REPCO HOME FINANCE LIMITED (RHFL): VALUE TRAP OR REAL VALUE?
Repco Home Finance is a Housing Finance Company (HFC) which began operations in 2000 and is headquartered in Chennai. It is a subsidiary of Repco Bank.
The company caters to the retail and affordable housing segments. Geographically, the company’s business is concentrated in Southern India.
The company’s key offerings/business segments are:
- Providing Long Term Housing Finance
- Loans against Property (LAP)
- Refinance Loans
The Housing Finance market is dominated by pure-play Housing Finance Companies as well as traditional public and private banks. There is significant competition across major cities where all these companies tend to co-exist and compete heavily.
Considering its size, Repco Home Finance would not stand a chance if it were to directly compete with the industry heavyweights (think HDFC, KOTAKBANK, SBI, LICHSGFIN etc).
Repco Home Finance has tried to differentiate its value chain by targeting low and middle income retail customers in Tier 2, 3, and 4 cities. Repco Home Finance’s customers are employed by / or own SMEs and MSMEs in these cities/towns. Most of these customers are unsalaried.
The large exposure to SMEs and MSMEs and the significant unsalaried customer base does increase the credit risk for the company. However, by catering to these riskier customer segments in relatively underpenetrated / localized geographies, the company is able to avoid cutthroat competition and earn higher yields for the increased risk that they take on.
AAVAS Financiers is another regional HFC catering to the low and middle income segment in Western and Central India with Rajasthan being their primary area of operation. Both AAVAS and Repco Home Finance have similar costs of borrowing (8.44% and 8.2% respectively). AAVAS has enjoyed higher spreads due to charging a higher interest rate on the loans disbursed.
I believe Repco Home Finance could improve spreads going forward since they currently operate from a lower base spread.
** Although comparing HFCs may not be correct due to differing business models, AAVAS’s business model is similar to Repco Home Finance’s.
Repco Home Finance has around 179 points of presence across India with most of them being concentrated in the key geographies (as mentioned above). The company believes in face-to-face meeting and assessment of the customer’s profile before a loan is sanctioned and disbursed. By doing so, the company is able to develop a certain level of trust with the customer which leads to repeat business for the company. It is also believed that personal interaction with the customer leads to better judgement and hence lower NPAs.
Due to their presence in Tier 2, 3 and 4 cities, the company enjoys lower rental costs as compared to their urban peers. Furthermore, the company has a policy of maintaining an optimal headcount at their branches (no more than 5 employees per branch). Hence, lower rental costs and optimal staffing policies allow the company to maintain a lean operating structure.
The company actively pursues different customer acquisition techniques.
- Loan Camps – Organized by branch managers every 2-3 months. This activity is responsible for over 35% of customer acquisitions.
- Direct Selling Agents (DSA) – Responsible for over 18% of customer acquisitions.
- Customer Walk-Ins / Referrals / Repeat Business from Older Customers.
Up until demonetization, the company’s asset quality was relatively stable. However, post demonetization, the company has suffered on the asset quality front due to higher lending to the unsalaried segment and higher exposure to Loans against Property (Real estate market has fared poorly). Both these segments were the hardest hit due to demonetization and this led to a sustained rise in NPAs. Today, the higher NPAs are due to the lending decisions made in the past.
The management has been very transparent regarding these asset quality issues and has actively worked towards rectifying these mistakes. They have followed an active policy of controlling the loan book mix by trying to increase exposure to salaried segments and reducing exposure to LAP and unsalaried segments. Furthermore, the company has set up two Asset Recovery Branches (ARB) in Chennai and Bangalore. These branches will focus on Stage 3 assets as well as potential Stage 2 assets moving into Stage 3. ARB’s efforts will be solely on controlling and helping the recovery of these assets.
The company has worked on reducing Stage 1 and Stage 2 assets thereby shrinking potential Stage 3 assets.
