There is a beautiful passage in Steven Johnson’s Where Good Ideas come from
“Good ideas are like the neo nurture device. They are, inevitably constrained by the parts and skills that surround them. We have a natural tendency to romanticize breakthrough innovations, imagining momentous ideas transcending their surroundings…… We like to think of our ideas as $40,000 incubators direct from factory, but in reality they have been cobbled together with spare parts that happened to be sitting in the garage.”
This passage has a striking resemblance to how I look for new companies to invest, trying hard to find a hidden jewel in an obscure corner outside BSE 500 without realizing that many of them are tangled in many spreadsheets stored on my PC
Let me run you past one such case last year I was reviewing one of my existing positions GRUH Finance and unlike previous years I wanted to review GRUH not only in comparison to itself but to its peers – REPCO and Canfin homes. The reason for picking these two Housing Finance Companies was
- I also had REPCO in my portfolio so I will kill two reviews in a single seating 🙂
- Loan book size was roughly same and they lent to similar customer profile
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I began my doing size comparison and comparative performance
All three companies were growing more than 25% and even with larger base Canfin homes was doing better than other two
Next, I looked into bottom line growth, here again, Canfin homes was doing way better than other two
then I looked at margins GRUH and REPCO had far superior margins compared to Canfin homes, this could have meant few things
- GRUH and REPCO had sourcing advantages (lower cost of financing) or
- Better pricing power or
- Better cost management or
- Simply they were taking undue credit risk by lending to a riskier customer
It could be mix of all above factors so I started looking at net NPA, cost of funds and cost to Income ratio
For all three companies there Net NPA were similar so credit risk was managed well, None of them were expanding loan book at the cost of defaults by lending to a riskier borrower
GRUH and Canfin homes had similar cost of funds cheaper compared to REPCO and still, REPCO had better margins (NIM)
Finally, on cost management, the cost to Income ratio was best for GRUH(Expected on lines of HDFC which is best in industry) but it improved significantly for Canfin homes compared to last year.
So my summary was cost management was leading to better margins for GRUH, for REPCO there has to be some pricing power as their margins are better even when the cost to Income ratio is more than Canfin homes.
Finally, I looked at return ratio to review if there any key takeaways
Both GRUH and REPCO were sweating their assets well, remember a few percentage points difference, on an increasing loan book can make a significant difference to the bottom line.
GRUH has superb ROE (best in industry) and there was a significant improvement for Canfin homes. It was getting pretty late in the night so I plugged few valuations metrics for all three companies and shut my PC to pick this up later sometime.
What did I miss?
Canfin homes was growing at similar pace to GRUH and REPCO, its cost management was getting better its return metrics were improving and still it was priced 1/3 of GRUH and almost half of REPCO
My normal self would have dug deep to understand if REPCO had any pricing power but I relied on my first conclusion from numbers and remained steadfast on my positions
Today as I write this post in a year opening the same spread to update GRUH’s FY17 numbers
Canfin homes is up by 111% compared to 47% of GRUH and only 15% of REPCO.
Almost a year later, CanFinHome stock have deep dived into a slumber, post split of its FV and continues to be a laggard.. the divestment news was also taken negatively by the shareholders… not much news coming from the AGM meets.. or maybe I’ve missed out on the numbers.
Any ideas?
When consistent growth stopped and Promoter wanted to sell out, it is reasonable to expect that price multiples would come down. I never got in so it continues to remain a miss even on downside
very good analysis
Hi Vivek,
Good analysis. Gives a layman a very good start in analyzing HFC’s. Appreciate the effort.
One quick question, has CanFin numbers and ratios shown an improvement from 2013/2014 like it has shown from 2015 to 2016. This will hopefully strengthen your hypothesis.
Many Thanks
Nikhil
Absolutely but every passing year Investor’s perception of business has improved now its no longer 1X or 2X book so returns expectations have to be reset
Vivek, why havent you looked at PNB in your analysis? Considering its geographical reach and the return ratios it looks like it could be the next Canfiin. What you think?
Hi Milind – When I started putting together this excel last year PNB housing was not listed
Nice analysis!
Thanks for sharing. This post is beautifully structured showing how analysis for HFCs should be done – learnt a few things from this.
Given your analytical edge – I’m sure you’ll catch other CanFins whenever the opportunity arises.
Thanks and I am flattered by your kind words
You win some , you lose some 🙂 . In better news , you should be happier when you see Ashiana Housing these days 🙂
Yes Ashiana thesis is playing out well