IndusInd Bank + Bharat Financial Inclusion

Stock Opportunities
1

SKS MICROFINANCE WAS PERCEIVED AS THE BLUE EYED BOY OF INDIAN MICROFINANCE SECTOR WHICH AGAIN WAS CONSIDERED AS THE NEXT BIG THING. BUT WITH THE ANTICS OF ANDHRA PRADESH GOVT, THE SECTOR AND THE STOCK HAVE TAKEN A BACK SEAT WITH SKS BEING HIT HARD TO THE TUNE OF 50% IN TERMS OF VALUATIONS.

SOME DETAILS ON SKS MICRO:

IPO was priced at Rs 935 per share (Rs 50 discount to retail investors)

Current market cap based on closing price of 676 is around 4865 crores.

Promoter holding is around 57% post the IPO.

BUSINESS:

It is the largest mircro finance institution with around 2100 branches and employing around 21000 persons as on March 2010. It has presence in 19 states with the bulk of business coming from Andhra Pradesh (29%), West Bengal (16%), Karnataka (11%), and Orissa (9%).

SCALABLE BUSINESS MODEL:

The business of SKS is a scalable one and with the company having accessed the capital markets and collected funds, some part of capital requirement has been taken care of.

ASSET QUALITY – Till March 2010, the NPA at net level were at 0.16% which is negligible but this part of the business remains the key monitorable paramter in the wake of the current controversy.

FINANCIALS:

YEAR 07 08 09 10

Operating Income(mn) 445 1625 5061 8736

Op profit 54 256 895 2341

OPM 12 16 18 27

NP 22 166 797 1748

As can be seen from above data, the company has been growing at a scorching pace till date.

PROBLEMS:

Problems are two fold as I see them

First is that the company is likely to see lower OPM due to reduction in interest charged as guided by the govt

Secondly there could be some cash crunch because govt has guided the company to collect payments on a monthly basis instead of weekly basis as was the earlier practice.

VALUATION:

Post IPO equity dilution, the EPS for FY 10 stands at around 24. Book value is around 224.

NOW THE MILLION DOLLAR QUESTION IS WHO WANTS TO BITE THE BULLET AND AT WHAT PRICE?

Here the assumption to be taken is that the company may not see the scorching growth shown earlier and margins may also be reduced but that does not take away the facts that the company is the largest MFI in the country and the MFI sector is likely to see good growth going forward.

On the management interview shown on TV recently, the management seemed confident of overcoming the crisis and had a target of loan disbursement of around 7500 crores and ROA of 5%.

WOULD LIKE VIEWS OF FELLOW INVESTORS.

Disc: No holding.

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Well, first of all, well written, I think its an opportunity in disguise, SKS as mentioned by its promoters was going to report an EPS of anywhere between 35-40 Rs for F.Y.11, that means a nett profit of Rs. 250 - 285 Crs, Now looking at current problems and as their ratings have been cut by several so called analysts, definitely their margins will be dented, now that I think is the most critical question, by how much? The current nett margins are around 22%, now if we take a conservative estimate and cut the NP margins to say 15%, i think that will be a fair estimate, So on expected sales of 1150 Crs for F.Y.11, the comapny will make a N.P of Rs.172-175 Crs, and that gives us a rough EPS of Rs. 25-26 for F.Y.11, Now as this one is a sector leader and growing at say 30% per annum for next 4-5 yrs, A respectable P.E. for this one should be anywhere between 30 - 35, So for a P.E. of 30, the price should rule at around 780 Rs, and for a P.E. of 35, the price should rule around 910 Rs. So, Yes, this is what should be a trading range according to my analysis, i.e., anywhere between 780 - 910.

Disc. No holdings.

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First of all Hitesh, thanks for bringing this up for discussion. Its current, and pertinent to discuss and be prepared just in case:). My initial thoughts

There are several overhangs on the stock:

1). The Andhra Pradesh ordinance capping interest rates, and imposing other restrictions

2). The CEO Suresh Gurumani who took it successfully past IPO was unceremoniously sacked by the board (read Vinod Akula, the founder) in Oct, with no announcement explaining the reasons for sacking a CEO so soon after the successful IPO. It was seen as a personality clash between teh CEo and the Founder who was back to assert himself.SEBI reacted quickly and publicly in asking the company to explain its action. It also let it be known (through media leaks) that it is not satisfied with the answer. We learn that one reason for SEBI’s quick response could be the fact that before the IPO (Initial Public Offering), some of its shareholders had complained about a preferential offer to a select group, which was later dropped.Read this moneylife article for more. That Vinod Khosla, Narayan Murthy, Seqoia capital and other luminaries from PE funds on the board could not prevent such action, raises major issues of Corporate Governance. I remember Murthy being quoted at that time “I have advised Akula to be transparently discuss the issues” something to that effect.

