Profiting from recovery: Non-banking finance companies

The NBFC sector has been one of the worst-hit sectors due to COVID-19. As the pandemic threat recedes, we assess the prospects of this sector and also discuss a promising stock.

Profiting from recovery: Non-banking finance companies


The pre-pandemic situation
Working as an alternative to banks, non-bank financial companies (NBFCs) facilitate lending across various segments, including consumer durables, vehicle financing and so on. Over the years, these institutions became so successful that their contribution to the country's GDP increased consistently - from 8.6 per cent in 2013 to 12.2 per cent in 2019 (as per the Reserve Bank of India's report on trend and progress of banking in India 2019-20). During 2014-19, the sector witnessed a healthy growth rate of 18.14 per cent CAGR. However, following the IL&FS crisis, the sector started facing headwinds such as an erosion of confidence, rating downgrades and an economic slowdown, which resulted in a weak demand scenario.

During the pandemic
The pandemic-induced lockdown had diverging effects on different players. Since people from the lower strata of the society suffered more economic loss, microfinance companies were immediately impacted. The situation turned worse when the government announced a one-sided moratorium on repayments, as companies had to continue paying money to their creditors, while their borrowers did not have to repay. Even though the government announced a host of stimulus packages and regulatory schemes to assuage the industry's concerns, smaller players still found it difficult to access credit due to adverse risk perception.

The present situation
Since the second wave of COVID led to localised restrictions, it left different effects on different sub- segments. While large housing- finance companies and gold-loan companies are now clearly in a better position, owing to the secured nature of their assets, other players, such as those offering vehicle finance, consumer-durable loans and personal loans, are facing significant stress. But the sector's long-term growth story remains intact. Although the first three months of FY21 have been washed out, the sector is still expected to grow in this fiscal. India is still underpenetrated in terms of access to credit (Household debt to GDP is at 11 per cent as compared to 54 per cent in China and 34 per cent in South Africa - as per a FICCI EY report on Non-Banking Finance Sector in India) and scheduled commercial banks are not expected to fulfil the needs of all sections of the society. Increased urbanisation, favourable demographics and consumption growth are some long- term tailwinds.

Shriram Transport Finance Company (STFC) is an experienced player in the vehicle-financing space. In the last four decades, the company has developed a niche in the used commercial-vehicle segment and emerged as a dominant player in the industry, with a 16 per cent share in the CV-financing market. The company has 2.1 million customers, a large network of 1817 branches and more than 24,000 employees. Out of its AUM of Rs 1,17,230 crore, almost 90 per cent is for financing used vehicles, while business loans (1.7 per cent), working-capital loans (2.3 per cent) and new vehicle loans (6.7 per cent) constitute the remaining loan book.

The competitive edge
The freight transportation industry has been struggling because of several reasons. While the post-GST regime led to a decline in the demand for CVs (since existing vehicles got more efficient owing to lower idle time at each state's borders), the current pandemic resulted in restrictions on movement to contain the spread of the virus. But now with these restrictions being slowly lifted, the company is all set to gain benefits because of two reasons. One, it is a leader in a space that still has a high potential, as almost 60 per cent of CV-finance needs are currently being met by private financiers and money lenders who charge exorbitant interest rates. With the economy bouncing back, the need for freight capacity is expected to increase. Second, several tailwinds, including regulatory changes in the form of stricter emission standards that ban older trucks (leading to an increase in the replacement demand) and growing rural penetration by cargo LCV's are likely to benefit the company. It also managed to raise Rs 1,492 crore in a rights issue in August 2020 and is currently well capitalised with a 22.5 per cent capital-adequacy ratio.

Financials & valuations
In FY21, the company's AUM increased by around 7 per cent. But its net interest margin reduced by 46 basis points to 6.7 per cent from 7.16 per cent. This resulted in a largely flat net interest income and consequently the bottom line. The company's interest-coverage ratio was at 1.9 times and had a RoE of 12.57 per cent. It is trading at a P/E of 15.28 (as of 30 August 2021) which is almost in line with its five-year median P/E of 14.73. But from a P/B point of view, it is attractively valued at 1.49 times - at a discount to its five-year median P/B of 1.74. Although its near-term outlook is expected to be volatile, the normalisation of AUM growth, asset quality and NIMs will make the company more valuable to investors.


Sensex vs sector stocks portfolio
In the analysis above, we have given a three-year chart of the portfolio comprising the top stocks in the sector vis-à-vis the Sensex. This chart will help you assess the movement in the sector as compared to the market. The stocks considered for this chart are the ones given in the table of key stocks. It was assumed that one invested an equal amount in each stock three years ago. If a company was not listed three years ago, it was incorporated in the portfolio from its listing and the appropriate adjustment was made.

Key sector stocks
This table mentions the top stocks in the sector, along with their key financial stability numbers. Given that most companies in the sectors discussed have witnessed a significant drop in their profits, profitability-related metrics may not be very useful. One must assess their balance-sheet and cash-flow strength. Following are the key columns in this table:

AUM: Assets under management of the NBFC. The larger the assets, the better the cushion.

Cash: Cash available with the NBFC. A large amount helps combat tough times.

Capital-adequacy ratio: Indicates the extent of a company's ability to pay liabilities and manage credit risk. The higher, the better.

Gross NPA: Non-performing assets or bad loans as a per cent of total assets. The lower, the better.

Net NPA: Non-performing assets after provisioning as a per cent of assets. The lower, the better.

Also in this series:

Profiting from recovery: Aviation

Profiting from recovery: Hospitality

Profiting from recovery: Media

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