HDFC, LICHF and MMFS set to see resilient growth; others to see
slower growth due to cyclical and structural issues
We see a limited impact on margins due to rising rates for most
NBFCs; HDFC, LICHF and MMFS best placed on asset quality
Overall HDFC and MMFS score better than others although
MMFS is fully valued; we prefer LICHF; IFCs are trading cheap,
but structural weakness makes them relatively unattractive
Growth
-50%
0%
50%
100%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
HDFC LICHF MMFS SHTF
IDFC PFC REC
Source: Company data, HSBC estimates
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Asset quality HDFC andLICHF key winners
Housing finance has had among the most resilient
asset quality over the years. Factors like first-time
purchases, rising income levels, sentimentality,
and a prudent credit culture in India have helped
financiers keep asset quality healthy and minimize
credit costs. Not surprisingly, both HDFC and
LICHF have had credit costs as low as 15-20bp in
the past few years.
On the other hand, given the rural market is
fragmented with physical cash recovery as a
repayment mechanism, it is a high risk segment.
Though MMFS usually has high credit cost, this
has been built into loan pricing and profitability,
helping it to maintain high profitability even with
high credit cost. Also, MMFS has significantly
improved its gross NPL levels since 2008 from
c.10% levels to 3% as of FY13 by diversifying to
various vehicle categories and reducing direct
linkage to agriculture activities. Going forward,
MMFS is likely to maintain stable asset quality in
FY14, buoyed by good monsoons and as a
possible beneficiary of election spending.
However, SHTF, being the largest player in used
CVs, could see some rise in delinquencies as 20%
of its loans are linked to industrial activity.
Therefore if IIP remains weak, it will eventually
impact cash flows of the truck operators.
On the infrastructure front, IDFC, REC and PFC
have seen very low NPLs and credit costs as most
of the growth in the past five years was due to
disbursements toward new capex in the power
generation sector by the private sector. However,
with issues continuing to plague the sector,
coupled with leverage on promoters balance
sheets, despite positive steps taken by the central
government in the past year, we think there is a
good chance of large-scale restructuring and
eventual write-off of a few assets. Nearly all gas-
based capacity is at a serious risk of being written
off over the next couple of years. See our report
Indian Power and Banks, published 12 July.
PFC and REC have made about 85% of their
loans to state and central sector utilities and may
therefore continue to report low NPLs. However,
their private sector exposure is increasing, which
could be a source of concern.
Gross NPLs
-6%-4%
-2%
0%
2%4%
6%
8%
10%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
HDFC LICHF MM FS SHT F
IDFC PF C REC
Source: Company data, HSBC estimates
Margins HDFC stands out
Margins vary significantly across NBFCs
depending on the segment that each is serving and
the required business model for the same.
However, given the current volatile rate
environment, their margins could be at risk as
they are wholesale funded. Having well-matched
ALM, along with matched repricing of assets and
liabilities and the ability to change asset mix
incrementally, is crucial in managing margins
under the current conditions.
Post RBI monetary action to increase the MSF
rate by 200bp to 10.25% in addition to other
measures on 15 July and 23 July, borrowing rates
have jumped across tenors with the short end
moving up 200-250bp from 8.5% to 11% and the
long end moving up by about 100bp from 9% to
10%. This has inverted the yield curve and
tightened liquidity, which could have a serious
impact on NBFCs margins till the measures are
reversed and liquidity eased.
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We have found that most NBFCs have tried to
manage spreads by:
Maintaining sufficient liquidity on the
balance sheet, which can be used during
tough times like these
Borrowing in surplus in 1Q, when money is
available more cheaply at 8.25-8.5%, which
they have lent in the current quarter
Using their committed cash-credit lines with
banks, which were available at a lower rate
than market
PFC and REC have also raised tax free bonds
Many have increased lending rates by 25-50bp
On 20 September, although the new RBI Governor
reversed 75bp of the 200bp hike on the MSF, he
simultaneously increased the repo rate by 25bp,
making the rate hike more permanent, though in
small amounts. This implies that while short-term
rates will come off from current high levels, they
will remain above the pre-15 July levels. With the
RBI further reducing the MSF rate by 50bp to 9%
now, short-term funding costs will decline further
and ease funding cost pressures for NBFCs.
However, we maintain our estimate for a 0-30bp
margin decline for our NBFC universe as the RBI
has started hiking repo rates.
