Proprietary RISQ valuation framework for NBFCs: IIFL Capital Services

12 Oct 2023 , 10:54 AM

NBFCs are trading in the wide valuation range of 1.5-6.0x FY25 P/B and market implied perpetual growth rates of 6-12%. Therefore, it becomes imperative to look beyond 2-3yr growth/ROEs forecasts. Consequently, analysts of IIFL Capital Services have developed a proprietary Residual Income with Qualitative Scorecard (RISQ) framework to value NBFCs’ ability to deliver long-term growth and profitability at scale. For this, analysts of IIFL Capital Services first calculate fair value of a stock using the Residual Income valuation method, to capture long-term quantitative value of the stock. Then, analysts of IIFL Capital Services apply requisite premium (0% to 15%) based on their asset and liability ranking as per their qualitative scorecard (RISQ ranking) to arrive at their TP. On analysts of IIFL Capital Services scorecard, BAF ranks the highest on their RISQ ranking (asset and liability). MMFS and LTFH score high on liability score (parentage), followed by SHFL (diversified funding, AA+ credit rating). On the other hand, SHFL ranks ahead of MMFS, LTFH and Fusion on asset score (competitive intensity, product and customer segment and historical underwriting track record).

Need to assess NBFCs beyond 2-3 year estimates 

NBFCs are trading at 1.5-6.0x FY25 P/B and market implied perpetual growth rates of 6-12%. Hence, it becomes imperative to assess NBFCs on many parameters not traditionally captured in 2-3 year forecasts of growth / ROEs. Apart from growing profitably, long term growth for financials is also dependent on the ability to scale and manage liability side of the balance sheet.

Liability: Looking beyond COF 

NBFCs, being wholesale funded entities, are vulnerable to cycles irrespective of whether the asset side is retail / wholesale. This has been evident during multiple cycles in the past: taper tantrum of 2013, IL&FS crisis and the early phase of the pandemic that forced many lenders to raise equity capital, etc. Post IL&FS, there was clear credit differentiation prevalent in the wholesale bond markets, with NBFCs not having strong corporate parentage seeing their cost of funds rise dramatically. For instance, SHFL and PEL saw their spreads over peers expand from 15-70bps pre-IL&FS to ~200bps.