Bajaj Housing Finance is down 15Percent from its high. Is it time to own it?

In another article, we concluded that the stock was overvalued. Realizing the same (maybe not), or perhaps due to overall market volatility, investors dumped BHFL stock. This led to a 25% correction. Currently, it is trading at 15% from recent highs.

As a result, its valuation has dipped to 8X from a high of 9.6X.

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Is it undervalued now?

Housing finance companies (HFCs) are different. An HFC can rack up non-performing assets (NPAs) in tough times. However, it may not lose much money since the collateral is a physical property. The lender can sell these in the market at fair prices, albeit with some delay. High NPAs have other consequences for an HFC. They raise borrowing costs, create a need for growth capital, and hurt competitiveness.

In short, you would have to work very hard to ruin a housing loan book.

This “safety" feature of housing finance makes it attractive. This might explain the higher price-to-book values of some top players. But that’s not all; growth is important too, as is profitability—return on equity (RoE).

But, quantitative factors alone do not justify a price-to-book ratio of 8X.

Prabhakar Kudva, co-founder and director at Samvitti Capital Pvt. Ltd, has an interesting framework. It explains why some companies trade at higher valuations than their peers.

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He calls it TRAPP, an acronym for:

1. Trustworthiness: Does the company have a clean track record? Or one full of corporate governance issues?

2. Reliability: Does the company have a perfect execution record? Or a spotty one?

3. Age: How long has the market known the stock? How well does it know the business's behaviour across cycles?

4. Potential: The future.

5. Pedigree: Promoter/parent company pedigree.

Many, including myself, are astonished by the 8-10X price-to-book value that BHFL received. But if we apply TRAPP, we begin to understand why BHFL deserves a premium valuation over its peers.

There are few companies as Trustworthy as Bajaj Finance in the lending space. Bajaj Finance traded at 13X price-to-book value at various points during the last 10 years. Because BHFL is a subsidiary of Bajaj Finance, it enjoys the same/similar trust factor.

There are few companies as Reliable as Bajaj Finance in the lending space. Some of the halo effect is passed down to BHFL. Also, BHFL's growth is impressive. Its NPAs are best-in-class.

Bajaj Housing Finance is young—it just got listed—but the market knows the housing finance space well.

For more such analysis, read Profit Pulse.

Potential for housing finance and Bajaj Housing Finance is attractive. The Reserve Bank of India's (RBI) sectoral data shows the housing loan market is worth ₹28 trillion ( ₹24 trillion excluding HDFC Ltd). BHFL's outstanding loan book is ₹97,000 crore as of June 2024.

It includes a large chunk from the banks, which have lower home loan rates. So, the ability to compete will depend on a more granular understanding of the segment. But, it would be hard to argue that a well-run HFC cannot grow at much higher rates than the industry.

The promoter Pedigree of BHFL is top-notch. Few business groups have a track record as enviable as Bajaj Finance.

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The TRAPP framework explains why a premium valuation might be appropriate. Of course, these factors are qualitative. They can change, just like quantitative factors. But they do a better job of explaining why Bajaj Housing Finance trades at a premium.

But how much premium over other HFCs is justified? That is a completely different question! Should it trade at more than 2X of Aavas Financiers? Aavas has the next best asset quality after Bajaj Housing and Can Fin Homes.

Aavas Financiers, Aptus Value Housing and Home First are affordable housing lenders. Their ROE is around 15%, the same as Bajaj Housing Finance.

Their growth potential is also similar, if not better.

For example, Home First had a 40% profit after tax (PAT) growth over the last two years and an RoE of 15.5% in 2023-24. It’s true Bajaj Housing Finance has a near-perfect gross NPA of 0.22%, but eventually, RoE is what matters.

If an affordable housing player can match Bajaj Housing's RoE and growth, why should it trade at more than 8X?

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Why should it trade at nearly double the P/B of many well-run affordable housing firms?

The TRAPP framework shows why a premium might be justified. It does not specify how much of a premium is justified (nor was it intended to).

Another view is that strong IPOs and higher retail interest are driving valuations. Large investors have not yet exercised their lock-ins. Anchor investors can sell 50% of their shares in 30 days from the allotment date, which is 12 October 2024. They can sell the rest 90 days after the allocation date. It will be interesting to see how the stock performs on these days.

In short, a 15% drop from high valuations does not change much.

Note: We have relied on data from www.screener.in throughout this article. Only in cases where the data was unavailable have we used an alternative but widely used and accepted source of information.

The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educative purposes only.

Rahul Rao has been investing since 2014. He has helped conduct financial literacy programmes for over 150,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an AIF, focusing on small- and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.

Disclosure: The writer and his dependents do not hold the stocks discussed in this article.