In this context, HDFC stands out with steady
spreads in the 2.2% to 2.4% range or margins in the
3.4% to 3.6% range. HDFC has a well-matched
ALM book, which when combined with its ability
to incrementally change its asset mix between
wholesale and retail, helps it to maintain steady
spreads. In the current quarter, given the jump in
interest rates, HDFC has been able to maintain
spreads by pre-empting surplus borrowing at lower
cost in 1Q, while steadily building up a retail
deposit base and minimizing reliance on bank loans
(under 10% of liabilities). Also, it is likely to have
increased its exposure to wholesale borrowers,
which is a high yield segment.
LICHF has seen significant margin compression
in the past few quarters, with FY13 spreads
dropping to a low of 1.1% versus the peak of
1.7%. Mismatch in its ALM and around 97%
retail loans in the overall loan book affected its
spreads significantly as rates increasedsignificantly in FY13. However, in the current
fiscal year, LICHF seems to be managing the
spreads well with 1Q spreads improving to 1.2%.
Also, like HDFC, it borrowed in surplus in 1Q
when money was available cheaply, which it is
now using to disburse incremental loans. Also, it
recently introduced new products at higher rates,
which can partially offset higher funding costs.
So, while it is likely to make spreads of 1.2-1.3%
in 1H, spreads can shrink to 0.9% in 2H asincremental new borrowing cost is likely to be
about 10%, while incremental lending yield is at
10.9%. Overall for FY14, spreads should remain
stable at 1.1% at best. Accordingly, while spreads
are close to the lowest levels, earnings could
remain weak till the spreads improve.
MMFS has been able to reduce the impact to a
large extent by using cash-credit lines and raising
lending rates for new borrowers. However, with
almost 100% of assets at fixed rates vs. 50% fixed
rate liabilities, a sudden rise in funding cost will
Yield curve pre and post 15 July 2013
6%
7%
8%
9%
10%
11%
ON
rates
1M
CD
3M
CD
6M
CD
12M
CD
AAA1Year
AAA
3Year
AAA
5Year
15-Jul 15-Sep 30-Sep
Source: Bloomberg, HSBC
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take time to pass on to borrowers. As a result,
MMFS is expecting a 20-30bp margin contraction
for FY14 over FY13, without much impact on
growth. However, 30bp in the context of a 10%
average margin is not much.
SHTFs margins have declined from a peak of 9%
in FY11, when it resorted to aggressive
securitization, which boosted margins to 7.8% in
FY13, when securitization levels fell along with
the loan book shifting to the 1-4 year-old used-vehicle category, where yields are lower.
According to SHTFs management, the last two
months have not had much impact on margins as
it maintains sufficient liquidity. SHTF has always
been a high cost borrower in the market and
securitized INR10bn in 2Q. The company is
replacing the 1-4 year-old vehicle segment with
older high yielding vehicle segments, which will
help to maintain margins.
The impact of rate volatility on margins is also
likely to be minimal for PFC and REC this
quarter, as they too have utilized their cash-credit
limits and raised tax-free bonds to fund growth
and reduce dependence on NCD and bank term
loans. Both PFC and REC have also raised their
incremental lending rates by 50bp to minimize the
impact of higher funding cost.
By contrast, IDFC has resorted to tapping the
market at higher cost and become extremelycautious on expanding the loan book. Refinancing
opportunities have also shrunk, as PSU banks like
SBI have been aggressive in refinancing this year.
Accordingly, IDFC will see only a limited margin
impact in the current quarter.
Going forward, with the RBI hiking repo rates, we
believe most of the NBFCs will start hiking prime
lending rates as they head into the busy 2HFY14.
Overall, HDFC, MMFS, SHTF, PFC, and REC
should be able to minimize margin loss, without
sacrificing much growth. However, IDFC could
see margin stress, while LICHFs margins will
remain low at an estimated 1.1% for the current
fiscal year.
