GRUH Finance

Source - Safal Nivesak

About Gruh Finance

Gruh Finance (formerly Gujarat Rural Housing Corporation Limited) was set up in 1986 by HDFC with the objective of providing institutional structure to rural housing finance. HDFC owns around 60% stake in the company and provides it equity support. Gruh’s major focus is to provide home loans to individuals and families for purchase, construction and extension. It also provides loan for repair and renovation of houses. The company has a distinct target market segment, which complements HDFC’s market.

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Association with HDFC

HDFC helps GRUH in many ways which include enabling funding at competitive rates, operational support, management support, operating policy, lending policy, loan sanctioning norms and loan schemes. GRUH benefits immensely by using well-established stringent credit appraisal and monitoring systems and processes, strong risk management systems and efficient recovery mechanisms of HDFC.

Although both GRUH and HDFC operate in the same industry, GRUH focuses primarily in the rural and semi-urban markets. This segment is distinct from HDFC’s target segment. GRUH also cross sells HDFC products.

Nature of Industry

There are three types of industries:

There are industries where only one or two players take away most of the profit eg. Google, Yahoo or NSE and BSE

There are others where nobody makes profits e.g. Airline industry.

Finally, there are industries where every player makes money. Housing finance (HFC) is one of them.

The success of an HFC is very much dependent on two things, as aptly described in the book “The Richest Man in Babylon” – Safety of principal and safety of interest.

Safety of principal is dependent on nature of collateral and value of collateral. Safety of interest is dependent on nature and ability of borrower to make timely payments.

Any HFC faces three broad risks:

1. Market risk is the risk of losses in positions arising from movements in market prices. HFCs face two broad type of market risks. There is adverse movement in price of collateral and high loan to book value (LTV).

After a loan is given, the value of collateral diminishes. For example, a bank gives a home loan of Rs 30 lac and after some time, the value of home declined to Rs 20 lac. In India, given that property prices have continued to rise in the past, HFCs have not faced risk on this account..

LTV is the ratio of loan given against the value of the collateral. The lower the ratio, the lower the market risk. In simple words, the market risk for an HFC reduces when the gap between the market value of collateral and loan taken is large. For example, if for a property worth Rs 50 lac a loan of Rs 20 lac is given, the market risk is low. On the other hand, if for a property worth Rs 50 lac, a loan of Rs 48 lac is given, the market risk is high for the HFC.

In case of Gruh Finance, the LTV is less than 80% for approximately 78% of the properties financed so far and LTV greater than 85% exists only in case of 4% of the properties financed. Therefore, the overall market risk remains low for the company.

2. Credit risk refers to the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do. The risk is primarily that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs.

Credit risk could be mitigated by stringent credit appraisal of the borrower by HFCs. Credit appraisal looks for ability and willingness of borrower to make timely payment.

Non-performing asset (NPA) is a measure of strength of credit risk policies and processes.

An NPA is defined as a credit facility in respect of which the interest and/or installment of principal has remained ‘past due’ for a specified period of time. In India, an asset is considered an NPA when the HFCs do not receive interest and/or principal for a continuous period of 90 days. If a borrower stops payment of EMI for 3 months, the bank considers the loan (asset) as non-performing.

For Gruh Finance, asset quality remains above industry average due to low gross non-performing assets (Gross NPA) and low Net non-performing assets (Net NPA).

3. Operations risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.

Examples of operational risk include fraud by employees, theft of information, hacking damage, third party theft and forgery, account churning, damage to assets due to disasters, system failure, accounting errors, and negligence. Correct operational risk policies and processes increase asset quality and decreases non-performing assets as seen above.

The profit and NPAs of two HFCs are quite depended on processes and policies defined for each of the above risks. HDFC is the best amongst housing companies for managing each of the three risks. Gruh, being a subsidiary of HDFC, has simply copied the processes and policies for managing the above three risks from its parent.

2. Checklist

I’ve analyzed GRUH by answering a few important questions that span its:

Business performance,

Financial performance,

Management quality, and

Competition.

Before we move ahead, here are the symbols that I’ve placed against each checklist point and that will tell you at a glance whether I have a positive or negative view on that particular point.

Indicates my positive view

Indicates my negative view

Let’s get started.

A. Business

1. Can I, in simple words, explain what the company does?

Yes. Gruh is a housing finance company where HDFC owns a 59.7% stake. Its major focus is to provide home loans to individuals and families for purchase, construction and extension in rural and semi-urban India. It also provides loans for repair and renovation of houses. The success of HFCs is highly dependent on managing market risk, credit risk and operational risk. The policies and processes covering these three risks determine both safety of principle and adequate returns.

2. Does the business have high uncertainty?

The inherent nature of Gruh’s business is not uncertain. Once a loan is given, it keeps receiving EMIs for the duration of loan which is usually between 10 to 20 years.

3. Has the business got an enormous moat?

Gruh has a weak moat. However, an HFC’s business comes under the service sector and there is scope for number of players to operate with decent profit. One moat here is switching cost. One incentive to switch to other HFC/bank would be lower interest rate. However, the interest rate of HFCs/banks do not differ significantly to offer this incentive. Also, a borrower who wants to transfer loan to other HFC/bank has to put in lot of efforts in doing the paper work. The pain of going through this paperwork during the switch does not compensate with the gain to be received by extra savings to be made by lower interest rate.

