As far as credit is concerned, India lags its western counterparts. The country's outstanding credit is just 15% of its GDP against the global average of 80% as of September 2021.
So clearly, there is a lot that needs to be done to expand the country's credit base. This is where non-banking financial companies (NBFC) come into the picture.
NBFCs are a breed of financial institutions that play a crucial role in India's credit ecosystem. These companies differ from traditional banks in several aspects.
A crucial difference between an NBFC and a bank is the ability to raise deposits. Banks can accept all sorts of deposits - demand and time - whereas NBFC can't accept demand deposits.
Nonetheless, an NBFC and a bank work quite similarly as far as credit creation is concerned. In fact, NBFCs along with the banks work with a single objective of expanding the credit base of the country while being profitable.
In India, NBFCs have become important constituents of the financial sector. Over the last decade, they have experienced phenomenal growth. As a result, they have surpassed the traditional banks in terms of credit growth.
It is expected that they would retain their growth momentum going forward. Given bright growth prospects, it's worth looking at the top Indian NBFCs from an investing perspective.
In this article, we compare the mightiest NBFCs of India, HDFC and Bajaj Finance.
Let's get started…
Bajaj Finance is a deposit taking NBFC registered with the Reserve Bank of India (RBI). The company is engaged in the business of lending and accepting deposits.
Bajaj Finance has a diversified portfolio comprising retail, SME, and commercial customers across urban and rural areas. The company offers products and services across six broad categories:
• Consumer lending
• SME lending
• Commercial lending
• Rural lending
• Partnerships and services
The company has two wholly owned subsidiaries, Bajaj Housing Finance (BHFL) and Bajaj Financial Securities (BFinSec).
The products and services offered via these two subsidiaries are an extension of its core products and services such as mortgages, margin facility, etc.
The company has its operational presence in 2,988 locations in India. It serves 48.6 million customers across the country as of March 31, 2021.
HDFC too, is a deposit taking NBFC registered with the RBI.
HDFC is a financial services company with its core operation centered around the Indian housing market.
It's India's leading provider of housing finance. Its core product portfolio is broadly classified in three categories: housing loans, non-housing loans, and other home loan products.
The company's website shows that HDFC has provided loans to 9 million customers since inception.
HDFC's secondary operation is concerned with investments in financial securities. HDFC is a major stakeholder in the HDFC group of companies having presence across different sectors such as banking, insurance, asset management, etc.
Here's an interesting point…
HDFC continues to hold all its investments in HDFC Bank, HDFC Standard Life Insurance, HDFC Asset Management, HDFC Ergo, and all other subsidiary and associate companies at the original cost of acquisition.
These investments are currently not accounted for on a fair value basis in the books of accounts.
The unrealised gain of Rs 2.6 lakh crore on the investments are not part of HDFC's current net worth nor its capital adequacy calculation.
Bajaj Finance's advances grew at a CAGR of 35.6% over the last five years. During the same period, HDFC advances grew at a CAGR of 11.9%.
It's clear that Bajaj Finance's advances are growing faster than HDFC. This is due to the fact that HDFC focuses exclusively on mortgages whereas Bajaj Finance has a diversified lending portfolio (including mortgages).
Fortunately, each lending vertical of Bajaj Finance is firing equally well. However, its consumer finance and housing finance verticals continue to be key business drivers.
Bajaj Finance is a leading lender for consumer durables, digital products and furniture. The company offers a no cost EMI scheme to its retail customers, making it convenient for them to pay for their purchases.
The consumer finance vertical accounts for 26.7% of the company's total asset under management (AUM) as of March 2021.
Bajaj entered the home financing fray in 2017 via BHFL, its wholly owned subsidiary. Since then, the vertical has grown phenomenally. It's now the second largest contributor to the total AUM.
As of March 2021, BHFL had assets worth Rs 23,900 crore under its home loan business which constitute 21.8% of BFL's total AUM.
HDFC's advances growth is largely driven by retail home loans.
Prior to the pandemic, India's real estate market was going through a rough patch. Despite sluggish overall demand, HDFC clocked positive double-digit growth during the period which is nothing short of an achievement and reflects the company's resilience to tide over adversities.
Talking about sources of funds, NBFCs source a major chunk of their funds from scheduled commercial banks (SCBs).
Other than that, NBFCs raise capital by issuing financial securities such as issuing non-convertible debenture (NCDs), or diluting equity via qualified institutional placement (QIP) route.
Last but not least are deposits.
NBFC, in general, aren't allowed to accept deposits unless they are permitted to do so by the central bank of India. HDFC and Bajaj Finance are deposit taking NBFCs and are authorised by RBI to accept deposits.
