NBFCs may see slow recovery, be cautious on its stocks

The world of the NBFCs seems to have been impacted by the crisis that the revelation of the IL& FS fraud seems to have unleashed. Suddenly, everyone wants to know about the quality of debt papers held by the mutual funds. So far, it was a blind trust on the rating symbols. The mutual fund managers have demonstrated that the rating symbols are not infallible.

However, the IL& FS fraud has set off a chain of events that has led to slower growth for the NBFCs as they focus on quality of credit as well as grapple with the shyness of the lenders. In a way, the NBFCs were growing at a pace that was scorching and this looks like a pause.

The NBFC growth was also fueled by the public sector banks lying in Intensive Care.

The NBFCs have an edge over the banks. Their lending can be quicker, and they are not subjected to interest rate caps. They also reach out to a customer instead of the customer reaching out to the lender ( as it happens in most bank loans at the lower end). They also lend to a large section of the ‘ un- bankable’ section of society. The credit from NBFC is an important source of money that creates demand in the economy.

There is also a ‘ liquidity’ scare that is putting on the brakes. Many lesser known names will not be able to raise money and even those who raise will end up paying higher interest costs. Thus, NBFC stock prices are under pressure.

Now, if we think that it is a good time to add to these stocks as prices are falling, we should pause. Do not let the mind anchor to recent ‘ high’ prices. Instead look at what valuations one would be buying them at. Very few will be very attractive. And the attraction could be due to reasons that are different. Look carefully.

It is not a bad time to focus on this sector and build a portfolio. However, I would urge a SIP approach rather than a one shot investment approach in this segment. It is going to take a long time before these companies can accelerate earnings. In fact the next one or two quarters could see a setback to the rate of earnings growth, which could give negative surprises as the results tumble out. A six to nine month window would be available, I think, for entry in to this sector.

While picking NBFCs, look at Return on Equity ( ROE). Their business is ‘ leverage’. Normally, higher the leverage, the better is the ROE. As liquidity drives growth to a slower pace, the leverage will come down, as would the ROE. There would also be the impact of higher borrowing costs. I am also factoring in an assumption that the frontline NBFCs are not hiding any NPA problems.

NBFCs with higher proportion of capital market related lending will surely see shrinkage in their loan books as “Loan Against Shares”, and “IPO Funding” start to slow down. So also, companies with exposure to builders could see some problems. I would be cautious in those companies that have high dependence on capital markets and property segments.

One related question that I would like to address is whether the worst is over for the PSU banks? While all the dead bodies seem to have come out, the root cause of poor lending has not been addressed. The credit delivery systems hold the key.

If the same system is going to continue, then it is hopeless. And there is the ‘ merger’ event risk still hanging. Like Bank of Baroda was forced to bite into few rotten apples, more banks will be forced in to weakening alliances. The healing process in the PSU banks is a long journey, and I would not look at this sector for a very long time. The political control is another problem. These banks will continue to be used as tools for political reasons which will ultimately weaken the health of the banks. So long as the ownership is unchanged, it is best to keep away from these banks for investment.

When it comes to choosing NBFC stocks for investment, stick to well known names, with long history and good promoter reputation. Do not jump in to stocks of younger names. Not that I have anything against them, but simply because they will find it harder to raise money than the larger and well known ones.

The writer is a veteran investment advisor. He can be contacted at balakrishnanr@ gmail. com