Only Three NBFCs Will Survive. The Rest Will Blow Up Warns Saurabh Mukherjea While Recommending Stocks With 70% Market Share & 25% ROC

I had warned that NBFCs and HFCs have unviable business models & major correction is coming

In June 2018, Saurabh Mukherjea had prophesied that a major correction is coming in NBFCs and HFCs and that they would crash.

“I cannot but help feel that a major correction in financials is overdue. I am talking about the wholesale market dependent financial companies who borrow money in the wholesale market and lend to the retail customers.

The wholesale market rates have tightened by 125-130 bps in the last six months. There is further tightening in rates coming in the wholesale market and I cannot feel that a major correction in NBFCs and HFCs is also around the corner,” Saurabh had said in a grim tone.

At that time, we had rubbished his warning though, in hindsight, the logic was impeccable.

Saurabh had pointed out that NBFCs and HFCs were borrowing heavily in the wholesale market at short-term rates (3-month CP & CD) and lending for 20-year home loans or five-year developer loans.

This was an unviable business model because the wholesale market rates started rising owing to inflationary concerns and rising fiscal deficit.

At the same time, the LAPs (Loans Against Property) became NPAs because of the slowdown in the realty sector.

L&T Finance and IndiaBulls Housing Finance are prominent victims of the LAP crisis because the massive loans that they had advanced to a builder named SuperTech has been condemned as “Junk” by the rating agencies.

The crisis culminated in the infamous ILFS liquidity crisis in September 2018 when NBFC and HFC stocks crumpled like leaves.

All housing finance companies crack!
DHFL now down 25%
Indiabulls Housing down 10%
Repco down 5%
Can Fin down 5%

— Mubina Kapasi (@MubinaKapasi) September 21, 2018

NBFCs thrashed

— Darshan Mehta (@darshanvmehta1) September 21, 2018

Chola Fin, Dewn Hsg, Indiabulls Hsg, Shriram Transport – all these stocks down and how !!

— Yatin Mota (@YatinMota) September 21, 2018

DOWN 20% NOW… whats going on here ? https://t.co/qYnpefY4Dl

— Yatin Mota (@YatinMota) September 21, 2018

Brutal shake out in the HFC and the NBFC sector is coming. Not more than three will survive

In his latest interview, Saurabh Mukherjea has reiterated the warning that NBFC and HFC stocks are still not out of the woods.

Instead, they are flying into more turbulent weather.

“We are half-way through the blow up,” Saurabh said.

“My reckoning is the rest of the blow up in the sector will happen in the six, seven months following the elections,” he added.

Saurabh referred to the Kotak AMC – ZEE fiasco in which the Mutual Fund bluntly informed hapless investors that it is unable to honour its commitment to repay the FMP because of ZEE’s liquidity problems.

Kotak Mahindra MF fails to fully redeem FMPs. We’ll pay you when Essel Group pays us, says the MF management. HDFC MF extends maturity of FMP 1168D Feb 2016; Maturity extended by 380 days to 29 April 2020 and many more will unfold going ahead….. pic.twitter.com/tEILeUnIfx

— Ambareesh Baliga (@ambareeshbaliga) April 11, 2019

Do you know a FMP is not supposed to invest in securities with maturity beyond the maturity of the scheme. Then how did Kotak FMP extend maturity of the Essel paper? And more questions… https://t.co/kpopBXraof via @BloombergQuint

— Sajeet Kesav Manghat (@sajeetkm) April 13, 2019

Cause For Concern: Kotak AMC: Investors Of Kotak FMP Series 127 Facing Delay In Full Redemption

Investors May Get Part Redemption, Rest When Fund House Recovers Money

Scheme Facing Delay In Recovering Money From NCDs Of Two Essel Group Cos@MuralidharSwami #BTVIFreeToAir pic.twitter.com/OYCmxIBgdI

— BTVI Live (@BTVI) April 10, 2019

“Those problems will exacerbate over the next six months and we are only half way through what will be a brutal shake out in the HFC and the NBFC sector,” Saurabh observed.

“There will be a few champions who will be left standing but I think of the top of my head I cannot see more than three credible NBFCs surviving this brutal shake out over the next two years,” he added.

This is scary. NBFCs will face serious issue for repayment: Varinder Bansal

Varinder Bansal has also sounded the red alert that serious trouble is brewing in the NBFC and HFC sector.

He produced data which shows that NBFCs will have to repay a colossal sum of Rs. 1.3 lakh crore by June 2019.

If even one NBFC defaults, it will set the cat amongst the pigeons and lead to havoc for the entire sector.

