Equity Investments

Potential stake sale in PNB Housing Finance- Here’s what investors needs to know

PNB Housing Finance’s stock surged earlier this week on reports that HDFC and Kotak Mahindra Bank are planning to buy a controlling stake in the company although both later denied such murmurs.

This comes at a time when market already has been abuzz with talks about an impending stake sale by private equity (PE) firm Carlyle Group and  Punjab National Bank in PNB Housing Finance.

PNB holds 32.96% in the housing finance company. PNB Housing Finance is a key subsidiary of PNB with market capitalisation at around Rs 20,000 crore, just a tad below the bank’s market cap. In an attempt to shore up the capital, the bank is looking to sell non-core assets. The board, in its meeting on June 8, approved of stake sale in PNB Housing, ICRA, CRISIL and BSE.

As per media reports, PE firm Carlyle’s 33% stake is also on the block. So, given the total supply of 66%, speculation on the potential buyer will be abound.

HDFC scouting for inorganic opportunities

HDFC, the largest mortgage player, raised Rs 13,000 crore capital in January 2018. It intends to utilise Rs 8500 crore to maintain its stake in HDFC Bank (that is raising capital as well in view of its promising growth outlook) and use rest for organic or inorganic growth across different businesses.

Earlier this year, HDFC explored buying a controlling stake in Can Fin Home Finance as Canara Bank intended to offload its 30% stake in the mortgage lender to augment capital. HDFC has an affordable housing finance subsidiary in form of Gruh Finance. However, geographical and customer segment diversification could have been the reason for considering Can fin homes. While Gruh is Gujarat based and lends mainly to self-employed segment, south based Can fin homes focuses on salaried customer segment. Despite the complimentary business profiles, the deal failed to materialize.

Could PNB housing be a good strategic fit for HDFC?

HDFC in its board meeting in December 17 had clearly indicated its intent for organic and inorganic growth in the affordable housing space. Individual housing loans constitutes 56% of PNB housing’s loan book. Within the same, we believe, the exposure towards affordable housing will be limited. As such, PNB housing is not a good fit for HDFC’s affordable housing expansion plans.

Secondly, PNB Housing has average profitability with return on assets (RoA) at 1.6% for FY18. The lender’s profitability has been primarily impacted by the average net interest margin (NIMs) and high operating costs. While NIMs are expected to benefit from the relatively high proportion of higher-yielding non-housing loans however, this will be partially offset by the impact of high competition on yields in the salaried housing loan segment. Operating cost can improve as it scales up the loan book. So, while there are levers for profitability improvement, a lot hinges on the lender’s ability to manage asset quality going ahead. Its loan book is inherently risky given the chunkier non-individual portfolio and relatively high share of self – employed people in the individual portfolio and needs to be tested through a business cycle.

In contrast, HDFC’s profitability on lending business is relatively better with core RoA over 1.9% for FY18.

So apart from increase in market share and exposure to fast growing self-employed segment, HDFC doesn’t stand to gain much if it buys PNB housing, the fifth largest mortgage lender.

PNB Housing’s current valuation – a big deterrent

PNB Housing’s current valuation could also be the big impediment for HDFC to consider the stake in the lender. At the current market price, PNB housing is trading at 3.2 times trailing book. In comparison, HDFC’s core lending business is getting value of 2.7 times trailing book. In terms of forward multiples also, HDFC is relatively cheaper at 2 times FY20e core book  vis-à-vis PNB housing at 2.3 times FY20e book. Acquiring PNB housing can undoubtedly consolidate HDFC’s market position, but the latter is unlikely to pay premium value for the same.

While the well-entrenched players like HDFC may not overpay for PNB housing, the financial investors or a new entrant could actively look at PNB housing.

What should investors do?

We believe investors will be better off by staying away from speculation on the potential stake sales in PNB housing and instead consider HDFC.

While HDFC’s headline valuation seems on a higher side, the core lending business is trading at a significant discount to its historical average. One of the argument for the lesser valuation is the fact that HDFC’s core earnings growth in mid-teens is lower in comparison to that of PNB housing and many other smaller housing finance companies (HFCs) that are reporting earnings growth of over 25%. But remember other HFCs are growing on low base. We believe HDFC’s ability to deliver consistent performance across rate and growth cycles in spite of its large size and high competition commands premium valuation. Moreover, there can be immediate upside trigger from value unlocking through proposed listing of HDFC asset management company (AMC).

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