PNB Housing: Good biz, reasonable price

Focused loan growth approach, ability to outpace rivals and fair valuation make the IPO attractive

Stocks of housing finance companies have given steady returns to shareholders for several years, as demand for home loans has remained firm in the country. The initial public offer (IPO) of PNB Housing Finance, a stable company from the sector, offers similar prospects for long-term investors.  

Despite being promoted by Punjab National Bank in 1988, it faced a survival crisis in 2003. In 2011, it began a restructuring programme, lasting five years. The aim was to centralise and standardise business processes, sourcing strategies and credit policies.

Changes were also made to its organisational structure, apart from developing a strong information technology platform and introducing new marketing strategies. In 2009, Destimoney, which belongs to private equity player Carlyle, took a 49 per cent stake.

While the restructuring measures have already started delivering results in the form of high and profitable growth, the company has come out with an Initial Public Offer (IPO), to raise Rs 3,000 crore of fresh equity capital that will help sustain growth.

Business model
PNB Housing has 61 per cent loan exposure to retail (to individuals) home loans and nearly 10 per cent exposure to developer loans. Stacked against peers such as Repco Home Finance and CanFin Homes (80–83 per cent of retail loans), PNB Housing’s exposure to these loans appears low. Also, it has higher exposure to selfemployed individuals (45 per cent) as against the salaried class (40 per cent).

However, it has adequate credit filters to ensure superior customer profile. Consequently, its gross non-performing assets (NPA) ratio fell to 0.27 per cent in the June quarter, from 1.04 per cent in FY12.

Of the around 30 per cent non-housing loans exposure, loans against property (LAP) are a big chunk (60 per cent versus 70 per cent in FY14). Corporate term loans and retail non-housing loans account for the rest. Nevertheless, the product mix has helped PNB Housing expand its loan book at a fast 60 per cent during FY14-16, way ahead of the sector average of 17–31 per cent.

 

Financials
Healthy loan growth helped expand its net interest income by 62 per cent annually during FY14-16, while net profit expanded  59 per cent in this period. Net interest income is the difference between interest earned and expended. However, the net interest margin at 2.98 per cent (in FY16) is lower compared to Repco (4.6 per cent) and CanFin Homes (3.24 per cent). This is despite being the second largest housing financier to accept public deposits.

A key reason for the lower margins is that PNB Housing’s cost-to-income ratio (30 per cent in FY16) has historically been higher than the sector average of 10-20 per cent. Advertisements and loan acquisition costs are the major costs.

Consequently, the return ratios (see table) are also suppressed and lower than peers (return on assets of 1.5-3.3 per cent). However, efforts to reduce cost of borrowing are showing results — down from 9.3 per cent in FY14 to 8.7 per cent in FY16. Therefore, until the full advantage of business restructuring flows into the operations, the costs might remain elevated, keeping a check on return ratios.

Potential risks
Should the ongoing sluggishness persist in the sector, its financiers could see some slowing in loan growth. More important, analysts at Motilal Oswal Securities note that PNB Housing’s portfolio is not fully seasoned to reflect true asset quality. “If it loosens underwriting standards to deliver strong growth, this could also impact asset quality,” the analysts add.

Being a fresh issue, the share of promoter holding will reduce to 39 per cent for PNB (now 51 per cent) and 38 per cent for Destimoney (now 49 per cent). However, in future, if PNB’s stake in the company falls below 30 per cent, there is a possibility of the company not being able to use the PNB brand. It would then have to rename itself and build a new brand from scratch.

Investment rationale
Overall, there is little doubt about PNB Housing’s ability to grow at a healthy pace (of 20-30 per cent annually) and profitably over the long term, especially when sector dynamics are turning favourable. Restructuring and cost reduction measures will strengthen it. Notably, the valuations are reasonable. At a price band of Rs 750-775, the issue is priced at 4.6 times the FY16 price-to-book value, adjusted for the inflow of IPO funds. “We believe the valuation is justified, given the strong growth prospects,” says Saurabh Rathi of IIFL.