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Can Fin Homes Ltd

Buy Rs.480/-. Duration: - 18 to 24 months or more for multiple

16th Oct, 2014

While the Indian economy has come a long way in the last few decades, not all the states are
equally placed in this transformation story. Some regions, despite being rich in natural
resources are at the lower most rungs on the ladder of development. While others, based on
education and job creation opportunities, have raced well ahead. A case in point is South
India - the region that houses one of the most urbanized states (Kerala); one of the most
developed state (Andhra Pradesh) and is a house to Asia's fastest growing cosmopolitan city
(Bangalore). The education and job opportunities in the IT sector in South India have drawn a
highly mobile educated workforce further fuelling the housing demand.
At a time when the Indian economy is witnessing a turnaround, the businesses that cater to
the basic needs of the growing population in these regions are likely to ride the overall
economic growth wave better than others. One such need is the demand for housing. And
while we would not suggest you to expose yourselves to real estate companies that are
laden with huge debts and dicey track record, investing in companies in the housing
finance business can be a good proxy play to participate in the story of the booming
housing demand.
One can guess the potential from the fact that the country has shortage of 19 million housing
units. And as compared to other emerging economies, the housing loan/mortgage is just 9%
of the GDP. With a huge demographic dividend and rising urban migration and affordability,
the growth of the housing business across India can hardly be questioned. However, as far as
stability and risk aspect of growth is concerned, no other region can be more reassuring that
South India.
However, high growth prospects breed competition. And housing finance sector even in
South is no exception to this. Almost all players in the segment want to grab larger market
share and this is getting well reflected in their valuations. As far as investing is concerned, to
benefit from this opportunity, investors should focus on companies that are operating in the
niche segments - based on the ticket size, regional exposure or the class of borrowers they are
exposed to. And there are enough such companies in the small cap segment that not just
enjoy huge growth potential, but being relatively small and less tracked, also offer strong
valuation upsides for the investors.

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Key Management Personnel
Shri C. Ilango- Managing Director, has been the Managing Director of Can Fin Homes Ltd.
since April 29, 2011. He has served as Deputy General Manager of Canara Bank and is a
senior banker with over 31 years of commercial banking experience having served across
India. He is a Post Graduate degree holder in Agricultural Science viz., M.Sc., (Agriculture)
and a CAIIB.

Shri K. N. Prithviraj - Chairman, is a rank holder in M.A.(Economics) and CAIIB. He was

also a Fellow of Research in the Department of Economics, University of Madras. He has
more than 38 years of experience in the banking industry. Earlier, he was the Chairman &
Managing Director of Oriental Bank of Commerce, Executive Director of United Bank of India
and General Manager of Punjab National Bank. He was a Government Nominee Director for
Oriental Insurance Company for two years.

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A stock investment as good as buying a second home
"If you had sizeable investible surplus, what would you do?"

An average middle-aged Indian homeowner would probably say, "I would buy a second
property."

Property is deemed to be the safest and most lucrative of investment assets in India. And why
not! It is a solid, tangible asset with limited downside risk... It is a good hedge against
inflation... And it has delivered solid returns over longer time periods...

While buying a second home may be a good idea, it requires a big capital commitment. And if
you're living in a big city or a metro, you will agree that property prices have gone through
the roof. And while investing in smaller cities and towns may be more lucrative, very few
have the time and money to identify the right investment opportunity.

What if we were to tell you that there was indeed a way to participate in the housing boom in
India's rural and semi urban markets? After a management meeting in Bangalore last month,
we were thoroughly convinced that we had indeed found a stock that was almost as good as
buying a second home. A company that could be your proxy investment in thousands of
homes...

The company that we are referring to is Can Fin Homes Ltd - our Hidden Treasure
recommendation for the month. Promoted by Canara Bank in 1987, Can Fin Homes is a
Bangalore-based deposit taking housing finance company with a focus on rural and semiurban markets. The company has pan-India presence with 103 branches in over 15 states.
While predominantly a South India-focused housing finance company, Can Fin has been
expanding its presence in non-southern markets which now account for about 30% of the
company's loan book.