The Andhra High Court has meanwhile restored Gurumani to the board, and asked the company to take shareholder approval before sacking the CEO

3). His former wife (she lost a child custody battle recently to Akula) wrote an open letter the following day -also published in all dailies revealing more about Akula’s style of functioning…and his need for power & control …but this can be taken with a bit of salt …the allegations & counterallegations…because of their bitterly fought custody battle, but nevertheless important points raised there.

So to my mind, several uncertainities:

1). State government interference in the business may remain a constant overhang…who knows what other states like West Bengal might come up with…like the oil PSUs, ONGC were until recently and still not fully free of

2). Corporate governance issues

3). Fight over the CEO…though this might get resolved soon, Gurumani may not have any numbers backing him, as his stint was pretty short in the company.

Financial firms valuations must be seen w.r.t BV. Remember this BV also reflects the current market price of assets(unlike manufacturing or other coys assets), and with recent changes, updated every quarter.

The current BV (as on Sep 30) is ~250 per share. so at CMP of 676, it is available at 2.7x. Not bad given that HDFC is available currently at 6.7x BV, and our own SBI at 3.9 BV. But with serious overhangs on the stock, I would like to own it only if it corrects below 2xBV or below Rs. 500.

Mr. Narayanmoorthy’s catamaran ventures btw had got in pre-ipo at Rs.300. Now if we can get somewhere near that price that will be a steal:)

lets discuss more views and counterviews and dig more.

-Donald

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With microfinance institutions suffering loss of business particularly in Andhra Pradesh, the Centre on Friday said it does not intend to strangulate the microfinance sector but regulate it.

“My idea is not to strangulate them (MFIs), but to regulate it so that the interest that they charge is not exorbitant and the method of realisation, under no circumstances, should be quick,” Finance Minister Pranab Mukherjee [ Images ] said at the HT Leadership Summit in New Delhi [ Images ].

The microfinance industry has been under pressure after Andhra Pradesh state government introduced an Ordinance last month to regulate its lending practices. MFIs have been criticised for charging very high interest rates and using strong arm tactics for loan recovery.

MFIs say they extend loans to unbanked areas and so the cost associated to it runs up to as high as 34 per cent. They usually lend money to borrowers through women groups in remote areas.

"The rate of interest should be moderate. Banks are also being instructed to provide them (MFIs) with necessary guidelines (and check) if those guidelines are complied to.

“I would not like to strangulate the system, because it is not possible for the banks to reach large number of people through regular banking services,” Mukherjee said.

Earlier, the microfinance institution network had said the companies would cut interest rates to 24 per cent eventually.

Mukherjee said that in certain cases the interest rates charged by MFIs varied between 30-35 per cent. “It (interest rate) cannot be uniform, so some sort of flexibility will have to allowed,” he added.

Last month, the Reserve Bank appointed a committee to examine the state of the MFI sector under the chairmanship of Y H Malegam. The committee would submit its report by January.

“After obtaining these (the RBI committee) reports, I will take appropriate measures in consultation with the RBI,” Mukherjee said.

Following a spate of suicides in AP, on October 15 the state government came up with the ordinance making it mandatory for all MFIs to register with the district

Registering Authority. Also, the MFIs should increase the loan repayment period for self help groups (SHG) to 30 days, as against the earlier practice of 15 days.

This has impacted the collections of MFIs; the country’s only listed microfinance company SKS yesterday said that its collection for November had come down and in future could affect its profitability.

The finance minister said he had analysed the ordinance and given some suggestions to the Andhra Pradesh government.

He exuded confidence that the suggestions would be carried out when an Act replaces the ordinance.

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SKS Microfinance has been correcting gradually since we last discussed this counter. Its coming closer to 2x BV level i.e. 500, CMP 529.

Have not been tracking this space. Whats the impact of the AP ordinance on the business for SKS? Dec Qr has seen good sales growth but major degrowth in Net Profits, and a small dent in OPms. On 9m basis, things are pretty good actually sales & net profits mirroring a 63% growth!