Net interest margins
0%
5%
10%
15%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
HDFC LICHF MMFS SHTF
IDFC PFC REC
Source: Company data, HSBC estimates
Liability mix (FY13)
0%
20%
40%
60%
80%
100%
HDFC
LICHF
MMFS
SHTF
IDFC
PFC
REC
Loans from Banks Other Institutional loansDepos its DebenturesCP BondsOthers
Source: : Company data, HSBC
Borrowings split (FY13)
HDFC LICHF MMFS SHTF IDFC PFC REC
Loans fromBanks
10% 30% 51% 38% 25% 16% 3%
OtherInstitutionalloans
1% 4% 0% 0% 0% 2% 3%
Deposits 33% 1% 11% 4% 0% 0% 0%Debentures 50% 61% 22% 45% 72% 0% 0%CP 6% 0% 0% 0% 2% 0% 1%Bonds 0% 4% 3% 12% 1% 76% 78%Others 0% 0% 12% 1% 1% 6% 15%
Source: Company data, HSBC
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Not just about profitabilityMost NBFCs deliver healthy returns, with ROA
ranging between 2.5% and 4% and ROA ranging
between 14% and 22%.
We believe that along with profitability, the
stocks should be assessed based on their credit
risk management, reporting transparency,
earnings visibility and earnings stability.
HDFC and MMFS stand out for their steady
growth in loans and earnings, healthy
profitability, high reporting transparency,
prudent credit risk management and good
earnings visibility.
LICHF comes next with healthy loan growth,
and prudent risk management. But with
margins declining significantly over the past
two years, profitability has dipped significantly,
though ROA is reasonable at 17-18%. A lack of
transparent reporting of its balance sheet has
considerably reduced earnings visibility in the
current volatile rate environment.
SHTF follows, with healthy profitability,
reporting transparency, good earnings
visibility and prudent risk management, but
has seen loans and earnings growth decline
over the past two years due to a CV demand
cycle slowdown. Profitability has declined
and is likely to continue to decline modestly,going forward.
Our least preferred IFCs are PFC, REC and
IDFC, as issues in the power sector continue
to plague earnings visibility. While IDFC has
seen steady profitability, high reporting
transparency and reasonably prudent risk
management, loan growth has been faltering
and asset quality risks increasing, implying
that profitability is likely to decline over
FY14-15. Given its low equity leverage, ROA
is likely to decline to about 12-13% over
FY14-15e, which would be the lowest among
all covered NBFCs. PFC and REC have
shown steady loan and earnings growth, but
asset quality risks on their private sector
exposure is increasing. Also, they have been
the least prudent in credit risk management,
historically. Therefore, transparency in their
practices remains low, leading to much lower
comfort in and confidence on their reported
earnings and book value.
ROA
1%
2%
3%
4%
5%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
HDFC LICHF MMFS SHT F
IDFC PFC REC
Source: Company data, HSBC estimates
ROE
10%
15%
20%
25%
30%
35%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
HDFC LICHF MMFS SHT F
IDFC PFC REC
Source: Company data, HSBC estimates
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ROA DuPont analysis as % of total assets
___ HDFC ___ __ LICHF ____ ___ MMFS ___ __ SHTF ____ ___ IDFC ____ ___ PFC ____ ___ REC ____FY13 FY14e FY13 FY14e FY13 FY14e FY13 FY14e FY13 FY14e FY13 FY14e FY13 FY14e
NII 3.40 3.44 2.10 2.10 10.16 9.90 8.58 8.17 3.88 3.73 4.15 3.69 4.47 4.18Fee income 0.13 0.13 0.16 0.13 - - - - 0.65 0.49 0.12 0.11 0.11 0.11Other income 0.46 0.42 0.11 0.10 0.17 0.15 0.57 0.45 0.73 0.81 0.13 0.11 0.15 0.14Optg revenue 3.99 3.99 2.37 2.32 10.33 10.05 9.15 8.62 5.26 5.03 4.40 3.92 4.73 4.43Opex 0.30 0.29 0.39 0.37 3.37 3.18 2.05 2.02 0.80 0.75 0.34 0.31 0.31 0.27Operating profit 3.69 3.70 1.99 1.94 6.96 6.87 7.10 6.61 4.46 4.28 4.06 3.60 4.42 4.16Total Provision 0.08 0.05 0.11 0.15 1.29 1.38 2.10 2.17 0.53 0.76 0.05 0.13 0.11 0.22PBT 3.61 3.65 1.88 1.80 5.81 5.49 5.00 4.43 3.93 3.52 4.02 3.48 4.25 3.88Tax 0.95 0.97 0.48 0.46 1.80 1.81 1.63 1.44 1.14 0.99 1.01 0.98 1.11 1.05PAT 2.66 2.69 1.40 1.34 4.01 3.68 3.38 2.99 2.79 2.53 3.00 2.50 3.14 2.83
Source: Company data, HSBC estimates
Ranking
HDFC LICHF MMFS SHTF IDFC PFC REC
RoA 3 7 1 2 5 5 3ROA 1 6 1 4 7 4 1Prudence 1 4 1 3 5 7 6Transparency 2 5 1 4 3 6 7Earnings' visibility 1 4 2 3 5 6 7Earnings' stability 1 4 2 3 5 6 7Management quality 1 5 2 3 4 6 7Points 10 35 10 22 34 40 38Overall rank 1 4 2 3 5 7 6
Source: HSBC estimates
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Company write-ups
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Robust growth set to continue
As one of the largest home financiers in India,
HDFC continues to benefit from the steady,
secular growth in home sales that we have beenseeing for years through economic cycles. The
trend continues even now with property buying
decisions still mainly driven by home prices and
income stability. While first tier cities have done
well, the pace of growth in second tier and third
tier cities has improved, which will continue to
support steady growth for HDFC. We expect it to
deliver 18-20% loan growth over FY14-15.
