Arman Financial Services Ltd

Stock Opportunities
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Some more notes from Q1 FY18 Conf Call

Asset Quality
PAR 60 is around 5.2% of overall portfolio. Loans where even a single installment was not paid are already written off. Also most of PAR 90 is also written off. There is no restructuring of loans to longer duration for stressed assets, they are simply delayed payments. RBI does not allow even penal interest for delayed payments. Total write-off was around 4.5 Cr.
65% of total assets are new assets created post demonetization. Most of the MFI loans are 14-month tenure product. In order ro remain competitive, we increased duration by 2 months (from 12 to 14 months) so that installments do not go up. The average ticket size is 23k. For the first time clients, the average loan size is 18-20k. Then the ticket size can go from 20-30k in subsequent cycles. Around 72% of new loan disbursements are to fresh clients.

Cost of Funds
The current cost of funds is at 14.4%. We expect to exit the year with 40 basis point reduction in the cost of funds. Actual average interest rate on loans is around 12.5%. The additional cost is attributed to cost of cash collateral, bank processing fees etc. Most of the term loans are for 2-3 years from banks.
We have raised 15 Cr of sub-debt which shall take care of all the growth plans for FY18. We are open to have a strategic investor at attractive valuations.

MSME
The loan tenure ranges from 12-24 months. 80% clients have loan duration of 24 months. These funds are used for inventories, part of working capital. In rural areas, some of the loans are used to buy buffaloes etc.
The MSME clients are mature clients who do not want to go for group model. Further they prefer monthly repayment cycle compared bi-weekly repayment cycle. Our underwriting are little bit strict in this area and hence yields are higher at 30%. The lending is done based on a percentage net positive cashflow and we consider many things in calculating net cash flow like lifestyle, expenses etc.
These are unsecured loans in essence as no client will usually submit collateral original documents for the loan of 50k to 1.5L.

Guidance
The disbursements in month of July are already at 32.5 Cr.
We expect to exit FY18 with following contribution - GJ 50%, MP 20%, UP 20%, MH 10%.
The company expects to exit FY18 with following AUM targets ->
MFI - 270 Cr (Disbursement of 425 Cr)
MSME - 75-80 Cr
2-Wheeler - 90-95 Cr

2-Wheeler
The target AUM for 2-wheeler segment has been increased. This is due to several factors like - we have cut interest rate by 100-200 basis points for our customers due to competition. We have changed our relationship metric with dealers where they make more money if they give us more clients as a dealer plays a significant role in customer’s decision in selection of financing institution. We also have recruited some experienced sales people.

Branch Network
We have opened most of our branches in Q1 FY18. We expect to open only 4-5 branches in the rest of the year.
The recurring capex per branch is approximately as follows ->
rent = 1.5L/year, Payroll = 60k-1.1L/month, Travel = 20k/month.
The branch breaks even when we have around 600-800 clients and it takes anywhere between 4 to 8 months. Since recurring capex per branch is reasonably low, we have separate branches for all 3 divisions.

Disc - Invested

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144

Thanks Rupesh for posting in detail about the concall. A key takeaway for me is managements focus on diverisfying the loan book. Having a diversified loan book enables them to stop lending completely post demonitization.

The next growth trigger can be MSME. I see this not only for Amran but for other companies too.

Here are some data pointers on MSME:

1: CSL Finance: CSL Finance Draws Marquee Investors Including A Bhanshali, Kela And Parekh

I have not done any research on this company but just look at the names that are investing in this microcap which is in SME loan.

2: Ujjivan: Ujjivan Financial Services banks on housing, SME segments for coming years

Again, competition is heating up and a lot of MFI institutions are trying to tap this market. Small Finance Bank can now collect deposit and so their cost of funds will decrease. And they already have expertise in small ticket loans.

3: Yes Bank: Yes Bank gets $150 mn from OPIC to fund SME lending

Private sector Yes BankBSE 0.62 % has received $ 150 million funding from the US government and Wells Fargo to increase lending to support women entrepreneurs and small and medium-sized enterprises in India

For Arman:

a. The opportunity for Arman can be good in Ahemdabad(and Gujarat) which has traditionally been a great city for SME companies. But how will the company establish conservative standards and check points for appraisal to curtail NPAs for MSME is to be checked. Right now it is very new for us to take a call as these loans as they are just given.

b. Competition from Banks and NBFC is another challenge the company might face.

c. The competition from Small Finance Banks will be intense as their cost of funds will go down because they will be able to collect deposit. This might impact the NIMs going ahead. This in my opinion is the biggest problem with Arman as their liabilities side of the business is very weak. They can’t collect deposit and their cost of funds are high. Also, the stake of promoters is also less so how much will they dilute also needs to be checked.