So what is it about the company that makes us say that it seems as good as buying a second
home? Here are the reasons.

The company has a highly secured home loan book with over 88% of the borrowers belonging
to the salaried class. Of these, 50% borrowers are PSU employees where job security is usually

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quite high. Moreover, the company has a loan to value ratio of 75% of registered value of the
property as against the market value of the property. This is a fairly conservative approach. It
is because of these reasons that the company has been able to maintain impeccable asset
quality over the years. For instance, the company's gross non-performing assets (Gross NPA)
have been continuously on the decline and stood at merely 0.2% as of March 2014. What is
more, the company has had zero net NPAs over the last five years.

If this has already got you interested, let us tell you that this is just half the story yet. One of
the biggest game changers for the company was when it got a new management team in
FY11. The new management team, led by Managing Director Mr C Ilango, revamped the
housing finance business by centralizing the system. It increased staff strength, expanded
branch network and also started sales through agents.

The post-FY11 financial of the company are a

testimony to the new management's thumping
success. Let us see how the company has performed
in the period up to and after FY11. Between FY07
and FY11, the company's loan disbursements grew
at a tepid 1.5% compounded annual growth rate
(CAGR). Compare this with a whopping growth
rate of 75.3% CAGR in the period from FY11 to
FY14! As of March 2014, the company's loan book
stood at Rs 58.44 billion.

Growth without compromise in asset quality

Even the branch network which had stagnated around 41-odd branches till FY11 has now
expanded to 103. It is worth noting that the average branch break-even period for the
company is just 4 to 12 months. One of the unique selling propositions of Can Fin Homes that
the management claims is its shortest loan turnaround time of about 7 days. Moreover,
hassles over documentation are less.

Given the strong structural growth drivers for the housing finance industry, the company's
robust business model and well-focused management team, we believe that Can Fin Homes
has the right ingredients that offer both safety and growth. It is noteworthy that the company
has a track record of consistent dividends since its listing in 1991.

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More about Can Fin Homes Ltd
Can Fin Homes Ltd is a 26-year old institution registered as a deposit taking Housing Finance
Company (HFC) with the National Housing Bank (NHB). The company was listed in 1991
and is promoted by Canara Bank which has 42.38% stake in the company. The company is
headquartered in Bangalore and has 103 branches across India in over 15 states. The
company's loan book has grown at an average annual rate of 38% over the last three years,
with 70% share coming from South India. The average loan ticket size stands at Rs 16 lakh
and majority of individual loans are towards salaried class, while the average age of
individual borrower is around 35 years. At the end of March 2014, the share of non housing
loans stood at 8.04%. The capital adequacy ratio for the company at the end of March 2014
stood at 13.8% while net interest margins in FY14 came at 2.7%.

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How Can Fin Homes Ltd will boost its fortunes...
1. Strong promoter backing

Can Fin Homes Limited is promoted by Canara Bank which is one of the largest
nationalized banks in India in association with reputed financial institutions including
HDFC and UTI. With Canara Bank's 42.4% shareholding in Can Fin Homes, the
company benefits largely from the bank's huge brand image and the goodwill it enjoys
in South India. Moreover, a rich legacy and experience of the promoter always serves
as a strong backup for the company.

2. Healthy funding mix backed by superior credit rating

Can Fin Homes by the virtue of strong credit New management since 2011 boosts growth
ratings and National Housing Bank (NHB)
refinance support has been able to maintain
healthy and low-cost funding mix. Superior
ratings from the top two rating agencies have
ensured Can Fin Homes to set competitive
rates in the market. And the NHB funding to
the extent of 41% (as at the end of FY14) has
been the icing on the cake. This has enabled
the company to create its own niche in the
southern states of the country and has enabled it to keep costs in control thereby
supporting margins.

