Should you buy or sell NBFCs now?

If you have an active trading account or have consumer loans or are thinking of taking out a loan, consider investing in NBFCs, says Devangshu Datta

Illustration: Uttam Ghosh/Rediff.com.

The past three years have seen a significant change in Indian household savings and spending patterns.

Households are allocating a larger share of savings to financial assets as opposed to real estate and gold. Households are also borrowing a lot more.

Data culled from the National Sample Survey Office, the Reserve Bank of India's annual reports, Association of Mutual Funds in India, etc, make this clear. There's been a huge jump in household holdings in mutual funds (MFs) -- around Rs 2.8 lakh crore has gone into these in the past year or so.

There's been a large increase in fixed deposit holdings, of about Rs 4 lakh crore, in the past three years. There's also been a large increase in debenture exposures.

At the same time, exposure to real estate has decreased as a share of total assets, though up in absolute terms. Part of the reason has been a fall in prices.

Households have also borrowed more over the period. This has been driven by real estate exposure to some extent.

Mortgages are still a very large component of household finances and households have not stopped investing in real estate by any means. But, the increase in household debt has also been driven by higher usage of credit cards, education loans, loans to buy personal transport, electronics, to go on holiday, etc.

This change in attitude has meant that the retail portfolios of banks and non-banking financial companies (NBFCs) have become very important.

While banks have a large and public problem with large corporate non-performing assets (NPAs), the NBFCs, which specialise in retail operations, don't have this problem.

This is one of the few sectors where current valuations seem to make a degree of sense. Growth in terms of both revenue and profits has been reasonable over the past few years.

Valuations are high but arguably justifiable because the growth has nearly matched the valuations.

To take a few examples, Bajaj Finance is a market leader with a price-to-earning (PE) of nearly 50. The price has risen about 70 per cent in the past 12 months.

Last year saw revenue growth at 35 per cent, and it's been a 36 per cent compounded annual growth rate (CAGR) for three years.

Earnings per share (EPS) has grown at 35 per cent CAGR for three years and at 38 per cent in the past four quarters.

It wouldn't appeal to a value investor, since the PE to EPS growth ratio is over one. But, the PEG (PE to growth) ratio is much closer to reasonable than with most hot stocks.

Motilal Oswal, Edelweiss and L&T Finance have similar metrics to Bajaj Finance. That is, the respective PEs are high but growth is also good.

Edelweiss and Motilal have actually seen EPS growth at 40 per cent and 72 per cent, respectively, in the past year, while their PEs are at 34 and 48, respectively.

That is within the acceptable zone even for a value investor, with the PEG ratios below one in both these cases.

Incidentally, while Bajaj Finance does a lot of consumer durable financing and also home loans, Edelweiss and Motilal Oswal have a much larger profile in retail trading and wealth management. So, these have been direct beneficiaries of the movement into financial assets, while Bajaj Finance has been a beneficiary of the greater household loan exposure.

Should an investor look at these stocks?

There are positive factors. Interest rates are not supposed to ride up, which means net interest margins should remain good.

This sector has other reputed players like L&T Finance, Sundaram Finance, etc, which also seem to offer reasonable value.

There are some concerns.

One is that retail consumption might collapse if the current low growth conditions continue and unemployment or under-employment increases.

The drive into equity and MFs is also associated with the strong returns from the stock market in the past year. If there's a big correction, a lot of that money will pull out and some will, of course, be lost.

There is an unscientific way to make up your mind.

If you have an active trading account or have consumer loans or thinking of taking out a loan, consider investing in NBFCs as well.

If you're uncomfortable about retail loan exposures or reducing personal equity exposure, avoid the sector.