- Stage 1 Assets – Reduced from 5% to 1% of Loan Book
- Stage 2 Assets – Reduced from 12% to 2.3% of Loan Book
As of today, the Stage 3 Assets (Gross NPA) constitute roughly 4% of the portfolio with a coverage ratio of 41%.
Furthermore, the company maintains a low Loan-to-Value of 53.4% which does provide further comfort on the asset quality front.
The Covid-19 pandemic has significantly affected the economy, especially the urban economy. The rural economy (on an isolated basis) has fared relatively better, however, SMEs and MSMEs whose fortunes were tied to the urban economy have faced significant trouble.
Unfortunately, I am unable to ascertain the exact impact on Repco Home Finance’s client base. From what I do know, Repco Home Finance has not opted for moratorium against its repayments to its lenders.
The company has provided moratorium to its borrowers. As of November 2020, roughly 4-5% of their borrowers had not paid any EMI under the moratorium. Collection efficiency has improved dramatically to 93% from 65% in the earlier months. The company expects to take a credit loss of around INR 214 Crs due to the Covid-19 pandemic. However, with the arrival of the vaccine, the actual losses should be lower.
Opportunities for Growth:
- Favorable Policies
- GST Cuts – GST has been slashed on under construction properties from 12% to 5%, and on affordable housing from 8% to 1%
- Pradhan Mantri Awas Yojana (PMAY) – This initiative was developed by the government to address the significant shortage of affordable housing in urban areas
- Budget 2021 – Priority on affordable housing, Tax exemptions for the Real Estate sector
- Other Drivers
- Rising affluency in semi-urban and rural areas paired with nuclearization of families
- Relatively underpenetrated market – Mortgage to GDP ratio of sub 10% in India which is significantly lower than other developing / developed countries
- The arrival of the vaccine should ease the revival of the economy
- Prolonged Economic Slowdown
- Demonetization Impact still exists in certain areas.
- Covid-19 pandemic induced slowdown has affected the low and middle income segments a lot more (especially SMEs, MSMEs, and unsalaried).
- Subdued Realty Market in the past few years has caused concerns for Loans Against Property (LAP).
- Repco Home Finance has significant exposure to unsalaried and LAP segments, hence, it is highly likely that increasing number of loans could go bad and asset quality could worsen. However, the company is adequately capitalized and has a strong liquidity position and hence fresh equity raises are unlikely to be required.
- Company’s ability to raise funds at competitive rates could be hampered if its rating is downgraded due to worsening asset quality and declining profitability. This downgrade in ratings will push up the cost of borrowing thereby shrinking spreads and further dampening profitability.
- The company is heavily reliant on Tamil Nadu for the bulk of its business. This geographical concentration poses a risk due to high impact of any adverse regulations brought about by the Tamil Nadu government.
- Intense competition in some geographies from larger banks, microfinance banks, and other HFCs.
- Interest rate risk.
The Indian Home Loan Industry is expected to grow at a rate of around 15-20% over the next 5-6 years, however, Repco Home Finance will grow slower due to a greater emphasis on asset quality protection.
The increased write-offs (probable) due to elevated legacy NPAs and additional Covid provisions will lead to lower profitability (lower ROE) over the next few years.
Repco Home Finance is well capitalized and will continue to maintain high Capital Adequacy Ratios of 26-27%.
My intrinsic valuation for Repco Home Finance is INR 407.11 which is well above the current market price of INR 256.
Based on my narrative, Repco Home Finance seems undervalued by about 59%.
It’s worth noting that the stock has nearly tripled since March 2020 (from a low INR 90.35) and thus could consolidate for some time. On the flip side, the stock has collapsed from an all time high of INR 924 (June 2017).
I believe that despite the riskier lending base and the elevated NPAs, Repco Home Finance is well capitalized and hence its precipitous fall is unfounded. It seems that Repco Home Finance offers ‘Real Value’!