The Hindu Business Line : Cash registers ringing for finance sector

IN June 2004, Business Line made out a case for the languishing finance sector. The inspiration for that article was the assessment of the finance sector by Mr Ruchir Sharma, portfolio manager of Morgan Stanley Growth Fund, in a newsletter in 2002.

He had then remarked that finance sector valuations were way below that of developed markets. Since then, the valuations of finance stocks have simply shot through the roof. They now reflect the value of growth stocks, in line with the expected above-average returns that the sector is likely to generate.

A great deal of care, analysis and patience may now be needed to generate returns from this sector. Consolidation is inevitable. It may not necessarily happen through mergers and acquisitions. Changes in market share, which would force some companies to wind up operations, may be more common than acquisitions.

Outsized returns: Over the past year, market capitalisation of a set of 65 finance sector stocks has risen by 78 per cent. These returns are without including the stupendous increase in values of newly listed finance sector stocks, post-listing, such as Indiabulls, IL&FS Investsmart and Yes Bank. Post-listing, the stock of IDFC would only add to the growing weight of this sector.

Estabished companies did better, too. For instance, a portfolio of 10 stocks recommended by Business Line in June 2004 has appreciated more than 150 per cent. Stocks featured in June 2004 were: Bajaj Auto Finance, Birla Global Finance, Cholamandalam Investment, Geojit Finance, GRUH Finance, IL&FS Investment Managers, PNB Gilts, Reliance Capital, Sundaram Finance and Tata Investment Corporation.

Even without further appreciation in stock prices, the weight of this sector in the market can only rise. This is because there are more unlisted finance sector companies than you can count. There are a few large unlisted, profitable finance sector outfits in segments such as asset management (UTI Mutual Fund), insurance (Life Insurance Corporation, General Insurance) and banking (Nabard).

There are also several , relatively smaller, unlisted profitable finance sector outfits such as Bharat Overseas Bank, IL&FS and Karvy group. One also has to reckon with subsidiaries of firms such as HDFC, SBI, ICICI and Kotak. There are also a number of foreign bank-promoted outfits. If these entities seek listing, then the weight of the finance sector in major indices may well cross 25 per cent.

In this backdrop, it would be unreasonable to expect further re-rating of finance sector outfits. Earnings growth powered by market share gains would principally drive stock prices. Existing listed companies may well have to give up some of their gains to accommodate some of their unlisted peers.

The time has come to book profits, at least partially, in a number of finance sector stocks.

These include HDFC Bank, Reliance Capital, Bank of India, Birla Global, UTI Bank, Corporation Bank, IL&FS Investsmart, Karnataka Bank, Oriental Bank of Commerce and Cholamandalam Investment.

Public vs private sector: In the finance sector, stock-picking inevitably boils down to a comparison between public sector and private sector outfits. Efficiencies and competitiveness of private sector firms forced many to stick to the latter in stock-picking. This stereotyping may no longer prove useful.

A number of public sector outfits such as Punjab National Bank, UTI Mutual Fund and LIC have demonstrated their ability to stand up to competition from private sector outfits. They have used their size and reach to grow their business and stay profitable.

Their competitiveness has not been eroded at all. At the same time, private sector outfits have been diligently gobbling up market share, quarter after quarter, year after year.

Rather than their shareholding pattern, strength of the business model may well be the clinching factor in deciding which among the more than 100 listed finance sector firms make it to your portfolio.

Based on factors such as earnings growth, valuations, return on net worth, business model, size of operations and attractiveness as an acquisition candidate, the following ten stocks are recommended for the next 12 months: Geojit Financial, GRUH Finance, HDFC, Indiabulls, Karur Vysya Bank, Punjab National Bank, Shriram City Union, State Bank of India, Tata Investment Corporation and Union Bank of India.

In this list, except HDFC and Indiabulls, the price to earnings multiple of other stocks is below that of the market.

These companies could, however, deliver earnings growth of about 10 per cent per annum over a longer term, enough to build value for your portfolio.

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