However, unlike SCBs, these companies aren't allowed to accept demand deposits (regular deposits). NBFCs are constrained to accept time deposits only. Time deposits include fixed deposits (FDs), certificate of deposits (CDs), etc.
From the cost perspective, deposits are the cheapest source of funds for NBFCs followed by NCDs and QIP. Borrowings from banks are the most expensive source of funds for NBFCs.
Given the low cost bearing of deposits, HDFC and Bajaj Finance are keen to grow their deposit base and their efforts are clearly visible.
Bajaj Finance's deposit base grew at a CAGR of 56% over the last five years whereas HDFC's deposit base grew at a CAGR of 17.5% during the same period.
Though Bajaj Finance is growing faster than HDFC on the deposits front, it is important to note that the company's high growth is coming off on a low base.
Net Interest Income (NII)
NII is income generated from core operations. NII is the difference between the interest income earned by an NBFC on its loans and the interest it pays on its borrowings.
Though rising interest income reflects growth and is important to look at, what is more important is to keep an eye on is interest expense. The interest expense part is an insight on where the company is bringing money from.
HDFC's interest expense to interest income ratio trickled down to 21% in fiscal 2021 from 36% in fiscal 2017. During the same period, Bajaj Finance's interest expense to income ratio dropped 300 basis points or 3% from 38.7% in fiscal 2017 to 35.7% in 2021.
Both companies' efforts to tap cheaper sources of funds have borne fruit and it may improve going forward.
It is the cost optimization efforts of these companies that makes them command a leadership position in the industry.
Net Interest Margins (NIM)
Net interest margin (NIM) is net interest income divided by the total amount of loan disbursed by a bank.
NIM is one of the measures of profitability. Thus, higher the NIM the better it is for NBFCs.
The following table shows NIMs of HDFC and Bajaj Finance over the last five years.
HDFC's average NIM for the last five years turns out to be around 11%. Bajaj Finance is marginally ahead with margins of 11.2% over the last five years.
The NIM of an NBFC tends to be higher than that of a SCB. This is because the statutory requirements for an NBFC is far lower than banks.
NBFCs are required to invest 15% of their capital in safe and low yielding assets whereas it is 24% for banks. This means that NBFCs have more money with them to give away as credit.
Non Performing Assets (NPAs)
Rajeev Jain, MD at Bajaj Finance, once said in an interview and I quote,
“We are in the business of managing risk and not lending.”
And as far as risks in the lending business are concerned, there's no risk above NPAs. NPAs beyond a certain limit has the potential to squander the fortunes of an NBFC leading to its bankruptcy.
Being the titans of the financial industry, HDFC and Bajaj Finance have a strong risk management framework at play. This framework helps them to gauge the credit-worthiness of an individual or an entity to whom the loan is being offered.
As a result, their NPA levels are among the lowest in the industry.
Bajaj Finance's average NPA for the last five years stood at 0.62 versus HDFC's average of 0.72 during the same period.
Nonetheless, both companies have been doing a commendable job at keeping their NPA under check.
Both have the ability to tide over rising inflation and interest rate cycles without additional NPA provision costs on its books.
Provision is a portion of the total income that is set aside to provide for the losses incurred due to NPAs.
HDFC and Bajaj Finance show their financial prudence through their provision allocation strategy. These companies are proactive with provisions and provide for the losses well in advance. This means that they set aside money as provisions for the losses that they might incur in the future.
The following table shows the provisions of HDFC and Bajaj Finance over the last five years.
HDFC's provisions to NII averaged at 1% over the last five years. This compared to Bajaj Finance's average of 0.3% during the same period.
HDFC clearly, is keeping aside more money for provisions.
Net Profit Margins
Here's a table showing both the companies' net profit margins over the years…
HDFC has been clocking an average net margin of 16.5% over the last five years. During the same period, Bajaj Finance clocked average net margins of 19.2%.
HDFC's lower net margins could be attributed to higher provisions. Also, Bajaj Finance has been putting in efforts to reduce its operational expenses to pump up its net margins.
HDFC has paid an average dividend of Rs 19.4 per share over the last five years. During the same period, its dividend payout ratio averaged at 23%.
Bajaj Finance has doled out less dividends to its shareholders. It paid an average dividend of Rs 6.5 over the last five years. This along with a dividend payout ratio of 10.7% during the same period.
HDFC is truly a dividend paymaster. It has been rewarding its shareholders with dividends consistently.
Bajaj Finance, on the other hand, is ploughing back its earnings back into the business. The company is focused on strengthening its digital infrastructure to create a seamless and frictionless customer experience.
