Indian investment banking firm JM Financial has initiated coverage on non-banking finance company (NBFC), Fedbank Financial Services, which made a weak market debut in November 2023. 

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JM Financial sees over 23 per cent upside in the stock, and views Fedbank Financial Services as a compelling player in the Micro Small Medium Enterprise (MSME) financing segment through secured asset classes, as the NBFC's small ticket loan against property is set to rise given less competition and strong risk-adjusted profitability. 

Also, business loans (unsecured) are approximately 16 per cent of the portfolio, which adds a layer of profitability kicker, as per the report. 

The brokerage expects the Asset Under Management (AUM) to grow at a 32 per cent Compound annual growth rate (CAGR) over FY23-26E. 

Further, the report also states that as Federal Bank holds a 61.6 per cent stake in Fedbank Financial Services, it aids in strong brand recall and relatively better borrowing costs (interest on bank overdrafts and borrowings). 

The brokerage highlights the following while taking a bullish stance:

-Asset quality of the NBFC is healthy given its focus on secured business and strong underwriting methods. 

-Long growth runway.

-Experienced management team.

-Strong risk and technology focus.

On the return on asset (RoA) front, which indicates how profitable a company is in relation to its total assets, JM Financial sees the NBFC to benefit from operating leverage, where opex to AUM could decline by approx 100 basis points (bps) over FY23-26. 

"We expect RoA to expand to 2.6 per cent in FY26E. Given strong AUM growth, we forecast earnings growth at 37 per cent CAGR over FY23-26," the report reads. 

As per the report, at current valuations, Fedbank Financial Services offers a significant margin of safety, and growth delivery could lead to a meaningful valuation upside at 2.0x FY26E P/BV. 

Citing the potential risks, the brokerage said sharp growth slowdowns and the inability to control credit costs are key risks to keep an eye out for.

Since listing at Rs 137.7 apiece on exchanges, shares of Fedbank Financial Services have declined over 6 per cent.

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