Hitesh, anyone else still tracking?Any one tracks NBFCs in particular?

-Donald

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its on the upmove again. The changing fundamentals is changing the fortunes of this stock. Anyone tracking it right now who can discuss this…

Dissclaimer: I am an investor in this stock …

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Not sure if somebody is tracking this stock or not, but again excellent set of numbers…

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Anyone tracking this stock. The juggernaut continues here with good results. The profits are expected to double in FY15 from FY14. Views invited from Valuepickrs…

its on the upmove again. The changing fundamentals is changing the fortunes of this stock. Anyone tracking it right now who can discuss this…

Dissclaimer: I am an investor in this stock …

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SKS stock price has shown steady upswing over last one year. I have been studying the microfinance sector for last two months and I see a very real compounding opportunity.

The growth is back in the sector, the asset size have started growing for the entire sector (61% in 2q2015 for the entire sector).The asset size is now almost at the same level as before the 2010 crisis. Asset quality is stable with less than 1% NPAs for the sector as a whole. This is remarkable, as sector had shrunk to a half after the crisis in 2010 and anyone associated with financial industry will tell you that as the book size shrinks the asset quality inevitably deteriorates. The leader of the sector, Bandhan, will soon convert itself in to a bank which will become a great advertisement for the sector. The small bank guidelines recently released are almost tailor made for this sector and we should see a few small banks from this sector in not too distant a future. The 10-12% cap above the cost of funds for charging interest with a max cap of 26% ( less than credit card interest rate that you and I pay) means that the competiton will be very limited, chance of any more political intervention is less and those MFI who can reduce their cost of operation (read big in size) will have permanent advantage on rivals as they will be charging less interest rate than others due to regulatory requirement. Their is real possibility of meaningful line extensions such as housing finance and vehicle finance in this sector which is a hot favorite for indian stock market ( gruh, repco etc). The last but not the least there is frantic PE activity in the sector with at least 5 deals that I have seen in last few months raising hundreds of million dollars at decent book multiple and similar amount in the pipeline . So a flurry of IPOs should follow in few years time.

Unfortunately we have only one stock to play with SKS. It is now no longer the largest but second largest but has started growing again after shrinking the asset size to less than a third from the peak. SKS asset size topped 3000 crs at the end of q2 which is way lower than what was there in pre criss era but double from the lowest level it reached after crisis. One of the post above says it was targeting 7500 cr asset size in 2010! The profitability is now higher than the pre crisis era having significanly reduced cost of operation. SKS has capitalized itself very well and CAR is well over 30%. This along with the return on assets of over 4% will ensure that growth upto 40% CAGR can be easily self funded without dilution. The management seems to have learnt its lessons and is determined to keep growth rate under check and not to go back to break neck speed of the past of well over 100%. Hopefully this will allow costs and asset quality to be under check. Overall I think it is now set to become a company that is poised to grow for 30%+ a year for the foreseeable future opening up the wealth creating opportunity that the investor can dream off. And should it decide to convert itself into small bank with RBIs blessing then in the words of Raghuran Rajan " banking Licence in India is licence to print money".

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Do you really think that @ 8.5 times the book value, this stock provides an investment rationale?

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Hi Atul,

Pretty good insights about the microfinance industry. Even whole sector the past 2 months and even I am impressed with the growth as well as low delinquencies in key risk, however, continues to remain the regulatory risk and political interference. Also, it would be important to track what kind of growth are microfinance companies targeting. Growth with poor credit checks can lead to problems for the sector.

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SKS does look good considering the growth rate of MFI industry in general. But, with new Small/payments Bank regulations in place, there needs to be more analysis on the future. Vikram Akula in an interview said that RBI is saying the days of NBFC-MFIs are over. They have to become Small or Payment bank, so that they can be regulated by RBI. This would mitigate the regulatory risk (state level), but would add costs of banking operations to MFIs. It would not be possible for a bank to sell nokia phones and charge a margin on that. Cost of start of banking operations and that of raising deposit (~5% of the deposit amount) might end up to be drag on SKS, if it becomes a small bank. I think we need more thought on the possible effects of changing dynamics of the regulations in the industry.

disclosure: I am invested.

