Axis Capital bullish on NBFCs as valuations expand, targets revised upwards

The strong performance of non-banking financial companies (NBFCs), supported by a peak in the interest rate cycle and robust loan demand, has led to an expansion in valuations. Brokerage firm Axis Capital anticipates that these valuations will continue to be sustained in the medium term, primarily driven by changes in management and revised business strategies. These strategies include a focus on diversification and the development of granular businesses supported by digital capabilities.

“We find comfort in valuation multiples for lenders under our coverage trading at a 2-30% discount to their 5-10-year average. Consequently, we roll forward valuations to FY25 and increase our Target Prices by 2-36%,” Axis Capital report said.

The brokerage house has identified Bajaj Finance, Piramal Enterprises, and Shriram Finance as its preferred picks in the sector amid their potential for growth and investment opportunities. Additionally, within the small-cap segment, Axis Capital expresses a positive sentiment towards Home First Finance and Ujjivan Small Finance Bank, suggesting that these companies may present attractive prospects for investors.

” We increase target prices of stocks under our coverage by 6-36% on roll forward of estimates to FY25, increasing comfort on growth driven by retail (increase loan growth assumptions), no major challenges on asset quality (controlled credit costs), and well-cushioned balance sheets with sufficient liquidity and capital (no dilution expected bar in CIFC). We retain our target multiples on housing finance companies and SBI Cards. However, we increase our multiples on most NBFCs under our coverage along with revising our growth and earnings estimates”, Axis Capital report said.

The brokerage house expects growth to remain buoyant over the medium term, a thesis supported by credit growth for NBFCs of 16% YoY in FY23 (RBI) as well as Q1FY24 provisional numbers.

Axis Capital anticipates that the impact of peaking interest rates will fully manifest in FY24, following which net interest margins (NIMs) are expected to stabilize with a positive bias. Over the course of the last 15 months, the Reserve Bank of India (RBI) has implemented rate hikes totaling approximately 250 basis points (bps). This has led to increased funding costs for non-banking financial companies (NBFCs), although the complete impact is yet to be observed due to the lag in the repricing process.

Meanwhile, Axis Capital maintains a cautious outlook on the unsecured loan book being built across NBFCs/SFBs. They identify any potential slowdown in economic growth rates or the emergence of a hyperinflationary environment as immediate threats. Additionally, an extended period of elevated interest rates can constrain growth rates and potentially lead to asset quality challenges. It is important for NBFCs and SFBs to be mindful of these risks and proactively manage their loan portfolios to mitigate any adverse impact on their business.