3. Business turnaround on the back of branch expansion and buoyant demand

Until FY11, the business of the company stood dormant in terms of negligible credit
and branch network expansion. Post the new management team that took charge in
FY11, the fortunes of Can Fin Homes' business started improving drastically and it
witnessed a complete overhaul of its business model. Centralization of the processes,
strengthening of the employee base, sales through agents and most importantly rapid
expansion of branch network set the ball rolling for the company's business. And then
there was no looking back. The loan book for Can Fin Homes grew annually at
staggering rates of 21.1%, 51.6% and 45.9% for FY12, FY13, and FY14 respectively.

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This was fairly commensurate with the branch network growth of 26.8%, 32.7% and
20.3% for FY12, FY13, and FY14 respectively. The incremental loan growth for the
company largely emanated from the increased branch network. This coupled with a
strong marketing network enabled the company to penetrate deeper and enhance the
level of business significantly. Besides, the company's major thrust on the expansion of
retail loan portfolio continues to drive the credit off-take. While 90% of the loan pie
comes from housing finance portfolio, merely 10% emerges from the risky nonhousing segment.

It is also noteworthy that the branch network grew 100% in a short span of just three
years. Moreover, we believe that the company is poised to maintain the growth
momentum in the coming years. Thus, stable interest rates, increasing demand for
housing loans and subsequent strong growth in disbursements supported by rapid
branch expansion would enable Can Fin Homes to maintain healthy growth
momentum in its loan book going forward. Moreover, the company continues to bank
upon the growing buoyancy in the southern property market that would aid the
aggressive credit expansion target. We envisage a conservative 16.6% CAGR in total
loans at the end of FY18 and reckon that the company could surprise us positively on
this count.

4. Shortest turnaround time supports the loan growth too

Despite the prevalent higher interest rates, Can Fin Homes continues to witness
increasing demand for loans. And that's purely because the loan turnaround time is
among the shortest. And that also becomes the unique selling proposition (USP) of the
company's lending business. Shortest turnaround time of 7 days and lesser
documentation hassles backed with expertise over housing loan finance segment set
the company apart from the competition.

5. But no compromise on quality

Aggressive loan book expansion has not deterred the quality of the loan book by any
means. In fact, the improvement in asset quality has been directly proportional to the
loan growth for the last three years. The gross non-performing assets (NPAs) that stood
at 1.1% in FY10, reduced sharply to 0.2% in FY14 despite the aggressive loan book

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expansion in the recent years. Interestingly, of the Rs 63.55 billion loan book (at the end
of quarter ended June 2014), a meager amount of Rs 0.12 billion account for non
performing assets (NPA). Also, with 100% provisioning policy, the net NPA has
remained nil over the last five years.

That's primarily because the company lends Cost/Income ratio down despite growth in FY14
to the secured salaried class that forms almost
88% of the total customer base. And what
more, 50% of this salaried customer base is
employed with public sector units that all the
more ensure a regular flow of loan
repayments. Thus, only remaining 12% of the
borrowers are self-employed which is one of
the biggest reasons that the company has
been able to maintain impeccable asset
quality over the years. Not just that, the loan-to-value ratio for housing loans stands at
75% of the registered value of the property and 50% for the mortgage loans. This
conservative strategy has also helped the company to keep the NPA additions at bay.

6. Secured loan portfolio and operating efficiencies support the earnings growth

Buoyant loan growth expansion backed by secured mix coupled with improving cost
efficiencies have led to superior earnings growth for the company post the business
turnaround. Despite aggressive network expansion, the cost-income ratio at 28.3%
(FY14) has remained under control and in fact has declined on annual basis.

Moreover, stable risk-free loan yields and costs benefits have ensured stable average net
interest margins (NIM) of 3.4% for past three years.

Consequently, the three-year compounded annual growth rate (CAGR) for earnings has been
21.7% (FY11 to FY14) and is expected to remain healthy in the coming years. Thus, consistent
credit growth, stable NIMs and superior asset quality have led to healthy return ratios. We
expect the company to clock average return on equity (ROE) of 17.4% and average return on
assets (ROA) of 1.3%-1.4% over the next 4-year period.