Superior liability structure andcost transmission to aid NIM
HDFC has a well-matched ALM book. That, along
with its ability to change its asset mix between
wholesale and retail, helps it to maintain steady
spreads. In the current quarter, given the jump in
interest rates, HDFC has been able to maintain
spreads by pre-empting surplus borrowings at lower
cost in 1Q, while steadily building up its retail
deposit base and minimizing its reliance on bank
loans (under 10% of liabilities). Also, it is likely tohave increased its exposure to the high yielding
wholesale borrowers segment. Among the NBFCs,
HDFC has the best liability structure with c.33% of
borrowings in the form of deposits, which is stable
funding. With c.30% of its liabilities likely to
reprice upward in the current fiscal year, HDFC
recently increased its prime lending rate by 25bp to
protect its margin.
Stable asset quality willcontinue to aid returns
HDFCs gross NPL ratio has been less than 1%
for the last 18 quarters and has shown a steady,
continuous improvement currently at 0.77%.
With credit cost remaining low at 15-20bp, we
expect it to continue to deliver ROA of 2.7-2.8%
and ROA of 22-24% over FY14-15.
Retain OW
HDFC trades at a 4.1x PB and 19.3x PE 12-month
forward. Ex-subsidiary value, it is trading at an
11.3x PE and 2.4x PB. We maintain our target
multiples of 24x PE and 4.5x PB. But after rolling
forward earnings (September 2015 base), we arrive
at a new target price of INR1,029 (INR1,007).
Under our research model, for stocks without a
volatility indicator, the Neutral band is 5ppts above
and below the hurdle rate of 11% for Indian stocks.
HDFC (HDFC IN)
Best play in the NBFC space on all measures and biggest
beneficiary of resilient housing growth with credible management
Margins least vulnerable to volatile rate environment; prudent risk
management helps maintain healthy profitability
Reiterate OW with a revised target price of INR1,029 (previously
INR1,007); our preferred stock in the NBFC space
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Our target price of INR1,029 implies a potential
return, including dividend yield, of 30%, which is
above the Neutral band; therefore, we are
reiterating our OW rating. Potential return equals
the percentage difference between the current share
price and the target price, including the forecast
dividend yield. HDFC remains our preferred pick
in the NBFC space.
