Bajaj Finance's rich valuations sustainable

Expectations of strong earnings growth and expansion in return ratios will support high valuations

The Bajaj Finance scrip has multiplied 10 times in three years; it rose twofold in the past year, to Rs 10,022 a share currently. Such a run-up up has made Bajaj Finance be among the most expensive financials stocks. At current levels, it trades at six times the FY17 estimated book value. The question now is: are these valuations sustainable or should investors brace-up for a correction? The latter seems unlikely at the moment.

Strong leadership position, thanks to its first mover advantage in the niche segment of consumer durables financing, has fuelled healthy growth for the company over the past many quarters. In fact, the consumer durables financing segment is still under-penetrated and analysts believe Bajaj Finance could continue to gain market share going forward.

The management’s focus on product innovation and cross-selling will be key factors in driving future growth. It is because of this quality growth and visibility that the Street remains positive on the stock, with majority of analysts believing these rich valuations/stock levels are sustainable.

While the firm will continue to grow at a good pace in the near-term as the catalysts for consumption demand namely good monsoon, higher pay for government employees, One Rank One Pension, etc, play out, Bloomberg consensus estimates suggest earnings will grow 36 per cent and 31 per cent, respectively, in FY17 and FY18.

This earnings momentum should translate into expansion in return on equity ratio from 21 per cent in FY16 to 23 per cent in FY18. It is no surprise, then, that of the 20 analysts polled by Bloomberg since July, just two have a ‘sell’ recommendation on the stock with nine each having ‘buy’ and ‘hold’ ratings. Their average target price of Rs 10,013 is pretty close to Tuesday’s closing price, indicating the stock is fairly valued for now.

But, as analysts roll over their stock price targets and earnings estimate to FY18, the price-to-book valuation should come down, if share price sustains current level. Some analysts cite risks to high growth and expensive stock valuations.

  “While Bajaj Finance continues to deliver strong growth, recent rally makes it the most expensive financial stock. We see risks to its growth which makes us believe there is little upside left in the stock,” wrote Sunil Tirumalai, an analyst at Credit Suisse in a recent report on the company.

He has raised his FY17 earnings estimate for the company by five per cent, but has a very low target price of Rs 6,200 on the stock. Such a downside in the stock price is possible if the company’s growth slows meaningfully and/or the asset quality worsens, for now unlikely, according to most analysts.