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Key challenges for Can Fin Homes
1. Lower income growth in smaller towns

Players like Can Fin Homes are largely focused on garnering business in smaller towns
and cities where banks and larger housing finance companies do not have sufficient
reach. In the past few years, the per capita income and consumption growth have kept
pace with that in the metros thus offering a very healthy momentum to financiers like
Can Fin. However, in the event of economic slowdown, the incremental growth of
smaller mortgage financiers can certainly take a hit.

2. Stiff competition from other housing finance companies and banks

Since Can Fin Homes largely caters to the salaried class, most of them being PSU
employees, nearly all banks (particularly PSU ones) and housing finance companies
are its competitors. This is because, the kind of credit appraisal and documentation
that Can Fin adheres to is very similar to that of any other mortgage lender. In fact, its
own parent Canara Bank can be its key competitor. The addition of new banks or
consolidation of PSU banks could also cannibalize the market share of mortgage loans
of smaller players.

3. Rise in provisioning costs

As mentioned earlier, Can Fin Homes has shown a very conservative approach in its
provision policy and has consistently improved its NPA ratios over the past 3 years.
However, given the fact that the company got aggressive in expanding its loan book
only since FY11, it is too early to say that such impeccable asset quality will be
sustained. Hence the risk that the company may have to provide more for NPA risk in
the coming years is real. We have accounted for this risk and have accordingly given
the company discounted valuations compared to the best housing finance companies.

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Risk Analysis
1. Regulatory Risk

Some businesses are subject to regulations by external government agencies. These

companies are subject to regulatory risk since they do not have the liberty to operate in
a free environment. Excessive regulations can create bureaucratic hassles and impede
growth. Thus, higher the regulation, higher is the risk for any business. The housing
finance sector is subject to various regulations imposed by the Reserve Bank of India
and National Housing Bank in terms of capital adequacy, lending norms, provisioning
requirements etc.

2. Cyclically Risk

An industry cycle is characterized by an upturn as well as downturn. Businesses

whose fortunes typically swing with industry cycles are known as cyclical businesses.
Cyclical businesses do well during an industry upturn and vice versa. On the other
hand, there are some businesses based on consumption stories that are non-cyclical.
These businesses are immune to industry cycle changes and have less risk. In short, if
the business is cyclical higher is the risk. The housing finance sector is extremely
cyclical and is in fact a reflection of the macro economy.

3. Competition Risk

Every industry is characterized by competition. However, some industries where entry

and exit barriers are typically low have higher competition risk. Low barriers means
more players can enter into the industry thereby intensifying competition. Low
product differentiation also intensifies competition risk. The Indian housing finance
sector is already very competitive with most banks and non-banking finance
companies (NBFC) offering mortgage finance. Plus the entry of new banks is expected
to intensify competition in the coming years.

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4. Income growth

Over the nine year period (actual history of past 5 years and explicit forecast for the
next 4 years) Can Fin Homes income CAGR is 18.8%.

5. Net Profit Growth

Over the nine year period (actual history of past 5 years and explicit forecast for the
next 4 years) the net profit CAGR is 15.6%.

6. Net interest margin

Net interest margin (NIM) is a measurement of the spread that the financial entity
makes on its average earning assets (typically loans, investments and balance with
other banks). Banks that are able to fetch sufficient low cost funds and lend them with
a good spread or invest in high yielding assets have steady NIMs. The higher the NIM,
the easier it is for financial entities to tide over volatility in interest rates. The average
NIM for Can Fin Homes over the 9 year period (actual history of past 5 years and
forecast for the next 4 years) stands at 3.1%, which is in-line with the average NIMs of
housing finance companies (HFC).

7. Net profit Margins

Net profit margin is a measurement of what proportion of a company's revenue is left

over after paying for all the variable and fixed costs inclusive of interest and
depreciation charges. Net margin is the final measure of profitability. It reflects the
total profits the company takes home. Higher the margin, better it is for the company
as it indicates better pricing power and effective cost management. The average net
margins over the 9 year period (actual history of past 5 years and explicit forecast for
the next four years) stand at 15.7%.

