Asset financiers / investors are looking forward to a cyclical upturn with renewed optimism. However, the regulatory and competitive landscape for NBFCs is changing significantly, in our view. We believe NBFCs are entering an era, where growing at a healthy pace while maintaining profitability will be an arduous task. We prefer to play the up cycle with niche / small NBFCs with potential to achieve profitable market share gains.
Growth prospects improving; But, do not expect fireworks: Improving IIP growth, falling inflation, pick-up in mining activity, rising government spend on infrastructure and signs of pick-up in urban demand, point towards improving growth prospects for asset financiers. The freight-fuel index, which has a strong influence on M&HCV sales, has picked up too. However, weak rural demand, uncertainty over mid-season monsoon, flatto- rising fuel costs and corporate deleveraging leading to delay in private capex cycle are certain offsetting factors, which can dampen the recovery process. Sustainability in some of these green shoots is essential for meaningful pick-up in growth. We expect a gradual recovery in asset growth for NBFCs.
Top private banks emerging as serious competitors: Our analysis of the branch expansion strategy of the top five private banks in context of ~890 unique locations covered by top 3 NBFCs reveals- a) Over FY13-15, top 5 private banks aggressively opened branches in 31% of the locations covered by top 3 NBFCs, where they now command ~45% branch market share, b) Of this, in ~20% of total locations, none of the top 5 private banks were present earlier and they now enjoy ~38% branch market share, and c) Despite aggressive rural / semi urban branch rollout, none of the top 5 private banks are still present in ~37% of these locations. In our view, private banks are strategically penetrating the NBFC turf and could emerge as serious competitors. Market share of auto financing NBFCs appears to be stagnating. Increasing competition from private banks raises risk of market share loss for large NBFCs.
Regulatory noose tightened; No scope to cut corners: Higher capital requirements, tighter securitization norms and a far more restrictive regulatory framework (similar to that of banks) clearly reflects RBI’s intention to plug regulatory loopholes, which benefitted NBFCs earlier. Of the proposed changes, stringent NPL recognition norms are likely to impact the profitability of NBFCs. We believe, NBFCs with low provision coverage ratios and aggressive loan write-off policies are likely be most impacted.
Bet on niche / small players for profitable market share gains: NBFCs have generally been preferred over banks for their superior growth and profitability. However, under the new regulatory framework, the profitability gap is likely to narrow. In such a scenario, we prefer niche / small NBFCs, where the visibility on growth as well as profitability remains relatively better (inducing profitable market share gains). Our preferred picks in this space are BAF (Initiate with ACCUMULATE rating), CIFC (Initiate with ACCUMULATE rating) and SCUF (Initiate with ACCUMULATE rating).