Fortunes seem to be favouring non-bank finance companies (NBFCs) as analysts are finally turning positive, even though cautiously, on the sector. Since the fateful 2018 collapse of IL&FS, and the subsequent insolvency of DHFL, the fall in the sector was unprecendented.
The sentiment resonates in the stock prices of the counters which plummeted up to 99 per cent between September 2018 and March 2020. In comparison, the S&P BSE Sensex tanked 24 per cent during the period, ACE Equity data show.
However, so far in the calendar year 2020, the stock prices have risen up to 153 per cent till September 2, 2020, as against around 5 per cent fall in the benchmark Sensex index, data show. (see table below)
So, what has exactly changed for the sector?
Liquidity. The crisis that crippled the sector seems to be behind the sector, says Subramanian Iyer, equity analyst at Morgan Stanley, in a co-authored report with Sumeet Kariwala, Himanshu Khona, and Rahul Gupta.
The recent steps by the government and the Reserve Bank of India (RBI) to keep systemic liquidity and rates benign and also direct liquidity to NBFCs facing constraints, in the wake of Covid-19 pandemic, have helped, they say.
“Liquidity levels on balance sheets are good, collections are picking up, there are no loan growth plans for FY21 for most and leverage has come off with asset run down / sales and equity issuances,” they said in a September 1 report.
Analysts at JM Financial, too, opine that liability profile for NBFCs has improved significantly since IL&FS. Improved asset-liability mismatch (ALM) profiles with on-Balance Sheet liquidity at 10 per cent of total assets – 400 bps higher than pre-Sep’18 levels; reduced dependence on short-term commercial papers (CPs) – share down to less than 10 per cent now compared with 20 per cent during pre-IL&FS; and more diversified/stable sources of funds – the share of banks is at 36 per cent as against 26 per cent during pre-IL&FS phase while of sticky deposits is at 17 per cent, down from 13 per cent.
“All this, coupled with a significant decline in credit spreads bodes well for the sector – 1-yr AAA/AA credit spreads for NBFCs are down 250/190bps and 3-yr AAA/AA credit spreads are down 185/150bps in the last three months post SPV announcement in May’20,” they said in a report dated August 20.
That apart, good loss absorption capacity on extremely stressed assumptions, supported further by capital raises, should mitigate tail risks by improving confidence of fixed income markets, Morgan Stanley report says.
In the past year, NBFCs raised a cumulative equity of Rs 38,000 crore, thereby significantly reducing leverage and leading to strong capitalisation levels with T1s of 15-20 per cent for NBFCs under the ambit of JM Financial.
“We believe, going ahead, the sector’s liabilities side will be complemented by absolute fall in BS funding costs in tandem with lower credit spreads, relief to margins as negative carry reduces due to normalisation of cash/liquid holdings on BS, and asset side support in the form of up to 170 bps of Covid-19 provisions,” they say.
Stock rally
Morgan Stanley believes that the recent rally in NBFC stocks was driven by pick-up in economic activity, improvement in collections / decline in moratorium levels, improved liquidity conditions for NBFCs / HFCs, equity raises, better balance sheet management, and depressed valuations.
The brokerage, therefore, remains constructive and has raised price targets by 6-32 per cent further driven by a combination of higher EPS forecasts and rolling forward our price target period to September 2021 from March 2021 previously.
“While stocks have run up from lows, valuations are still below pre-Covid trough valuations . We see 55-100 per cent upside if stocks move up to pre-Covid 2020 highs and 100-290 per cent if they were to move to trailing 5-year mean levels over time as business conditions improve,” they said.
Investment ideas
Morgan Stanley, while picking stocks, remains “selective” as even though stock prices have bounced from very depressed valuations, they need to be “contextualised”, they say.
Morgan Stanley is ‘Overweight’ on M&M Financial Services and has raised target price on the stock from Rs 170 to Rs 180. Besides, it has upped target price on Shriram City Union Finance and PNB Housing Finance to Rs 1,165 (from Rs 885) and Rs 365 (from Rs 290), respectively.
On the other hand, it is ‘Underweight’ on Indiabulls Housing Finance, IndoStar, LIC Housing Finance and IDFC First Bank.
Those at JM Financial pick Bajaj Finance, HDFC and M&M Financial Services as they believe large retail finance NBFCs with strong promoter backing and well-managed ALM should do well.
Emkay Global Financial Services remains positive on HDFC for its high-quality secured mortgage book, capital position and valuations, and on Cholamandalam Investment and Finance Company and Shriram Transport Finance for their strong capital base, high provision buffers and expected early recovery in the vehicle finance segment make.