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Year to 3/2013a 3/2014e 3/2015e 3/2016e
P&L summary(INR m)
Net Interest Income 61,829 73,686 88,899 105,906Non-interest Income 10,739 11,768 13,107 14,661
Processing fees & other income 2,413 2,848 3,360 3,965Income from investment 7,962 8,539 9,346 10,275Misc income 363 381 400 420
Total Operating income 72,567 85,454 102,006 120,567Operating expense 5,389 6,196 6,893 8,038
Staff costs 2,462 2,856 3,313 3,843Other oper expense 2,927 3,340 3,580 4,195
PPOP 67,178 79,258 95,113 112,529Provisions 1,450 1,015 1,137 1,273HSBC PBT 65,728 78,243 93,976 111,256Exceptionals - - - -Profit-before tax 65,728 78,243 93,976 111,256Taxation 17,245 20,705 24,869 29,441PAT 48,483 57,538 69,108 81,815
Minorities + pref dividend - - - -Attributable profit 48,483 57,538 69,108 81,815HSBC attributable profit 48,483 57,538 69,108 81,815Balance sheet summary (INRm)
Total assets 1,960,061 2,325,547 2,764,421 3,290,099Customer loans (net) 1,700,462 2,039,328 2,447,151 2,936,937Investment assets 136,135 143,363 151,253 159,876Other_assets 123,465 142,855 166,017 193,286
Total Liabilities 1,710,061 2,043,338 2,443,861 2,923,910Customer deposits 519,328 643,967 775,980 935,056Debt securities issued 1,068,953 1,260,274 1,509,203 1,808,916Other liabilities 121,780 139,097 158,678 179,937
Total capital 250,000 282,209 320,560 366,190Ordinary equity 250,000 282,209 320,560 366,190Minorities + other capital
IEA (avg) 1,808,431 2,132,206 2,535,952 3,017,901
IBL (avg) 1,489,778 1,746,261 2,094,712 2,514,578Capital adequacy (%)
RWA (INRm) 1,534,347 1,425,431 1,684,669 1,994,155Core t ier 1 13.9% 17.2% 16.8% 16.5%Total t ier 1 13.9% 17.2% 16.8% 16.5%Total capital 16.4% 20.0% 19.3% 18.7%
ROAA deconstruction
Net interest income 3.40 3.44 3.49 3.50Total interest income 11.03 10.94 10.76 10.83Total interest expense 7.63 7.50 7.26 7.33
Income from investment 0.44 0.40 0.37 0.34Other income 0.15 0.15 0.15 0.14Operat ing income 3.99 3.99 4.01 3.98Operat ing expenses 0.30 0.29 0.27 0.27
Staff costs 0.14 0.13 0.13 0.13Other oper exp 0.16 0.16 0.14 0.14
PPOP 3.69 3.70 3.74 3.72Provisions 0.08 0.05 0.04 0.04Non-op items - - - -PBT 3.61 3.65 3.69 3.68Taxation 0.95 0.97 0.98 0.97PAT 2.66 2.69 2.72 2.70
Year to 3/2013a 3/2014e 3/2015e 3/2016e
Growth (YoY %)
Net interest income 18.4 19.2 20.6 19.1Non-interest income 10.1 9.6 11.4 11.9Operating expense 19.3 15.0 11.2 16.6PPOP 16.9 18.0 20.0 18.3Provisions 81.3 (30.0) 12.0 12.0PBT 16.0 19.0 20.1 18.4PAT 17.6 18.7 20.1 18.4
Customer loans (net) 20.7 19.9 20.0 20.0Total Assets 16.7 18.6 18.9 19.0RWA 18.4 (7.1) 18.2 18.4Customer deposits 43.1 24.0 20.5 20.5
Ratios (%)
NIM 3.42 3.46 3.51 3.51Gross yield 11.10 10.99 10.80 10.86
Cost of funds 9.32 9.20 8.83 8.82Spread 1.78 1.79 1.97 2.04
NPL/gross loans 0.7 0.7 0.8 0.8Credit cost 0.09 0.05 0.05 0.05Coverage 106.3 133.3 129.0 129.7NPL/RWA 0.8 1.1 1.1 1.1Provision/RWA 0.1 0.1 0.1 0.1Net write-off/RWA - - - -NPL/NTE 4.8 5.4 5.9 6.2Net loans/total assets 86.8 87.7 88.5 89.3RWA/total assets 78.3 61.3 60.9 60.6
Avg IEA/avg total assets 99.4 99.5 99.6 99.7Avg IBL/avg total liab 81.9 81.5 82.3 83.1
Cost/income 7.4 7.3 6.8 6.7
Non-int income/total income 14.8 13.8 12.8 12.2ROAA (including goodwill) 2.66 2.69 2.72 2.70ROAE (including goodwill) 22.0 21.6 22.9 23.8Return on avg tier 1 26.7 25.2 26.2 24.9Leverage (x) 8.3 8.1 8.4 8.8
Valuation data
PE (diluted EPS) 25.6 21.6 18.0 15.2P/PPOP 18.5 15.7 13.0 11.0P/BVPS 5.0 4.4 3.9 3.4P/NTE 5.0 4.4 3.9 3.4Dividend yield (x) 1.6 1.7 2.1 2.5P/Asset 0.6 0.5 0.4 0.4
Price relative
543
593
643
693
743
793
843
893
943
993
2011 2012 2013 2014
543
593
643
693
743
793
843
893
943
993
HDFC Rel to BOMBAY SE SENSITIVE INDEX
Source: HSBC
Note: price at close of 3 October 2013
Financials & valuation HDFC
Per share data (INR)
