How has the NBFC, HFC segment fared after the recent liquidity crisis?
There was a liquidity challenge in the market, driven more by a crisis of confidence in the NBFC ecosystem, rather than an actual impairment on balance sheets. However, that situation is gradually subsiding, and we are seeing the liquidity flows return to the sector and, hopefully, the worst is behind us on the liquidity side. The good takeaway from this episode is that it has given a reality check to the sector. The focus, historically, was on chasing growth and ensuring disbursements, but not so much on asset quality.
In my assessment, this event has ensured that companies will re-examine the fundamentals of the lending business—the asset quality, asset liability management, diversification of the liability profile and the quality of the systems and processes. This reality check bodes very well for the industry and, over the long term, it will lead to more robust balance sheets.
What are the possible changes that are expected in the way these institutions are run?
In my assessment, the aggressive growth that was there in the industry will be a bit mellowed, going forward.
You are going to see NBFC 2.0 come about, but with far more stable and strong balance sheets, and with a granular focus on asset liability management and credit quality. This may take 12-18 months. In the interim, you may see a contraction in margins and slowdown in disbursements for sure.
This has already manifested itself in the private transaction valuations in this segment, which are a bit more muted than, say, six months ago.
However, the long-term opportunity continues to be large and attractive. According to various estimates, the unmet credit demand from MSMEs (micro, small and medium enterprises) alone, is in the vicinity of ₹ 25-30 trillion.
What role can PE firms play? Will we see more PE-driven mergers and acquisitions, and consolidation in NBFC-HFCs?
PE interest continues to be high for high quality businesses in this segment. We are confident that the market will consolidate. You will see consolidation among NBFCs and HFCs, partly propelled by financial investors in these companies. It will be driven by the need to have stronger and diversified asset bases, and to ensure diversification of risk, driving benefits of scale and operating leverage, and lower funding costs.
So, PE interest remains high for consumer firms despite the fact that they command extremely high valuations?
Most investors have reconciled to this fact. This is unlikely to change in the near future. However, funds are now more focused on the ability of the brand to deliver earnings growth and increase market share.
Last couple of years have seen a lot of disruption and structural changes thanks to demonetization and GST. What impact has that had on the consumer space? Are we seeing a massive trend of unorganized market moving to organized, as was expected after these structural changes?
Chandra: GST specifically has led to a significant shift from the unorganized to organized market. As consumption per capita has been increasing, the market was already witnessing a shift from unbranded to branded products, aided by easier availability.
GST has provided a significant impetus to this by shifting trade from the unorganized to the organized market. We are already seeing signals in the private markets of earnings expansion aided by a significant growth in market share for some leading consumer brands.
A large part of this growth is attributable to the informal market fading away. This is most apparent in segments like food, apparel and footwear. Another significant shift is that consumption demand is percolating down to Tier2/3 towns.
While the aspiration to own consumer brands was always there, it is now being aided by an increased capacity to pay coupled with easier availability of the products (supported in large part by online commerce). This has also provided the elbow room for specific regional brands to grow and gain market share—most apparent in the food segment wherein some regional food brands are becoming very popular. Over a period, you will see category market leaders emerge from these brands.
So, PE interest remains high for consumer companies despite the fact that these companies always command extremely high valuations?
Chandra: Consumer companies have always commanded alpha premiums in the Indian market. Most investors have reconciled to this fact and PE interest for marquee consumer assets continues to be strong. This is unlikely to change in the near future, as the opportunity canvas continues to be very large and profitable. However, funds are now more focused on the ability of the brand to deliver earnings growth and increase market share.