Does Bajaj Housing Finance deserve a kingly valuation?

Nearly six months later, the stock corrected to Rs 121/share, and the valuations are relatively tamer.

Source: http://www.tradingview.com

If it was overvalued at 10X book value, it is undervalued at 5.7x book value, right? It is not that simple.

Multiple factors contribute to the valuation that investors are willing to ascribe to an HFC. Some of the important ones are:

• Good asset quality (low GNPA – gross non-performing assets)
• Profitability (ROE – return on equity)
• Growth in EPS – earnings per share or BVPS – book value per share.
• Managing risk i.e. – asset quality, is by far the most important in our view.  Let us begin there.

Can Bajaj Housing Finance Limited manage risk?

BHFL’s historical GNPA, the percentage of loans overdue by 90 days or more, is impressive. Despite a spike in FY21, an industrywide phenomenon, GNPA has remained under 0.35 per cent.

This is excellent. I can’t think of any other HFC that had a GNPA lower than this. Can-Fin, one of the most respected HFCs, hit a GNPA of 0.91 per cent in FY21.

Source: Bajaj Housing finance, Q3FY25 Investor presentation.

But BHFL’s Achilles heel could be its unseasoned portfolio. Given the pace of AUM growth (72 per cent CAGR in the last seven years), the bulk of the book is less than 2-3 years old and may not reflect the true underlying portfolio quality. This could potentially lead to portfolio issues down the line. Every single NBFC that has imploded grew rapidly before things went bad.

Source: Bajaj Housing finance, Q3FY25 Investor presentation.

One can hope such a fate will not befall BHFL. Let us just hope that the 72 per cent CAGR assets under management (AUM) growth does not hurt down the road.

Along with the currently best-in-class GNPA ratios, BHFL has another advantage most HFCs don’t. It is parentage. The enviable record of Bajaj Finance allows BHFL to enjoy a “trust premium”.

But is it even profitable?

BHFL’s return on equity, a key profitability metric, is trending downward largely because margins have been under pressure due to the increasing cost of funds. However, the management indicated in the last two quarters that borrowing costs have peaked and are likely to trend downward. This view is supported by the fact that rate cuts have accelerated and RBI has switched to a more ‘accommodative stance’.

Source: Bajaj Housing finance, Q3FY25 Investor presentation.

The declining cost of funds, coupled with increasing yields from a higher percentage of lease rental discounting (LRD) and affordable housing finance, is likely to support net interest margins (NIMs) going forward.

It is not just the contraction in NIMs that has led to a deteriorating ROE. ROE has also contracted because the company raised primary capital of Rs 3,560 crore during its IPO, the full impact of which was visible in the December 25 quarter.

Source: Bajaj Housing finance, Q3FY25 Investor presentation.

Going forward, management has guided for a 13-15 per cnet ROE for the medium term. The key levers for ROE (ROA * leverage) include a targeted ROA range of 2-2.2 per cent and a leverage ratio or equity multiplier of 7-8 times. This means that for every Rs 1 of equity capital, BHFL has a loan book outstanding at 7-8X.

So far, so good. But what good is an NBFC that manages risk well but doesn’t grow? Let us see how BHFL is placed on this front.

Growth

BHFL has five business segments – housing finance, LAP – loans against property, LRD – lease rental discounting (borrowing against rental cash flows), developer financing and others.

Together, they make up an AUM of 1,08,314 crore as of December 2024.

AUM growth has been a dizzying 72 per cent CAGR over the last seven years.

Source: Bajaj Housing finance, Q3FY25 Investor presentation.

Along with the currently best-in-class GNPA ratios, BHFL has another advantage most HFCs don’t. It is parentage. The enviable record of Bajaj Finance allows BHFL to enjoy a “trust premium”.

BHFL’s return on equity, a key profitability metric, is trending downward largely because margins have been under pressure due to the increasing cost of funds. However, the management indicated in the last two quarters that borrowing costs have peaked and are likely to trend downward. This view is supported by the fact that rate cuts have accelerated and RBI has switched to a more ‘accommodative stance’.

Leading up to the IPO, LRD and developer finance were growing faster than the overall AUM growth. This is evidenced by the fact that LRD went from 12.9 per cent to 19.6 per cent and developer financing went from 5.2 per cent to 11.7 per cent between FY22 and FY24, respectively, in the overall AUM mix.

In the future, the growth levers are going to be different. According to the management, future growth will likely come from the near prime and affordable housing segment from next year onwards.

The initial focus for the affordable segment will be on purchase transactions (buying loans from existing lenders) in India’s southern and western states, with average ticket sizes of Rs 16-17 lakh.

But this business segment will have its own learning curve. Affordable housing is a different ball game compared to prime housing loans. For one, operating costs are higher, and the NPA profile of this segment is likely to be higher compared to BHFL’s overall NPA profile. So, it is not as simple as it sounds.

An investor interested in the BHFL should keenly track the performance of this portfolio.

Growth is unlikely to be a major concern, it rarely is with lenders. Profitable, sustainable growth that does not blow down the line is yet another matter.

All said and done, the question remains:

Is Bajaj Housing Finance undervalued now?

On a relative basis, it is not. It trades at a significant premium to the so-called “B or C players”, and while its operations suggest excellent NPA management, it is probably too soon to conclude it’s the “best in class risk manager”.

But then again, a better way to look at the business is on an absolute basis. We believe two considerations may justify a high price to book value.

Value and growth – priced in.

First, let us bear in mind that 5.7X is NOT 5.7X because this includes book value only until September 2024 and not for the full FY2025.

Second, if BHFL continues to maintain a low GNPA, have a decent ROE and continue to grow EPS at 24-26 per cent over the next three years, its Book value per share (BVPS) should nearly double.

This means on a forward basis, assuming that BHFL can execute profitably, because very few lenders can, its price-to-book value will be 2.75x, assuming the price remains where it is today.

Barring significant challenges in the underlying business, it appears unlikely, although stocks remaining flat for many years is known to happen all the time.

The downside to this approach – ‘paying up for both value AND growth’ at the outset is that there is no margin of safety.

Sometimes, an investor can end up with EPS growth being “good enough”, say 20 per cent CAGR, but not the originally hoped-for 24-26 per cent CAGR. This can again leave the investor caught in a side-ways trend for many years. Think Bajaj Finance, Think Kotak Mahindra Bank. Think MAS Financial.

Bajaj Housing Finance Limited is neither too expensive nor too cheap. At these valuations, an investor is paying up for both value and growth going in, leaving little room for disappointment.

It may be fairly valued, but that assessment is contingent on your expectations of whether Bajaj Housing Finance can pull off something similar to what Bajaj Finance did consistently. The premium is for the trust and consistent operating performance; the lack of either will hurt valuations.

Note: We have relied on data from http://www.Screener.in and http://www.tijorifinance.com throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.

The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only.

Rahul Rao has been Investing since 2014. He has helped conduct financial literacy programs for over 1,50,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an AIF, focusing on small and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.

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