A Sector that Continues to Surprise

It is often being said that,?“In the business world, the rear view mirror is always clearer than the windshield.”?Relate it with the experience, observation and analysis, that’s how market works, isn’t it?

AIF & PMS Experts India always attempts to manifest sessions which are pre-eminent and above the canon. One such session has been witnessed which was curated with?Mr. Vikas Agrawal?(MD & CEO, AIF & PMS Experts India) and?Mr. Saurabh Mukherjea?(Founder & Chief Investment Officer,?Marcellus). The?Blue Collar of Dalaal Street?have authored the book “Coffee Can Investing” along with his colleagues. The symposium was ablazed while onlooking their discussion on the topic – “A sector which continues to surprise – BFSI”. Let us gleam into their articulation which have attracted the curiosity of the attendees.

A Bird’s View

Financial sector has been the emissary of Indian Economy! It can be witnessed from the undeviated relationship between them. Besides having a roller-coaster ride, the BFSI sector has been onlooking round the clock speculation and remained the talk of the town! The more the Financial sector is interlinking with the technology, the more it is upsticking towards the growth.

Why Financialization is so dynamic!

Taking a glimpse on why the world talks about this sector?

Out of 80% companies of the Indian stock market, there is no free cash flow. By free cash flow we mean, the excess money that the company generates in excess of it’s cost of capital.

Putting this into formula: Free Cash Flow = Return on capital – Cost of Capital.

Due to scant capital, be it NIFTY or BSE500, the earnings growth is close to zero. This is the reason why investing in high quality financial stocks during a crisis gives multiple benefits over others.

Also, nobody wants to invest in such companies who steals money from the home country. Because if we do so, our money will end up being in some countries like in Dubai, in Swiss Banks etc. So, it becomes necessary to identify the companies who have in-rooted and have strong hold in the market. What makes a difference if we do not do so is, we will end up having no money!

A study evinces that, 99% of the companies are failures because they fail to beat the competition and cannot survive it. If one cannot beat the competition, generating return on capital above cost of capital becomes over sighted.

Potentiality of monopolization of Financial services sector?

How striking is it that financial services sector is the only sector which has not been monopolized yet! However, 25% of our country’s economy and 35% of the stock market consist if this sector. Professionals see a wide slot of monopolization in this sector in the near future. Let us see why!

In case of banks, 655 of bank loan outstanding in India are from PSU Banks. We know that PSU do not really make money, they return on equity of SBI. The return on equity of SBI has been below their cost of equity for last 20 years. Suppose, if an individual files his income tax return at the end of the year, his money will be shown in the balance sheet of SBI. So, in case the share of PSU bank drops, it will let the private bank expand their market share. A simple calculation is that, in 16 years, KOTAK bank has given 180x returns but it’s market share in Indian banking is just 3%. If this 3 hikes to 5% over 10 years, everybody can expect a compounded return of 20% just by pulling 2% of Market share of PSU banks. Isn’t that astonishing! And at that very time, the government will not have the money to save the PSU banks which will make private banks to take an edge.

?Even if you take?NBFC?as an example – There are 10000 NBFCs in the country and around 70-80% NBFCs are frauds. It means that around 7000-8000 NBFCs are manipulative and are window dressed by auditors, Credit rating agencies and debt mutual fund managers. However, there has been arrangements made to attack these manipulations. Ministry of Corporate Affairs have provided a watch dog for the auditors, Credit rating agencies have become more strict and SEBI has made a cap of 25% on NBFCs. Due to this, manipulative firms/NBFCs have lost funding and well run NBFCs had the money. Taking an example of Bajaj Finance, the funding gap became so wide that it’s competitors started getting everything at an extra penny. This is the hint of visibility of monopoly in the handful of lenders.

Edge for High Quality Banks and Lenders!

Visualizing a general phenomenon from history, during a crisis, NPA doubles and PE Ratio halves. Investing in high quality stocks during a crisis gives edge over others. Even in world-wide pandemic, it is being observed that high quality banks has been growing deposits at 20-25%.

Also,High quality lenders have access to funding, liquidity and are well capitalized. For the reason that they main discipline, the increase in NPAs for high quality lenders is not proportional to the increase in case of the whole industry. Post the crisis, as the competition fades away due to several reasons like not having enough funding, NPA issues in balance sheet, do not have access to liquidity etc. high-quality banks like are able to pluck the borrowers of their choice. They will also be able to charge desirable interest rate due to which net interest margins will expand which will improvise the asset quality which in turn will improve the returns on equity.

On the other hand, high quality lender gains the market share which leads to better growth. This improves their ROE (asset quality), which eventually normalizes their PE Ratio over a period of time.

Marcellus talks about “Kings of capital” – Financial Services focused fund

While the colloquy continued, Mr. Sourabh Mukherjea talked about?“Kings of Capital”?which is a?Universe of 95 stocks?above of 1000 crores in financial services (Banks, NBFCs, Insurance, Brokers and asset managers). They apply different filter over these stocks, like they list outs the companies with poor quality accounting, capital allocation filter is run, they list in the companies which generated consistent return on equity over the cost of equity and at last, the research team looks if these companies have high barriers to entry, sustainable competitive advantage by communicating with branch managers, existing management teams, collection agents, brokers etc.?These all, in conjunction ends up with a 12-stock portfolio! The synergistic session continues with top-drawer Q&A round which is definitely not worth missing! Below has been provided the link for the video which will connect you with both the finance aficionado over YouTube.

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