Can Fin Homes

Background

Canfin Homes Ltd was established in 1987 by Canara Bank, HDFC and UTI. Canara Bank has the management control and has the guiding role in all the policies. Canara Bank chooses CEO and MDs of the company. The Company was listed in 1991, when home finance was a neglected part of the economy. Now Mortgage Business has been growing at about 20% y-o-y even through the economy has not been doing great. I think that this growth can be sustained in the affordable housing segment for many years to come. The average size of loans is about 20 lacs for Can Fin homes, which is priority sector lending (up to a limit).

Source of Value

Till FY11 Can Fin was growing at a normal 15% rate, like GIC Housing Finance and other government owned home loan finance companies. Canara Bank Bank deputed Mr. Ilango as the MD and he started professionalizing the company. Now the company has good customer service levels and is amongst the fastest in loan approvals (on their website they advertise that they would approve a loan in three days and sanction in week). The company has been growing its book at 40% y-o-y since FY12 and has given guidance of a book size of 11,500 crores for FY16.

The company has the lowest NPAs in the Home Finance NBFCs, because more than 90% of its borrowers are salaried class and only 5% of portfolio is Loan against property. That is, it chose lower profit margins to higher NPAs. Now, perhaps the company feels confident and is slowly increasing its share of Loans Against Property (LAP). The Net Interest Margin on LAP is double of that on pure Home Loans. I think that they will restrict the LAP to 20-25% of the total portfolio, which should be fine even when we consider higher possible NPAs in LAPs.

Canara Bank would need about 25,000 crores of equity in next four years to meet BASEL III guidelines. It is 1.5x of the Banks current market capitalization. The Government has told PSU banks to sell non-core businesses to raise funds. It would make sense for Canara Bank to create valuation in Can Fin Homes and then monetize it to meet its net worth requirements. So, this could be an interesting story for next 3 to 5 years. I think that Can Fin should grow even if the current CEO is not at the helm. 

Crystal Ball Gazing 

I think that maintaining growth in book size would not be a challenge for the company. The company has been growing at a rate of ~45% per year for the previous 3-4 years and should manage to grow at ~40% for next 2 years. PNB housing finance, which is not listed, has grown at a rate of ~70% over the same period. It is the strength of an existing network of the parent bank across the country that makes this kind of growth possible for Can Fin and PNB Housing Finance. Can Fin should comfortably meet the guidance of 11,500 crore book size in March 2016 and 16,000 crores in FY17. The number of branches has increased from about 45 in FY12 to 110 at present. Earlier Can Fin was a Bangalore based lender, but now it has branches all over the country. Post FY16, the branch increase should stabilize and post FY 17, the book should grow at the organic rate of 20-25% per annum.

Profit margins are harder to predict, but it should improve given that the company is increasing the portion of higher yield loans like LAP. Right now the interest rates are also very high, which puts pressure on margins. The ROA is 1.2% at present. It has declined from 2% about 2 years back due to the cost of rolling out new branches. It takes 9 months for Can Fin to breakeven a newly opened branch. With gradually decreasing pace of opening of new branches, the RoA should keep on increasing till FY17. RoA should cross 1.5% by FY16. More aggressive home finance lenders have RoA of 2.5% to 3%. However, I would prefer a less aggressive, but high asset quality lender to invest.

The Numbers

Let’s look at around March 2016, where there is good visibility. After 18 months, (June 2016)

Book Size = 12,000 crores                             a

RoA = 1.5%                                                    b                     

Profits = 180 crores                                         c = a*b

Pessimistic Scenario (P/E Ratio of a slow, inefficient PSU with poor customer service)

P/E Ratio = 12x                                  d

                Valuation = 2160 crores                 e = c*d

                Number of shares = 3 crores           f

                Price per share = 720                      g = e/f

Conservative Scenario (base case - P/E Ratio at a discount to average for HFCs)

P/E Ratio = 16x                                 

                Valuation = 2880 crores                

                Number of shares = 3 crores      

                Price per share = 960                     

Optimistic Scenario (optimistic but quite possible – P/E ratio at average of the better firms in HFC sector)

P/E Ratio = 24x                                 

                Valuation = 4320 crores                

                Number of shares = 3 crores      

                Price per share = 1440

Right now, the holding by P/E funds and institutions is only 2-3%, when it grows big enough to get their interest, or if the company does a QIP in FY 17 to raise funds the P/E ratio can go to much higher than the current level. To give you an idea of the possible upside, let’s consider their loan book target of 16,000 crores for FY17, that is, after about 2.5 years.  Let’s consider RoA of 2%, which is possible given higher presence of non-salaried class where interest margins are more than double. That gives profit of 320 crores. At average sector P/E of 24x, the company would be valued at 7,680 crores, that is, share price of over Rs. 2500.

Upcoming Rights Issue might cause volatility in stock price, but do not forget to subscribe:

Can Fin has ~2 crore shares issued and subscribed. Current share price is Rs. 500. In January rights will be given to existing shareholders to acquire new shares. We do not know the number of shares and the price, but the approval is for issuing 1 crore shares and mopping up Rs. 300 crores. This works out at Rs. 300 per share and the right to acquire 1 new share for 2 existing shares. Let’s say that rights shares are given at Rs. 350, then the investor who uses his rights will have 3 shares for Rs. 1350, that is, his cost would be Rs. 450 per share.   

Even the pessimistic scenario of Rs. 720 per share corresponds to a return of 60% after 18 months. Infact, it is very hard to think of something reasonable that can make one lose money if one can keep invested over a 2-5 year kind of time horizon. This is why I like Can Fin so much, although other companies might give higher returns in a bull market.

(It is interesting why equity is being raised by rights and not QIPs. Can Fin said that they want to infuse money by rights and not QIP, because they do not want other institutions to poach their company. They have mentioned in the draft document that they would acquire the balance rights shares if some existing shareholders do not pay to buy their rights shares. The shareholding of Canara Bank would go up after rights issues. It is noteworthy that Canara Bank is infusing equity in Can Fin while they are short of equity themselves.)    

Risks that I can see

Ilango is on a deputation from Canara Bank and his tenure got over this year. He has been given extension in Can Fin till July 2015 and the management has said that the matter of his further extension will be taken up with Canara Bank at the right time. Canara Bank has been supporting Ilango to create valuation for them and given that he has 2 more years of service left, it would be foolish to remove him from Can Fin. But, no one knows the future. Ilango has computerized all the branches and put good systems in place including hiring contract employees. But, it is possible that in case he has to leave early, the operations would be adversely affected.

In case Government says that they will fund all the equity for PSU Banks to meet BASEL III, then the motivation of Canara Bank to monetize Can Fin might disappear. But, considering the amount of money that would be needed by the Government, it looks unlikely to me.  

Disclosure J 

(I had written the following for my friend.) 

I am heavily invested in this (relative to my poverty level) and hence my views will be very biased. Take a look at it and let me know the potential risks that you can think of. I have some research reports if you want. You might want to watch the latest interview of Mr. Ilango.

http://www.moneycontrol.com/news/business/if-approved-see-rights-issuejanfeb-can-fin-homes_1236158.html “Our loan book size is growing at 44 percent and our bottomline is growing around 20-25 percent via net interest income (NII). We will maintain the gross NPA .25%, but incidentally we would like to add that we are striving hard to reduce it still further and our asset quality and we have strengthened our follow-up mechanism. In fact our branch managers, everybody has been given an extra sensitization on this subject because Can Fin Homes means asset quality is the number one strength, which we will maintain in future also because we are ahead of others in the industry. We will maintain the number one position in the future also. I do not see any pressure.”