This is scary for me.
Nearly Rs 1.3 lakh crore of NBFC borrowing from MFs coming up for repayment in Q1. NBFCs under stress will face serious issue for repayment. pic.twitter.com/Id9w6lxy2N

— Varinder Bansal ?? (@varinder_bansal) April 26, 2019

Another chart from CS: exposure of AMCs to stressed groups pic.twitter.com/1ttRxZy9xg

— Varinder Bansal ?? (@varinder_bansal) April 26, 2019

Also CARE Ratings downgrades Reliance Home Finance’s long-term debt programme to “default” https://t.co/rd4Ml6Dl5d

— Varinder Bansal ?? (@varinder_bansal) April 26, 2019

Whether NAMO or RAGA, Kids will not stop drinking milk. So, buy only compounding stocks

Saurabh Mukherjea came down heavily on the tendency of intellectuals and novices to fret about the outcome of the elections and endlessly debate what stocks to buy or avoid.

He contemptuously described these people as “hobby investors“.

“It is a natural human tendency and this sort of investing is as best seen as a hobby. If you want to professionally invest or make good money with your savings, it is best to buy the classical compounders in our country which really are not swayed by elections,” he stated.

Saurabh gave a homely example to explain his point.

“Kids will have baby milk powder ever after 23rd May, regardless of who wins the elections and in that regard, just to take an example, it is difficult to see why say a Nestle’s earnings should be swayed by the identity of the winner on 23rd May? Similarly, houses will be painted after the elections regardless of who wins and Asian Paints’ earnings therefore should hold up regardless“.

“But the human mind does not like boring things. It wants excitement which comes from these sorts of big ticket events and people try to gamble around it. It is natural to want to do so but it does not make you a great deal of money if you want to gamble. It is a good hobby to have but that is not professional investing,” he said.

Buy “Coffee Can” Stocks which will compound wealth slowly but steadily

Saurabh Mukherjea is known to be an authority on the credo of “coffee can investing“.

In fact, he is the co-author of a bestseller named “Coffee Can Investing: The Low Risk Road to Stupendous Wealth“.

Saurabh explained that to qualify as a “coffee can” candidate, the stock should have return on capital employed (ROCE) consistently above 15% and revenue growth consistently above 10%.

“Look for stocks which can consistently give you 20-25% compounding on the basis of really superior underlying fundamentals which can grind out superior performance year after year,” he advised.

“To make really good money, you need to settle down on 10 large bets on high quality firms and ride with them,” he added.

Asian Paints and HDFC Bank are known to be classic examples of that.

To make really good money, you need to settle down on 10 large bets on high quality forms and ride with them. I don’t expect @UltraTechCement stock to be a consistent performer, says Saurabh Mukherjea to @AyeshaFaridi1 pic.twitter.com/rRXphobPqS

— ET NOW (@ETNOWlive) April 26, 2019

TCS has the hallmarks of a legendary franchise

Saurabh cited TCS as a textbook example of a “coffee can” stock.

“This is a business which is giving you free cash flow, the return ratios are strong, cash is coming back to the shareholders and margins are between 25% and 28%. How many businesses in the world can grow at 8%, 9%, 10% at that run rate and give you dividend and cash back or buyback every two years?” he noted.

“TCS’s ROCs are in the vicinity of 30% and at the moment they seem to be well set for dollar revenue growth of 10% which should be rupee revenue growth of at least 12-13%. This has all the hallmarks of what is already a legendary franchise and the ability to be a Coffee Can Franchise potentially over the next decade or so,” he added.

Pidilite is also a classic ‘Coffee Can Compounder’

Saurabh revealed that he has granted Pidilite pride of place in the hallowed ‘Coffee Can portfolio’.

“It is a classic Coffee Can Compounder with market share of 70% odd in adhesives, ROC’s north of 25% and whilst growth has not been the greatest over the last couple of years, I think Pidilite’s just does not dominate adhesives, but now the waterproofing business as well which bodes well for the future,” he opined.

“It is a well-run firm and part of our portfolio,” he added.

Coffee can stocks have low volatility and are a “free lunch”

Saurabh explained that one of the benefits of investing in ‘coffee can’ stocks is that they enjoy low volatility, just like AAA Govt Bonds.

“Not only will you get good returns from franchises like HDFC Bank, Asian Paints, the Pidilite’s of the world, the volatility of your returns is as low as a Government of India bond,” he said.

“You are getting returns well ahead of the Nifty 6%, 7% , 8% ahead of the Nifty for half the volatility of the Nifty“.

“For a Government bond volatility, you get 20-21% returns pretty consistently even for a period as short as three years. That is all really one can ask for in equities. If you are getting returns well ahead of the Nifty, ahead of the benchmark, half the volatility of the benchmark is as close to a free lunch as people like me can get to in the Indian stock market,” he exclaimed.