Discl: Invested

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145

Hi everyone,

I am planning to attend the AGM this week. If anyone has any questions please let me know. If anyone is planning to attend, please ping me so that we can connect.

Thanks,
Kunal

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146

Could you pls check -

  1. Be in biz for decades, many other NBFC/MicroF grown high, however Arman its flattish. What are growth plans? What is the plan to take next level?
  2. Why one of the promoter selling shares?

Thanks.

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Hi Kunal,

I would appreciate if you could tell us in brief about the discussions in the AGM.

Thanks
Pranav

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Notes from AGM:

1 This was the twenty fifth year of the company. And it was the most challenging year because of demonitization. They stopped disbursement for four months in microfinance.

2 First quarterly loss in twenty five years

3 As on 30th June, 2017 the par 30 is less than 2% compared to industry average of eleven percent

4 August MfI disbarment was 35 cr which is double compared to previous month.

5 Repayment rate of 99.99% for new disbursement

6 Out of 100000 customer only 9 are overdue accounts

7 hundred percent cashless disbursal in up. Target of 50% cashless disbursal for entire mfi portfolio by end of year

8 for msme the current aum is 18 cr. they have 3800 customer. This years target is slightly reduce from 80cr to 50 cr. they want to go slow here as they are having high filter to check and assess. Door to door collection happens in msme.

9 aum for mfi in up is 32 cr and Maharashtra is 18cr

10 stake sold by incofin is acquired by reliance which owns 7%

11 ncd of 33 cr was raised and 15 cr tier 2 long term sub debt was raised

12 the company will pilot affordable housing market. On questioning about the higher ticket size they acknowledged that this is not their core competency and they themselves are skeptical. They will focus on rural areas where say someone wants to build a additional room, etc. There focus is very rural where customers can’t do paper work. This will be a secured loan. They reiterated that it will be a pilot and nothing is final

13 Jayendrabhai thanked profusely Amit M for his long years of service and gave an emotional speech on how they started together. Amitbhai was in the audience with us and he is retiring due to health reason. He does attend office to give guidance but is now going to take a back seat

14 Shareholders asked for more dividend and jayendrabhai clarified that they were in fact contemplating not to give any. But on inisitence of board they decided to share profits.

15 Alokbhai acknowledged that the company will have to raise tier 1 capital but they will wait for right valuation

16 when asked about their low equity of 27% and its potential impact on future dilution, he said that when the company raised money on 1992 on bse, there was no concept like seed funding. They were Struggling to meet ends and his father had to dilute then. Second time dilution happened during incofin and that gave them good growth. Incofin sold their dvrs to promoter which effectively gives them 40% holding.

17 he acknowledged that he should have raised money earlier but he was looking for the right price. Because of demonitization he is facing issue. But the company is well capitalised

18 Alok appears very conservative as he has seen first hand the global financial crisis of 2008. He is straightforward and ethical when it comes to deal making. The management took a conscious call not to lend to farmers. He believes that small farming is economically not viable and he does not want to take any chances here

19 his head of two wheeler said that in the last twenty years this was the most competitive in terms of two wheeler financing

20 other interesting stories: we met the Babulal Duggar, the biggest shareholder in the company. In 2007-8, On reading an article in a paper about companies quoting below face value of ten, he bought the stock for Rs. 3. He started checking with friends about Arman and someone said k.k.shah and c.r.shah are on board so it is an honest company. He stood by the company and now is a crorepati. Value investing ? Go figure:)

21 when asked about the competition by small finance bank, they said the difference in cost of funds is minimal. Sfb are currently issuing FDs of 9%. Even with two percent cost of funds the emi difference is of five to ten rupees. Small finance banks also have to invest massively in software solutions like Infosys core banking etc. Arman has very less operational cost which is an advantage

Personally, I think the management is top notch and if the company would have been headquartered in Mumbai, raising money would not have been so challenging. They were neither bullish nor bearish and communicated things in a matter of fact manner. Unlike other managements who are selling the moon. They wanted everyone to understand the risks involve in the business and how challenging it is. They humbly acknowledged that when the business grows challenges on operational front is enormous.

Discl: Invested

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149

Thanks Kunal ,the way you have put everything in detail ,really helps investors like us who are based outside of India (discl: I am invested heavily in Arman).

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Thanks Kunal for the meeting notes. Gives us confidence and perspective. Thank you.

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Pretty bad set of numbers by Arman →

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  • Despite 75% growth in loan book for Namra, there is barely any PAT. This is mainly due to 63% rise in employee cost & very high other expenses (mostly provisioning for PAR portfolio).
  • Borrowing growth rate is way more than loan book growth rate i.e. all additional lending is from additional borrowing as book value is not growing. This is compressing the NIM & RoA

Disc - I hold

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Thanks for the update Rupesh. In my opinion, Employee cost is higher because of the branch addition this year.

