Kotak Mahindra Fin:A long-term buy

Sanjiv Shankaran

UNCERTAINTY is the theme that dominates discussions about the current state of the stock market. More so after a bit of speculation on the possibility of a slowdown in software sector earnings.

In this backdrop, any company that promises a steady stream of earnings should command a premium to others sooner or later. An unlikely candidate in list of companies that promise to deliver a steady stream of earnings is Kotak Mahindra Finance.

Business: In the core financing business, the company has moved towards retail segments and small entities in addition to financing traditional areas of strength such as commercial vehicle financing.

The threat from the better endowed banks and financial institutions have pushed non-banking finance companies to segments where their better service and understanding of the condition allows them to neutralise the disadvantage of higher cost of funds.

Kotak Mahindra has followed a policy of shrinking its balance sheet (asset growth) during the slowdown of late 1990s. Partly because of the decision to wait out a tough phase and also an efficient recovery mechanism, the company has managed to restrict its total non-performing assets (NPAs) to 1.62 per cent of its total assets.

Suitability: The factor that may insulate the company, to an extent, from business cycles that adversely impact other financial intermediaries is the income derived from its subsidiaries. Kotak Mahindra's investment banking arm was spun off as a separate company, Kotak Mahindra Capital Company (KMCC), wherein Goldman Sachs has a 25 per cent equity stake.

KMCC is a top rung investment banker that has consistently made profits, a considerable portion of which flowed back as dividend to Kotak Mahindra Finance.

Another subsidiary, Kotak Mahindra Primus (KMP), a joint venture with Ford Credit International, is engaged in car finance. This subsidiary will play a critical role in imparting stability to Kotak Mahindra Finance's earnings because it has agreed to pay Rs 355 crore as royalty between January 2000 and January 2006.

Kotak Mahindra has also made strategic investments in telecom, finance and media companies that may yield big returns in future.

Concerns: Kotak Mahindra is a finance company, a group that has received poor valuation over the last few years because doubts about the quality of their assets, increasing competition and high volatility of earnings. While Kotak Mahindra is among the top end companies in the sector, the relatively low valuation for the sector may affect adversely Kotak Mahindra share price.

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Recommendation: The stock currently trades around Rs 81, leading to a price earnings ratio of 6. At the current level, the stock presents an opportunity for the long-term investor, one willing to wait out the temporary doubts and whims of the stock market.