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The ITC of the Banking Sector

Dec 15, 2022

The ITC of the Banking Sector

Is Mahindra & Mahindra (M&M) the ITC of the auto sector?

I asked this question to Equitymaster readers in November 2020.

Here is the video in which I explained the striking similarities between the best FMCG stocks in India and the evergreen auto maker. In both cases the financial numbers inspired confidence. But the market sentiments about the stocks were at all-time lows.

Most importantly, just like ITC, the stock of M&M had not moved for years. Between 2018 and 2022, M&M had swung in a narrow range. It reminded me of the 'Fevicol ka majboot jod' meme on the stock of ITC.

M&M had been a laggard in new product launches. And like ITC, it had underperformed peers enough to lose the trust of investors.

But my biggest reason to call M&M the ITC of auto sector, was my conviction that the business was at an inflection point in the post pandemic recovery phase.

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While the markets were focussed on the poor quarterly performance of M&M, smart investors bought into the stock betting on the business' long-term potential. Its deeply discounted valuations offered massive downside protection.

And guess what? Investors who believed the ITC-M&M hypothesis made 100% gains over last two years.

Bandhan Bank, one of the newest private sector banks in India, seems to be suffering a similar fate in the stock markets.

Like the tobacco business is for ITC, the microfinance business is the biggest drag on Bandhan Bank's valuations. It is also the biggest source of problems for Bandhan Bank as the biggest source of NPAs.

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Every flood, drought or unrest in the north-eastern states, especially Assam, impacts Bandhan's lending quality and recovery rate.

For ITC, the turning point was the replacement of a big chunk of tobacco revenues with food and FMCG revenues. For Bandhan, the turning point can be the replacement of a big chunk of high-risk microfinance lending with low-risk retail lending.

Also, like tobacco is to ITC, Bandhan's linkage to its core micro-lending business is decades old. Founder Chandra Shekhar Ghosh started Bandhan Bank as a microcredit entity when he saw a money lender offer a Rs 500 loan to a shopkeeper at exorbitant rates.

However, he used technology and doorstep service for small ticket loans to grow the business exponentially.

To survive, ITC must lean on the growth prospects of the FMCG business. The regulations and tax laws regarding the tobacco business make it prohibitive for capital allocation.

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Bandhan Bank's return ratios, in single dights, are the lowest among its peers. So, it must get aggressively into retail credit to fetch higher lending margins at the cost of low NPAs.

But if you are in a hurry to make a quick buck on the stock of Bandhan Bank, this is not for you. Both ITC and M&M have, over time, corrected the flaws in the respective businesses. This has fetched them better valuations.

It would be extremely speculative to bet that Bandhan Bank's return ratios or NPAs will significantly improve next quarter itself. But the trend is visible.

Also since banking is a business with leverage, both upside and downside in business prospects can get magnified. Hence only a long-term investing approach to make the most of the value buy should be your goal.

And rest assured, there are plenty of 'ITCs' in other sectors too.

Stay tuned.

Warm regards,

Tanushree Banerjee
Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)

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