Also, to increase the loan book, borrowing, reducing the cost of funds by getting better rating in near future and profits are the only way the company has.

The fund raising will not be possible at current price which promoters feel is less.

Provisions have also gone up which is slightly worrying.

Discl: Invested

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A bit surprising that this quarter they did not explain their business performance alongwith the quarterly results. Also, I have not seen any intimation on the con-call to discuss the results.

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If anyone attended the concall, then please share the major points discusses. This time there is no transcript yet on the company website or researchbytes.

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Arman Q2 concal highlights:
Am summarizing some points not covered in their press note.

  • AUM target 400 cr by fy18 end (it was 191 cr at fy17 end).
  • Less than 50% total aum in Gujarat, compared to 80% last year
  • 1/3rd book is non mfi
  • 15cr subordinated debt recently taken. Will be sufficient for aum of upto 420cr odd. Will look at raising tier 1 capital within next 6 months
  • Cost of funds increased by 20bps. PSU banks take time. So borrow partly from nbfc whose rate is higher but disbursement is faster and more assured. Pvt banks are also lending. Last year their lowest sanction rate was 11.6%. recently they got sanction from sbi at 10.2%. nbfc rate is 13-14%.
  • Current debt equity is 4.6x

Mfi

  • disbursement is 37cr per month, up from 26cr per month pre demon time
  • PAR 60 mfi book is 3.82cr – 1.9% of book, compared to 5% pervious quarter
  • PAR 90 is 1.1%
  • Separate collections team personally supervised by Jayendra Patel to recover from demon defaulters. Sit in same branch but separate line of reporting; not reporting to business head. Collect appx 2.5L per day, of which 10-15k is from 180+DPD customers which are written off. Will continue as long as recovery covers employee costs.
  • 80% of problem loans are from Gujarat milk belt. It is not intention issue. They were not getting paid by dairies.
  • Avg aum in H1-18 is almost same as avg. aum of H1-17 inspite of big jump in disbursements. Hence interest income is less. And costs are high. It will balance out over next few months
  • Out of 105cr mfi disbursed, 22% is in UP which is all cash-less.
  • MFI Gujarat aum is 60% now, will reduce to 40% by mar18. 20% aum will be from MP and UP each and 10% Maharashtra. Roughly.
  • Mfi avt ticket size is 23100. They don’t go above 60k loan although RBI permits 1L loan.
  • 60-70% are new customers acquired post demon. Yield is 24% plus 1% processing fee.
  • In mfi in H2, the earlier plan was to open 3 new branches in Maharashtra and UP each, 2 in MP and 1 msme branch in guj. They may open lesser branches. Depends on opex cost.
  • They do not lend directly to farmers due to the risk.
  • 600-800 mfi customers are needed to break even a branch. Generally takes about 6-8 months.

Msme

  • aum is 25 cr. 4300customers. 58k avg ticket size
  • Msme aum target was 80cr when they started. However now it will be 55cr by mar18. Reason is that they are eligible for lesser loan amounts by their calculations – about 55-60k whereas mgmt. had earlier anticipated eligibility would be 1L.
  • Msme are mostly 24 month loans. Almost all the book is 1 yr old. Hence nil npa. Only 12 overdue accounts out of 4200. Mgmt. had estimated 3% loss ratio when they started out. Time will tell how they perform. Also starting LAP of 2-2.5L for msme. But still early days.
  • Msme has 13 branches whose capacity is to disburse upto 5.25-5.5cr per month. This can be increased to 6cr.
  • Msme has doorstep collection service which works very well
  • 2W business is mostly from dealer side. Tie up with 50-60 dealers and staff sit there.
  • Msme has 13 branches – 11 in guj and 2 in MP
  • Msme tat is 9-11 days which they are trying to reduce
  • Current profit from msme is 12-13L – just breakeven. which will increase going ahead.
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157

some observations from arman Q2 results and press note:

in general, mfi may be coming back into vogue. for some time at least. had invested in arman earlier, but booked out during demon. the uncertainity around it seems to be now getting cleared. hence entered this week.

very conservative and transparent and honest management. their commentary had been bearish through demon time. last 2 Qs however they turned bullish, and moreso quite aggressive in their Q2 press release. seems worst seems to be over for them.

http://www.bseindia.com/xml-data/corpfiling/AttachLive/14c9c25d-d099-401b-87ab-d2bf19591c3a.pdf

they had been growing well before demon and stopped disbursements in 2 months post it. and now looks like growth may resume.

stock has held on to around the 200-220 levels + - 10-15% even in the worst of times, hence bottom for the stock also looks to be in place.