EPS reported (fully diluted) 31.4 37.2 44.7 52.9HSBC EPS (fully diluted) 31.4 37.2 44.7 52.9DPS 12.5 14.0 17.0 20.0NAV 161.7 182.5 207.3 236.8NAV (including goodwill) 161.7 182.5 207.3 236.8
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HDFC chartsLoan growth Disbursement growth
10%
15%
20%
25%
30%
35%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
Loan Grow th (YOY%)
0.00%
10.00%
20.00%
30.00%
40.00%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
Disbursemen t Growth
Source: Company data, HSBC estimates Source: Company data, HSBC estimates
Margin Gross NPL
2.8%
3.0%
3.2%
3.4%
3.6%
3.8%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
Margin
0.60%
0.65%
0.70%
0.75%
0.80%
0.85%
0.90%
0.95%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
GNPL
Source: Company data, HSBC estimates Source: Company data, HSBC estimates
ROA/ROA Rolling PE PB 12-mth fwd
2.2%
2.4%
2.6%
2.8%
3.0%
3.2%
3.4%
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14e
FY15e
FY16e
15%
20%
25%
30%
35%
HDFC ROA HDFC R OE (RHS)
0x
10x
20x
30x
40x
Sep-
92
Sep-9
5
Sep-9
8
Sep-0
1
Sep-
04
Sep-0
7
Sep-1
0
Sep-1
3
0x
2x
4x
6x
8x
Rolling P/E Average 5 year
Rolling P/B (RHS) Av g 5 y r PB (RHS)
Source: Company data, HSBC estimates Source: Company data, HSBC estimates
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Steady loan growth to continue
Housing finance remains fairly buoyant, despite
economic growth faltering and interest rates rising,
as property buying decisions are more dependent
on prevailing property prices and job creation than
on interest rates. Also, while Mumbai and the NCR
have seen slower growth, first and second-tier cities
continue to grow at a steady pace. Demand from
the government sector as well as service sector
continues to support healthy demand. Accordingly,
we maintain our loan growth estimate of 20-22%
for LICHF over FY14-15. The developer segment
should remain muted.
Spreads at the bottom, but
difficult to improve
At 1.1%, LICHFs spreads are near the bottom
given that its average funding cost is c.9.75%
against an average lending yield of 10.9%. LICHF
also borrowed in surplus in 1Q at c.8.5%. In the
current quarter, given the sharp rise in funding
costs, LICHF has avoided borrowing at higher
rates, by using the surplus funds as well as raising
10-year money at 9.5-10%. Going forward, while
near-term rates will come off slightly post reversal
of RBI measures, they will remain high enough
that will not allow LICHF to improve its spreads
much from current levels.
Profitability at the lowest point,but likely to continue
With steady loan growth and robust asset quality,spreads are the single most important driver of
LICHFs ROA. Therefore, with spreads not likely
to improve much above 1.1%, ROA is likely to
taper off at 1.3-1.4% levels, one of the lowest
among NBFCs and leading to ROA of 17-18%.
Retain OW
As returns are unlikely to improve in the near
term, the current trading multiples of 1.2x PB and
7.6x PE are probably pricing in the worst-caseearnings scenario. This makes us constructive at
the current price. We maintain our target
multiples of 1.4x PB and 8.2x PE. With an
extended period of low spreads we cut our EPM
value to INR208 (previously INR251). This
combined with a roll-forward of earnings
(September 2015 base) arrives at our new target
price of INR236 (INR243). Under our research
model, for stocks without a volatility indicator,
the Neutral band is 5ppts above and below the
hurdle rate of 11% for Indian stocks. Our target
price of INR236 implies a potential return,
LICHF (LICHF IN)
Expect loan growth to remain stable at 20-22%
Spreads and ROA have bottomed out at 1.1% and 1.3%,
respectively; improvements likely from next year onward
Reiterate OW with a revised target price of INR236 (previously
INR243); current price factors in worst-case margin scenario
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including d