Financial groups: Focus shifts to their ability to boost parent's valuation

Not long ago, even as the core business of financial conglomerates such as Housing Development Finance Corporation (HDFC), State Bank of India (SBI), and ICICI Bank was doing well, the Street had turned increasingly bullish on their subsidiaries and how their contribution would boost the overall valuation of their parents.

While some Budget proposals may have cast a shadow of scepticism in terms of the future performance of subsidiaries/other businesses and their ability to contribute to their parent’s stock valuation, the jury is out on this.

Among key announcements of the Budget is removal of tax exemptions, including on home loans and insurance premiums, under the proposed new income-tax regime.

Given the potential impact for insurance companies, some analysts have started reducing their target prices for listed life insurers. This, in turn, could have implications on stock valuation of finance majors, as roughly 14-16 per cent of their valuation, based on sum of the parts, is contributed by their insurance businesses (see table), according to brokerage estimates.

Having said that, investors need not be alarmed as clarity is required on the quantum of long-term impact on insurers. Besides, these players would also have some time to rework their business strategies.

Nitin Aggarwal, analyst at Motilal Oswal Securities, for instance, estimates a marginal impact on valuations of the insurers’ parent companies due to the new tax regime. “If these lenders (parent companies) continue to report strong operating performance, their valuation would get good support, even if their insurance business sees some disturbances,” adds Aggarwal.

Wide distribution franchise, scope for efficiency enhancement, and likely improvement in overall credit costs are some other factors suggesting that the core business performance of these financiers would remain strong. In fact, after the December 2019 quarter results, the Street was looking at corporate banks like SBI positively, mainly due to asset quality improvement.

Some tweaks though may be necessary on growth expectations. Under the proposed new tax regime, exemptions for interest paid on home loans has also been excluded, which could hurt the retail loan book growth of lenders.

According to Kajal Gandhi, analyst at ICICI Securities, “Though it is difficult to assess the impact on home buying due to removal of 80C tax exemption, it disincentivises home buying by borrowing funds, which was lucrative earlier.”

This becomes a concern, given many banks have already started scaling up their retail loan portfolio. Since March 2019, shares of SBI and ICICI Bank’s retail loans in their overall loan book has gone up by 300-400 basis points to 61-63 per cent as of December 2019. Retail home loans account for 76 per cent of HDFC’s loan book.

There could be an impact on their fee income, too, as these lenders also earn some income from cross-selling insurance and other investment products, say analysts. Gandhi, thus, believes that strong core performance of these financiers would be key for their valuation, even if the contribution from other businesses fall marginally.

Positively, analysts also say that life insurance is now being considered more as a protection product rather than a savings option and believe that life insurance penetration would improve further. In that case, if insurers are able to drive their high-margin protection offerings, it could help the growth top line as well as profits.

Likewise, individuals are also focusing on securing products, such as health insurance, to protect their families from adverse medical situations, rather than as a tool to save taxes. Thus, the medium- to long-term growth story seems intact, and the immediate impact could be more for insurers with high share of savings products like ICICI Prudential Life than ones with higher protection share like HDFC Life. Moreover, it is also not clear how many taxpayers would opt for the new regime.

Lalitabh Shrivastawa, deputy vice-president at Sharekhan, says, “Until Budget, robust business growth of the life insurance business was considered a good value support for their parent companies in most cases. Though there is minor recalibration after Budget, we are still positive on life insurance.”

While stocks of the major lenders have recouped a significant chunk of their post-Budget loss on the bourses, investors would be better off focusing on the core business performance of financiers.

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