from numbers - h1 writeoff is 4.5 rs per share. eps is 2.5. w/o will stop going forward. aum grwoth since march is 54% and since sep is 38%. interest expense grew by 46% but revenue by lesser amount of 25%. significant loans were given towards Q end whose income will start reflecting going forward. however interest, provision (on standard assets 1%) and employee/branch expenses were already incurred , hence depressing profits.

no. of employees and branches increaed by 45% and 52% over 30.09.16.

out of 3.13 cr write off in H1, Q2 was 1.2 and Q1 1.93. big qoq improvement. and they have said that all demon affected loans have been cleaned by. collection eff is 99.84% in sep Q

their msme business has just broken even and will start contributing to profits hereon.

in current setup they can do 120cr disbursement per Q in micro finance. they have reached 104 cr by sep.

they say Q3 is busiest for 2-wheeler loans. in Q2 they disbursed 23cr (22% yoy and 10% qoq growth). q3 last year was 26cr disbursement.

msme was 12.4cr disbursement (0.39cr yoy and 10.6cr qoq, which was 4.9cr in mar Q).

yields on these are also around 20-25%.

their aum is 296cr and they are conservatively targeting to make it 1000 cr by 2020. for this year they took subordianted debt and it is sufficient to maintain their current growth rate and for fy18. they may have to raise debt or dilute later.

views welcome.

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Vinay thanks for the detail note

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Hi Vinay,

I share your investment thesis. I invested during demonitization and frankly it has been an agonizing wait for the last year but company seems to be getting its growth back. The fund raising would be interesting development if they are able to get it done at the right price. They were planning to get it done before demon but wanted better valuation. If the price reaches those level(basically pre-demon price), they will be able to lever it more and might reach the target quickly.

Recently, I was checking the presentation of Satin Creditcare, which is also showing good growth. Here is what one slide said:
“20 years to reach AuM of Rs 100 Cr; next 7 years to reach AuM of Rs 4,000 Cr”

This is a very similar story for player like Arman. They have been in the business for 25 years now and have reached an AUM of 296 cr. This gives us an idea about the kind of growth rate possible in a company like Arman.

Another data point, that I came across recently, is the interview of Mr. Samit Ghosh. He said that the MFI Banks are occupying the space vaccated by PSU banks like SBI, PNB, etc. So they are filling in that space.

I had asked Arman management that with no banking licence, will it not be a threat as competitors will get deposits and lower cost of funds. They said, no, since they lack expertise to run a bank as well as cost of running a bank is too high for them. So in my opinion, going ahead, we will have to see that how will pure play MFIs like Satin and Arman compete with SFBs like Ujjivan, Bandhan, etc.

Other change that is there in the industry is that SFB banks are slowly diversifying their MFI loan book and entering other areas. This is also mentioned in the press note by Arman and Satin Creditcare, so this will also be positive in the short run.

Disclosure: Invested

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Kunal,

To add to your last point,

Ujjivan SFB management has clarified time and again that they will continue to grow their MFI loan book but since more business will be coming from other products and services, MFI will become 50% of their business.

Don’t know about other SFBs intentions but no one seems to be vacating the MFI space. So my question to you, if you can please explain how will this be a positive in the short run for Arman?

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I am in no way saying that they are vacating MFI space. But since their focus on diversification will increase, and this is true for everyone, including Arman, markets like UP will be witnessing less players.

Both Arman and Satin Creditcare said this in their interview and concall.

Arman Press Release:

Since April 2017, MFI disbursement have grown an average of 17% month-over-month, with September 2017 monthly disbursements crossing Rs. 37 crores. We have rapidly expanded our MFI business in UP to capture the space created by our competitors due to demonetization disruption

If you see the growth in disburesement and branches for Arman, UP is a major part.

Also, it was mentioned by Mr. HP Singh in his interview during earnings announcement that they are filling in space left by other MFI players in UP(am unable to find the link).

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While you are right that MFIs in UP and other major DEMON affected states are witnessing lesser competition, I do not think it is due to focus on diversification.

It is due to curtailment of credit to customers who are in default. Ujjivan, for example, has stopped new loans in specific branches where defaults are high.

This could have opened up space in these regions for other MFIs.

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Two questions from my side. I hope that someone asked them these questions in the concall that I could nto attend. Feel free to pitch in.

  • Is Arman funding the people who defaulted to other lenders after demonetization? Those lenders would have stopped lending to these people, so these would be easy pickings for Arman. But, wouldn’t this be bad growth?

  • Why does company have to wait for share prices to go up to raise equity? Why not do a rights issue? Promoters may also subscribe and won’t get diluted. A rights issue of 25% of equity would see them through till FY19.

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