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8. Return on net worth (RoNW)

RoNW is an important tool to assess a company's potential to be a quality investment

by determining how well the management is able to allocate capital into its operations
for future growth. A RoNW of above 15% is considered decent for companies that are
in an expansionary phase. The average RoNW over the 9 year period (actual history of
past 5 years and explicit forecast for the next 4 years) stands at 16.0%.

9. Cost to income ratio

This ratio helps assess the operating cost efficiency of a financial entity. It primarily
takes into account the operating cost for the company vis-a-vis income by way of net
interest earned and other income. Financial entities that are lean in terms of cost to
income ratio manage to retain a healthy profit margin across cycles. The average cost
to income ratio for Can Fin Homes over the 9 year period (actual history of past 5 years
and forecast for the next 4 years) stands at 27.8%.

10. Transparency

Transparency is the key to any business. Transparency can be gauged by assessing the
past dealings of the company with various stake holders be it the customers, suppliers,
distributors or shareholders. The easiest way to gauge the same is checking the level of
disclosures in the company's quarterly financial updates and communication with
minority shareholders. Most importantly, the management's willingness to explain its
stance if there is a negative development in the company or stock shows its
forthrightness. Transparent managements would get a higher rating. The management
of Can Fin Homes has been reasonably transparent in its operations. However there is
always room for improvement.

11. Capital allocation

Apart from honesty, capital allocation skills are equally important in assessing
management quality. By capital allocation we mean how the management chooses to
deploy capital in the business or across businesses. Managements that have in the past
destroyed shareholder wealth by diversifying in unrelated, unviable businesses or

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make expensive acquisitions would rank low on this parameter. Further managements
that focus on capital intensive growth at the cost of profitability would also fetch a low
rating. The management of Can Fin Homes has a good track record in terms of capital
allocation. The company is standing on a growth trajectory and is well geared to take
up to next level.

12. Promoter Pledging

Promoters typically pledge their shares to take a loan which is generally infused in the
company. This exercise is generally resorted to when all other sources of external
liquidity dry out. The risk with this strategy arises when share price falls. This triggers
margin calls. If management is unable to provide some sort of a collateral to the
lending party from whom the money is borrowed that party may sell the shares to
recover its money. This accentuates the share price fall. Hence, higher the promoter
pledging higher is the risk. With none of the promoters' equity being pledged.

13. Net NPA to advances

A good asset quality is the hallmark of good lending practice of a financial entity.
Financial entities that tend to have high non-performing assets (NPAs) during periods
of economic stress deserve a lower rating. Ones that have average net NPA ratio in
excess of 1.5% are particularly risky. The average net NPA to advances ratio for Can Fin
Homes over the 9 year period (actual history of past 5 years and forecast for the next 4
years) stands at 0.02%. Given that the asset quality of the company stands one of the
best in the industry and is expected to remain stable (despite being conservative with
future projections).

14. Capital adequacy ratio (CAR)

This is one of the most important factors that are used to judge the soundness and
sustainability of a financial institution's business over the longer term. It shows the
ratio of capital to assets financed. The RBI has stipulated a minimum CAR of 15% for
NBFCs as per Basel II and 12% minimum CAR is stipulated by NHB. Since Can Fin
Homes CAR at the end of March 2014 stood over 13%.

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Why Is the Stock Worthy Of Investment
Under the leadership of the new management team since FY11, Can Fin Homes has
transformed into a strong player in the retail housing finance market over the last three years.
With a well-crafted business strategy focusing on quality growth the company is poised to
tap the affordable housing finance market potential. The company boasts of a rich dividend
payout since its early years. Niche lending business, faster turnaround time for loans and
secured loan book backed by prudent risk management practices makes Can Fin Homes the
preferred choice for the home loan borrowers in the semi-urban and rural markets.

What more, the strategic branch locations serving customers of relatively small size (average
loan ticket size of Rs 16 lakh) have enabled the company to carve its own niche in the highly
competitive housing finance market. Moreover, the company's huge customer base typically
comprising of salaried class ensures healthy loan book for the company. Besides, the growing
branch network with faster break-evens would continue to aid robust loan book expansion
going forward.