The second advantage for an HFC like Gruh is that the policies and processes designed to manage market, credit and operational risks differ from HFCs to HFCs. Gruh has stringent policies and processes for lending, copied from its parent HDFC, which are best in the industry.

4. Does the business generate strong free cash flow?

Yes. Since Gruh does not have to invest in any plant and machinery and also does not have to hold any receivables or inventory, whatever cash it generates from operations is almost free cash. Most of its assets are free cash and book value closely resembles liquid assets.

As can be seen for the year 2013, the fixed asset of approximately Rs 12 crore is very low compared total asset of Rs 5,600 crore. It means whatever profit after tax is generated (Rs 42 Cr in 2008 to Rs 146 Cr in 2013) is almost free cash.

5. What is the bargaining power of suppliers and buyers?Gruh borrows from various entities – National Housing Banks, commercial banks, debentures, etc. – to meet its short-term and long-term borrowing requirements. Since the rate of interest charged by all HFCs/banks are not significantly different, the rural and semi-urban borrowers do not have bargaining power.

B. Financial Performance

6. Does the business have a consistent sales and profit growth history and is there room for future growth?

Gruh has an excellent track record of financial performance…

Both gross and net NPAs have been one of the best (lowest) in the industry.

Net interest margin is high compared to peers

Loan assets have been increasing steadily over the years.

Average annual growth in Profit after tax has been 28% for the past 6 years, which is quite robust

As far as the future is concerned, given the continuous demand for new residential housing in semi-urban and rural India, I do not see mush problem on the growth front for Gruh, though growth may not be as high as in the past owing to the higher base.

7. Does the company have a good dividend history? Good enough. In terms of dividend payout (amount of dividend paid as percentage of net profit), Gruh has averaged around 60% over the past 10 years, which is a good payout.

8. Has it got a high and consistent return on equity?

Yes. A company’s return on equity is akin to you earning a certain amount every year on your investments (no paper profits but actual dividend and interest income plus any profit on sale of investments). Looking that way, Gruh’s average return on equity of 27% is a good number. This is reflective of the good yield its investments have earned for it over the years, which has largely been a result of an overall good performance by the stock market.

C. Management Quality

9. Is the management known for its capital allocation skill and integrity?

Being a HDFC group company, there is no doubt that Gruh has a management that considers integrity as a core business value. As far as capital allocation skill is concerned, that is reflected in the good 27% average return on equity the company has earned over the years.

As can be seen, the retained earnings is approximately 60% and balance is distributed as dividend.

10. Has there been any substantial equity dilution in the past? No. Gruh had seen a 30% increase in its outstanding equity shares in the year 2006-2007. This was on account of rights issue in the ratio of 3:10

11. Are management’s salaries too high?

During the latest year, the Managing Director was paid gross remuneration of Rs 1.7 cr. This is around 1.19% of the company’s net profit and thus not a big figure.

12. What has the management done with the cash in the past?

Gruh has, over the last ten years, distributed around 40% of earnings as dividend and balance was reinvested in the business. The average return on equity has been around 27% and it has increased over the year. It means the, management does not hesitate to return the money to shareholders in the form of dividend, instead of employing them in business when returns are not going to be good.

D. Competition

13. Does the business face high competition?

As of now, not much, as there are not many big players catering to the rural and semi urban market. However, when these markets grow in future, many big players would enter them to gain market share.

14. Has the management focused on market share or profitability in the past?

Looking at good capital allocation decisions, decent return on equity, high asset quality and low NPAs, the management as focused exclusively on profitability.

3. Future Prospects

Gruh operates in seven states – Gujarat, Maharashtra Karnataka, Rajasthan, Madhya Pradesh, Chhattisgarh and Tamil Nadu. The bulk of revenue comes from Gujarat and Maharashtra. These two states accounts for 76% of its loan portfolio. Gruh has a total of 134 retail offices and employees strength of 517 in these seven states.

There is enough room for growth for the company in the future. Gruh has the financial strength and support of its parent HDFC to expand and establish branches in remaining 21 states. Looking at India’s growth story, the future growth in housing finance would come from rural and semi–urban market and Gruh is well establish to take advantage of this opportunity in future.

4. Risk Statement

Gruh’s business, when purchased at a good buying price can provide a great amount of stability to an investor’s portfolio. The one risk that remains very high is the price paid to acquire stocks.

I am not sure after the retirement of Mr. Deepak Parekh, how the new head of HDFC and Gruh would be able to carry the legacy forward. Remember what happened to Infosys after Mr. Narayan Murthy retired; he had to be called back to lead the company after the gap of seven years. Essentially, the company is too much dependent on the vision and management skills of its founder.

5. Financial Snapshot

Disclaimer: I, Asif Nadaf, have no position in the company or in any company related to the promoter group. Readers are advised to do their own independent assessment before taking any decision. You can expect some errors or forward looking statements, so do your own research as well.