Bajaj Finance has an operational presence in 2,988 locations across the country. The company sells its products and services via physical points of sale present. It has a total of 110,300 points of sale across the country.
In addition, the company has been strengthening its digital channels for the tech savvy. As of March 2021, Bajaj Finance had 48.6 customers under its ecosystem.
HDFC's distribution channels include HDFC Sales, HDFC Bank, and third-party direct selling associates (DSA).
HDFC Sales (HSPL) is a wholly owned subsidiary of HDFC. HSPL has a physical network of 206 offices across the country. This distribution channel accounts for 54% of all loans disbursed.
HDFC taps the enormous customer base of HDFC Bank to cross sell them home loans. HDFC Bank brings in 27% of all loans disbursed by India's largest mortgage lender.
As far as third party DSA's are concerned, HDFC has distribution tie ups with commercial banks, small finance banks, other NBFC's, and housing e-portals. This channel brings in 17% of the total loans disbursed.
Return Ratios and Valuation Ratios
Return ratios depict the efficiency of a company with regards to different parameters. When comparing banks or NBFCs, analysts look at two return ratios to see which of the two is more efficient and generates more returns.
These ratios are return on equity (ROE) and return on assets (ROA).
ROE tells an investor how much profit a company generates on shareholders capital. It is expressed in terms of percentage.
ROA tells an investor how much profit a company generates on its assets.
The five year average ROE of HDFC and Bajaj Finance is 15.2% and 16.8%, respectively. Though HDFC's number seems to be lower here, one should note that it is on account of higher provisioning.
Bajaj Finance shines on the ROA front too with average ROA of 2.9% over the last five years. HDFC lags by a margin of 0.5% with a five-year average ROA of 2.4%.
To sum up, Bajaj Finance beats HDFC in the game of efficiency.
Impact of Covid-19
The Covid-19 pandemic was a minor blip in the growth journey of HDFC and Bajaj Finance.
The first two quarters of the financial year 2021 were a complete washout as these companies reported a sharp drop in their business. However, signs of recovery were visible from the third quarter onwards.
If looked at the brighter side of things, the pandemic accelerated the digitisation efforts of these companies. HDFC and Bajaj Finance strengthened their digital infrastructure to strengthen its customer engagement, collection process, and product distribution.
Besides digitisation, the pandemic turned the interest cycle. RBI slashed the repo rate to stimulate economic growth. The Indian real estate market was the biggest beneficiary of low interest rates.
The low interest rates along with other favourable factors spurred the demand for housing.
High demand for housing translated into higher demand for home loans. This was clearly visible in quarterly results of HDFC and Bajaj Finance. Both the companies reported robust growth in their home loan portfolio.
One thing for sure is that if these companies can tide over the unprecedented challenges posed by the pandemic, then they can overcome any adversity going forward. This is something that investors must take note of.
Home loan is a common product among the product portfolio of HDFC and Bajaj Finance. As per some estimates, the Indian real estate sector is expected to reach $1 trillion by 2030 from the current market size of $200 billion.
Though real estate is a broader term that includes commercial properties along with residential, growth of the overall sector bodes well for HDFC and Bajaj Finance which are leading players in housing finance.
For Bajaj Finance, its consumer finance vertical has a promising outlook. The consumer durable finance market is expected to grow from $1.1 billion in 2021 to $2.7 billion by 2027, implying a CAGR of 21.6%.
So, there's a lot of headroom for growth. HDFC and Bajaj Finance, being the leading NBFCs, stand to be the biggest beneficiaries of India's growth story.
Which is better?
If you go by the data points discussed above, Bajaj Finance emerges as the winner. Bajaj Finance outperforms HDFC on every parameter except for provisions.
It's the higher provisioning done by HDFC that's responsible for its underperformance to Bajaj Finance.
But HDFC is no less than Bajaj Finance when it comes to quality. In a sector which is so closely linked to the macro environment, its ability to manoeuvre through market cycles with exceptional capital allocation sets it apart from all other NBFCs.
Investors have lofty expectations from Bajaj Finance which is reflected in its high valuations. The stock is trading at a price to earnings (P/E) multiple of 80.5. HDFC, on the other hand, is trading at a PE multiple of 33.
On the price to book value (P/BV) front too, Bajaj Finance trades higher than HDFC. The former trades at P/BV multiple of 10.7 whereas the latter is trading at a multiple of 3.8.
Clearly, Bajaj Finance is trading at a more expensive valuation than HDFC. Before choosing a company to invest in, it is important to check its fundamentals and valuations to help make an informed decision.
(This article is syndicated from Equitymaster.com)
(This story has not been edited by NDTV staff and is auto-generated from a syndicated feed.)