Investors should use rallies to exit weaker NBFC stocks, say experts

Bajaj Finance, HDFC most preferred; analysts favour shift to high-quality banks

Stocks of non-banking finance companies (NBFCs), among the biggest losers in the recent carnage, undoubtedly benefitted from Wednesday’s market rally,  as they gained up to  16 per cent. The good spell did lift these well above their 52-week lows.

Yet, experts urge investors to use such rallies to exit from the weaker names. “As liquidity crunch is here to stay, at least in the medium term, earnings are likely to be weak for the sector. Investors should use relief rallies such as Wednesday’s to exit from the weaker NBFC stocks,” says Pankaj Pandey, head of research at ICICI Securities.

This comes even after Tuesday’s assurance by the country's largest lender, State Bank of India (SBI), that it planned to buy loans worth Rs 450 billion from NBFCs, as compared to Rs 150 billion last year.

The cautiousness has reason. Experts say the impact of tight liquidity on profitability and fear of a likely asset-liability management (ALM) mismatch would weigh on many of these stocks. Rising interest costs over the past few months was already seen to impact the margins of NBFCs, while pressure on asset quality was also inching up.

Illustration: Binay Sinha

Among those which could witness weak investor sentiment are Cholamandalam Investments, Dewan Housing Finance, Gruh Finance, Indiabulls Housing and Repco Home Finance, say analysts.

The recent developments have in fact pushed brokerages to slash their earnings expectations for the segment by seven to 15 per cent for FY20. “We expect the markets to be more conservative in lending to NBFCs, which is likely to push up pricing (interest costs),” say analysts at Morgan Stanley.

A bigger worry is a decline in their loan growth rate, one key reason why NBFCs traded at valuations much higher than even the top-notch banks. For now, Bajaj Finance, a niche consumer lender, and HDFC, market leader in housing loans, emerge as top analysts’ picks in the NBFC space.

Apart from these two names, experts say now is a good time to mop shares of banks, “On a more sustainable basis, banks appear more attractive over NBFC stocks in the medium term,” says Siddhart Purohit of SMC Global. “Bank stocks have been less affected in the recent correction, reflecting their strength to tap market funds.”

Morgan Stanley, Nomura and CLSA have also expressed a preference for banking stocks.

Another factor is that the banking sector is seen at the cusp of a strong bad loan recovery cycle. “Overall, banks are expected to see a robust drop in gross non-performance assets as resolutions pick pace,” analysts at Kotak Institutional Equities say in their September quarter earnings preview.

Also, in a tight liquidity situation, banks are better placed to tap low-cost funds, thanks to their deeply penetrated current and savings account deposits. More, if growth for NBFCs slows, the lending competition in retail loans could diminish for banks, helping them increase their lending margins. “This could help drive up revenues for retail-funded (meaning, from loans to individuals) banks,” say analysts at Morgan Stanley.

ICICI Bank, IndusInd Bank, Axis Bank, HDFC Bank and SBI are the top picks for brokerages in the banking space. A valuation reset of 20-25 per cent after the recent stock price correction also boosts their appeal.