To put into numbers, the loan book for Can Fin Homes has grown at a compounded annual
growth rate of 38.5% for the last three years (FY11-FY14). Both net interest income and
profitability have grown at a compounded average growth rate (CAGR) of around 26.2% and
21.7% respectively over the last three years. Superior earnings profile has also translated into
higher return ratios for the company. The return on equity (ROE) and return on asset (ROA)
have stood at over 17.9% and 1.5% respectively as at the end of FY14.

Strong parentage, sound financial, impeccable asset quality, robust return ratios and healthy
dividend payout makes the stock worthy of investment. Moreover, it a value play riding the
theme of the promising housing finance market that is poised to grow with the improving
economic prospects and the government thrust on housing and developing smart cities.

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Rationale for valuation
The banking and mortgage finance sector is dependent on credit growth, which comes from
both corporates as well as retail. This is in turn a function of how well the economy is
performing. Unlike other sectors, a mortgage finance company's asset is cash and the ability
to grow the top line is therefore, largely dependent on the capital base (net worth in a broader
sense). Therefore, more than the price to earnings ratio, the adjusted price to book value
(P/BV) is relevant while valuing a mortgage finance company stock. By adjusted P/BV, we
mean reducing net non-performing asset from the net worth and then, dividing it by the
number of shares.

Considering the economies of scale that the business model of Can Fin Homes provides on
account of niche positioning, robust fundamentals, superior growth prospects backed by
strong capital sufficiency, we value it at price to adjusted book value multiple of 1.0 to 2.0
times estimated FY18 adjusted book value. Owing to the entity's short financial history and
small size of the asset book, we have chosen to value the company at a discount to its peers.
Nonetheless, we remain confident of the promising business prospects of the company in the
long-run.

Comparative Valuations
FY14

Can Fin Homes

Repco Home Finance

45.9

34.0

3.1

5.5

1.2

Return on Equity (%)

17.9

17.8

Return on Assets (%)

1.5

2.8

Price to adjusted book value (x)

2.1

4.1

Dividend yield (%)

1.4

0.3

Loan growth (%)

Net interest margins (NIMs, %)
Net NPA/ Net advances* (%)

Valuations (FY14)

* Can Fin Homes Ltd had nil net NPAs in FY14

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Financials at a glance
(Rs m)

FY13

FY14

FY15E

FY16E

FY17E

FY18E

Net Interest Income

1,095

1,550

1,779

2,036

2,367

2,721

20.8

41.6

14.8

14.5

16.2

14.9

3.3

3.1

2.7

2.6

2.6

2.6

Operating profit margin (%)

18.8

19.3

16.3

15.4

14.6

13.7

Net profit

541

759

860

973

1,116

1,254

Net profit margin (%)

13.8

13.1

11.1

10.2

9.7

9.0

39,955

58,306

72,039

84,851

98,596

114,181

Fixed and other assets

556

662

781

950

1,258

1,813

Investments

159

149

152

155

160

164

40,670

59,117

72,972

85,957

100,014

116,158

Current liabilities

5,366

6,731

9,087

6,906

2,693

2,693

Net worth

3,922

4,523

5,215

6,020

6,968

8,054

30,730

46,947

56,304

68,715

83,864

102,351

652

916

2,366

4,316

6,489

3,060

40,670

59,117

72,972

85,957

100,014

116,158

Net Interest Income growth (%)

Net Interest Margins (%)

Balance Sheet
Loans and advances

Total Assets

Borrowings
Provisions
Total liabilities

Valuations
(Rs m)

FY13

FY14

FY15E

FY16E

FY17E

FY18E

Revenue (Rs m)

1,095

1,550

1,779

2,036

2,367

2,721

PAT (Rs m)

541

759

860

973

1,116

1,254

EPS (Rs)

26.4

37.0

42.0

47.5

54.5

61.2

191.4

220.8

253.8

293.0

338.0

389.7

2.4

2.1

1.8

1.6

1.4

1.2

17.7

12.6

11.1

9.8

8.6

7.6

Adj. book value (Rs)

Price to adj. book value (x)
Price to earnings (x)

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