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18th June 2014
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Repco Home FinanceShiv Puri
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- Repco provides housing finance to "self-employed" customers in the Tier II and Tier III towns with an average ticket size of $10,000. It has a total loan book of $760mn on 70,000 units.
- The Modi government has an ambitious target of "housing for all" by 2022. Today, there is a shortage of 65 million housing units in the country - 20 million urban units and 45 million rural units, which is expected to increase further over the next eight years unless the supply side is not addressed.
- Home mortgages are underpenetrated in India, with mortgage to GDP ratio of only 8%, vs 15% in China and 30%-40% for other Asian countries. If the government were to achieve 60% of their goal by 2022 and even if, on a very conservative basis, only 60% of these new units were to be financed, outstanding housing loans would grow from $150bn currently to over $900bn by 2022, which is a 6x increase or a 25% CAGR over 8 years, assuming house prices rise in line with inflation.
- The competitive environment for Repco is low as the big players find it too cumbersome to underwrite small ticket loans outside metro or tier 1 cities, especially when the customer does not have a monthly salary in the traditional sense. Repco will mostly compete with and displace the unorganized money lenders who charge interest rates ranging from 36%-48% per year.
- While the likes of HDFC will continue to do very well, we believe lenders into mass market housing in India, such as Repco Home Finance (where the customer may be a farmer or daily construction worker or truck driver, or any category outside the formal salary structure) will do even better.
- We found was that their process for disbursing a loan (evaluating the title of the property, evaluating the personal profile of the customers, visiting the customer's business premises, capping LTV @ 65%, holding loan officers accountable for collections, et al) is similar to the best of breed large housing finance companies like HDFC.
- The stock trades at 2.5x forward adjusted book and 15x forward earnings. The valuations are only slightly higher than the market average, despite having significantly higher growth potential, business quality and return metrics.
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The Modi government has an ambitious target of "housing for all" by 2022. Today, there is a shortage of 65 million housing units in the country - 20 million urban units and 45 million rural units, which is expected to increase further over the next eight years unless the supply side is not addressed. The key supply side issue for low cost housing is land clearance. Affordability is generally there. Given the bureaucratic reforms underway, we expect this initiative to gather steam this year and low cost or mass market housing will likely grow exponentially in the years to come. The development of these houses would also provide a significant boost to housing related sectors such as cement, paints, furniture, tiles, adhesives, etc. At the same time, this would require large investments in developing infrastructure such as public transport, water and sanitation. The trickledown effect of this one program can be enormous.
One of the biggest beneficiaries would be the housing finance companies. Home mortgages are underpenetrated in India, with mortgage to GDP ratio of only 8%, vs 15% in China and 30%-40% for other Asian countries. If the government were to achieve 60% of their goal by 2022 and even if, on a very conservative basis, only 60% of these new units were to be financed, outstanding housing loans would grow from $150bn currently to over $900bn by 2022, which is a 6x increase or a 25% CAGR over 8 years, assuming house prices rise in line with inflation. Even after that, mortgage to GDP ratio for India in 2022 would still be 20%, much lower than other Asian countries today.
The housing finance market is dominated by three banks - SBI, ICICI and Axis, and two housing finance companies HDFC and LIC Housing. These five companies combined account for over 55% of the total housing loans outstanding. These companies largely focus on the middle to upper class segment with average ticket size of over $30,000. Their target market is the salaried customer in the top 50 cities. While the likes of HDFC will continue to do very well, we believe lenders into mass market housing in India, such as Repco Home Finance (where the customer may be a farmer or daily construction worker or truck driver, or any category outside the formal salary structure) may do even better. This is because a huge supply of housing units will come in this market and the competition to lend here is limited.
Repco provides housing finance to "self-employed" customers in the Tier II and Tier III towns with an average ticket size of $10,000. It has a total loan book of $760mn on 70,000 units. It is not hard to imagine this company at some point over the next decade having a 3% - 5% market share. That would imply it can finance around 1.5 - 2 million units. In other words, the size of the loan book can grow by many multiples. In reality, it might grow a little slower to be mindful of credit quality and other risks but such is the magnitude of the opportunity. (Note HDFC grew its book 60x over the last 20 years)
While the market opportunity is immense, the key challenge is credit underwriting risk. For the self-employed, the informal source of income makes it difficult to understand the credit worthiness of the customer. During our due diligence of Repco, we visited several of the company's branches across India, spent days conducting a survey of a number of their customers, and spoke to many people within the company. Our goal was to understand the process followed while disbursing a loan, risk management systems in place and the true profile of their customers. What we found was that their process for disbursing a loan (evaluating the title of the property, evaluating the personal profile of the customers, visiting the customer's business premises, capping LTV @ 65%, holding loan officers accountable for collections, et al) is similar to the best of breed large housing finance companies like HDFC. Our interaction with the CEO and the senior management gave us great comfort on their ability and strategy. For example, Repco's strategy for branch expansion is by growing their geographic radius (like Walmart did when it started) and not trying to establish a national footprint by going into many markets at the same time. This allows them to learn the nuances of a region, grow the book smartly, and move on to the surrounding area. This strategy makes sense and helps manage risks. The track record of the company on NPAs and recoveries has been extremely good with loss given default of only 8bps, equivalent to that of HDFC!! We feel the company is an undiscovered jewel.
The competitive environment for Repco is low as the big players find it too cumbersome to underwrite small ticket loans outside metro or tier 1 cities, especially when the customer does not have a monthly salary in the traditional sense. Repco will mostly compete with and displace the unorganized money lenders who charge interest rates ranging from 36%-48% per year.
Repco's lending rate is about 13% and its cost of capital is about 10%. Its net interest margins (NIMs) are at 4.5% and the cost to income ratio is only 18%. The low credit cost (due to solid underwriting) helps them achieve a ROA of 2.5% and ROE of around 20%. The annual profit growth over the last 3 years was 25%. We believe Repco can continue to compound its loan book and profits at a 25%-30% compounded over the next five years, without compromising on credit quality. With Tier I capital above 20%, the company is more than adequately capitalized to fund this growth.
The stock trades at 2.5x forward adjusted book and 15x forward earnings. The valuations are only slightly higher than the market average, despite having significantly higher growth potential, business quality and return metrics. Strong earnings growth and a rising ROE usually translates into higher multiples. However, even without any multiple expansion, the returns here should be in line with earnings growth over the next three years. This company has the potential to be a "compounder" which we can hold for a very long time.
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