No they are not perceived to be just another NBFC, they are given premium valuation because of the sector they operate in and its probable future growth.
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Actually, I have that issue with both IREDA and IRFC or NBFCs of their type. After all what do they earn their income from- by giving loans and earning interest income on that.
May be those NBFCs that give personal loans earn more.
But I would accept if the market considers their business premium. And does it for a long time, through ups and downs. After all, bajar bhagvan chhai. We make money by recognising and accepting how the market treats a company or a sector.
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NBFC giving personal loan may earn more in absolute term. But, I, as long term investor am more interested in % growth rather than absolute income.
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On a big picture level IREDA stock has two main issues it needs to contend with.
Valuations- I highlighted it last year. Market in the initial phase of hype overlooked the massive gap in valuations with respect to peer PSU lending companies such as REC that have much better ROE performance but trading (for good reason) at close to book. I also heard or read some investor defending IREDAâs lofty valuations comparing it to Bajaj financeâŚI guess underlying thesis was that IREDA will be able to show the same caliber and track record of underwriting and superior ROEs as highly valued lenders Bajaj Finance and Kotak have demonstrated.
Nature of business- They are in a B2B lending business which makes loan book too concentrated and too much exposed to risks. This risk is further compounded in sectors like power which are heavily regulated, capex intensive and guzzlers of free cash flows.
So even with dramatically improved underwriting, I find 4x valuation excessively high considering the borrowersâ profiles.
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Iâm puzzled by why someone would pay four times book value for IREDA when PFC is available at book value. Both are government-owned companies operating in same line of business, but PFC is nearly ten times larger in terms of capital. For financial institutions, size matters in key waysâlarger entities typically have a greater ability to absorb losses. Another critical distinction is the composition of their loan books. IREDAâs book has 77% exposure to the private sector, with only 23% backed by government loans. In contrast, PFCâs book has 77% government-backed loans and just 23% private sector exposure. With such a high proportion of secure, government-backed loans, PFC appears far less risky.
While I acknowledge that IREDA is growing at roughly twice the rate of PFC, the valuation gapâfour and half times book value for IREDA versus one times for PFCâseems too stark to justify. I struggle to envision a scenario where IREDAâs premium leads to better investment outcomes. Please point out any flaws in my analysis or factors I might be overlooking?
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One of the primary reasons for a higher P/B ratio is the interest and hype around the renewable energy theme. In my opinion for NBFCs only the P/B matters and anything above 1 is not justified if someone is a value investor.
Generally thereâs a delay in collections from Government customers.Larger exposure to private players is a double edged sword. If the underwriting is done appropriately, higher exposure to private players maybe a good bet. The risk of default is always there.
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Iâd like to discuss two key points regarding your perspective on NBFCs, specifically PFC and IREDA:
Why Prioritize P/B Over ROE for NBFCs?
You emphasized P/B as the primary valuation metric for NBFCs, but I believe ROE is a more critical indicator of a companyâs ability to generate value, as it is for any business. For instance, PFC is currently trading at book value and a P/E of 5 and offers a 4.5% dividend yield, which suggests it is undervalued. While you might argue that competition could erode such metrics over time, consider Bajaj Financeâs performance over the past 20 years. It has consistently maintained an impressive ROE while achieving significant growth. Similarly, PFCâs ROE metrics over the last decade have been consistently strong, demonstrating its ability to sustain profitability over a substantial period. Could you clarify why you believe P/B should take precedence over ROE in this context?
Concerns About Government Payment Delays
You highlighted the potential impact of delayed payments from government entities on PFC and IREDA. However, both companies impose penalties on delayed payments, whether from government or private borrowers, ensuring uniform treatment across all loan accounts. Notably, their exposure is predominantly to state government backed DISCOMS, with minimal exposure to the central government entities. This structure offers the best of both worlds: the security of lending to government-backed entities with treatment similar to private borrowers. This provides a significant safety net compared to lending to private entities, where default risks are higher. I would like to point out, lending is different from the general government contracts. If an account is due more than 90 days , the treatment is same. The whole state will become a defaulter resulting in increasing borrowing cost to all entities related to state. This is a strong deterrent to default on loans from PFC. Given these factors, I doubt if concerns about delayed government payments hold substantial merit.
Iâd appreciate your insights or any counterarguments you might have on these points.
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Itâs not P/B taking precedence over ROE. The first is a valuation metric while the latter is a return metric and while they are corelated they are not interchangeable.
P/B is a primary valuation metric for lenders and it is determined by the market based on a host of factors such as loan book growth, quality of underwriting, NIM etc and these things directly translate into return metrics.
ROE, although an important return metric, shouldnât be considered in isolation as it doesnât share much on how efficiently the lender is utilizing its capital assets. ROE can also have a lot of lag. Bad performance shows up many years later in the form of malpractices, accounting errors (intentional or unintentional) or high NPAs from defaults on long term borrowings.
So one also should consider things such as ROA (return on asset) track record, lenderâs loan book mix, borrowersâ profile, operational cost, balance sheet growth, earning quality, management, NPAs etc to decide how well a lender is positioned to perform in the future.
B2B lending itself is not seen as very attractive by lending industry due to relatively lower yield as compared to retail lending and private banks are very selective about lending to corporate segment. And they are definitely not that hot on lending to risky and regulated sectors (like power) as these have had very bad track records with NPAs and that situation hasnât changed dramatically on the ground even with all the reforms.
There is a reason decently run companies like REC or PFC get lower P/Bs (and will continue to do so). Itâs primarily because of their borrowersâ profiles.
Ultimately math is simple. As a lender, you raise capital and pay interest on it, then you lend that capital and you collect interest on that and pocket the difference after deducting operational cost.
So if as a lender you can raise capital cheaply, lend it at the highest possible rate, minimize operational cost and NPAs.. and do all this consistently for year after year, market will award you with higher P/B which it did for quality lenders like Bajaj Fin and Kotak (in the early days) before punishing them for several years for slight lapse in the performances. Bajaj Finance P/B used to be 10+ in its heydays before settling down to 5 today after 4 years of grind and stock performance settling down to a steady growth rate.
So if market is punishing IREDA stock itâs because the business performance so far hasnât done justice to significantly higher valuations. Once fundamentals change and sustain for long enough it might again find favor with investors, assuming valuations support.
Sharing a good article on bank performance analysis (this can be applied to any lender type).
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I think you misunderstood the context of my explanation.
First, the discussion started because the user above stated that P/B is the most important metric to track valuation in an NBFC. My point was to say that ROE, ROA, and all the other factors you mentioned affect P/B. P/B alone canât be used to say if an NBFC is cheap or expensive. I think because I mentioned ROE, you assumed nothing else would be looked into. I was just trying to impress upon the author of the previous post to look at factors other than P/B in valuing an NBFC.
Second, I would request that you please read the post above once again. The comparison was between IREDA and PFC. âBothâ operate in exactly the same segment, with one trading at 4 times book value and the other at book value. So my point is that PFC is cheaper than IREDA. Again, no one is disputing the segment they operate in or the positives/negatives of it. The comparison is with IREDA (another player in the same industry). And the thesis was not that the market is âpunishingâ IREDA but rewarding it more than PFC (a better investing opportunity in my view).
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