I have been studying the the sector. The

I think that there is need for more thought on what future can bring, considering

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Bomi

A valid point about book multiple for finance company. However I will be a little charitable to SKS as the AP crisi caused a sharp drop in book value. But the small upside of it is that it has now deffered tax credit of Rs. 30 which if taken in to consideration then book value will be Rs 100 which will translate in to book multiple of 4 high but not excessive. Moreover it will be wrong to to dismiss SKS just because of book multiple, imagine SKS does a QIP now at current price of Rs. 400 then the book value will jump to 150 and the multiple will be just 2.5! The point I want to make is you will be little unfair to dismiss stock just because book multiple is high.

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Ankit,

Thanks for the kind words. I am discounting the political and regulatory risk and I think it is very low to nil. Let’s take each one separately.

Regulatory risk. SKS is now a NBFC MFI and regulated by RBi. The regulations are transparent and audited. As long as they play by the rule there is no regulatory risk.

Political risk: The AP political risk primarily came because the MFI industry was working in vaccume (just like app based taxi services Uber etc) which allowed AP government to invoke Moneylender act and shut down microfinace institutions. After NBFC tag no court will allow any state government to intervene as it has become a central subject and now state subject. Moreover SKS is making sure that the one state exposure will be more than 15% of book which reduces the disruption risk dramatically. The political risk came because MFI wer charging very high intrest rates which easy to discredit them in the eyes of uninformed public . With 26% cap on intrest rate no one will be able to say the intrest rate are usurious ( I pay 36% for my credit card).

As you wrote rightly I think the biggest risk comes from growth. They can easily grow at 100% as demand is so high, but doing so will mean the lending standards will become very lax which will inevitably result in some crisis or the other and also new capital will be needed . I for one will like SKS to grow below the industry growth rate which will allow it to control this risk. If it grows say 40% next two years and industry grows at 50% that will be great for the stock price.

I have been studying the the sector. The

15

Pranav,

I missed the vikram akula interview I will try to dig it. You bring an interesting point about cost of deposit mobilization. That is the reason why SKS does not want to convert into bank I guess. They (SKS) are raising money at 13% now and with improving credit rating it will drop more. Which mean they can pay at best 8% for deposit which I guess SKS thinks is not good enough for deposit mobilization. Bit I also agree with Akula bank is the way to go for MFI industry and I think SKS will bite to bullet and apply for license.

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SKS Micro-Finance â Is it growth/Illusion??

CMP â 513

Mcap â 5580 Cr

BV â 79.2 â (Set to improve, as the book has been improving every quarter)

p/bv â 6.48 (Looks expensive, but this # is all set to improve)

EPS â 13.8

P/E â 32.03

CAR â 34.6%

Cost of Borrowing â 13.3% (9M Average)

Borrowing distribution: The company meets 3/4th of the borrowing requirement (total borrowings @ 3031cr) from private banks. With falling interest rates, a 50 bps reduction in borrowing cost would lead to increase of close to 11-13 crs bottom line for the company. (Assumption # 1: Donât think SKS will pass on the reduced interest rates to the borrowers, as the borrowers are mostly rate insensitive due to limited access to credit.)

- Term loans from banks â 76%

- Securitisation â 10%

- Managed loans â 6%

- Commercial Paper â 6%

- Cash Credit - 3

Now (7/4/2015) with RBI hiking the borrowerâs limit(detailed below), lets try to understand the impact:

Previous

Revised

Eligible HH annual income

Eligible HH annual income(Earlier)

Rural Household

50000

100000

100000

60000

Urban Household

50000

100000

160000

120000

- Average loan size/borrower (based on Dec qtr numbers) â 12,152 (SKS qtrly report)

- This was a difficult assumption for me - I find it hard to make an assumption here that this regulatory change will materially impact the company, looking at the average loan size.

- To understand this better, let look at SKSâs customers borrowing profile â (Sourced from SKS dec qtr report)

o Livestock 25% - Impact

o Tailoring, Cloth weaving 11% - No Impact

o Grocery stores and other retail outlets 8% - Impact

o Masonry, Painting, Plumbing, Electrician, Carpenter 8%- no Impact

o Trading of vegetables & fruits 7% - No impact

o Trading of agri-commodities 6% - No Impact

o Vehicle repairs 6% - No impact

o Eateries 5% - No impact

o Agriculture 4% - Impact

o Garments & Footwear retailing 3% - No impact

o Other income generating activities 18% - Cant say

- I just made some assumptions, considering rough numbers.

- Assumption # 2 - Looks like 33% of the book is likely to be impacted. However, am not sure if this will result in long term healthy book, as the borrower with an annual income of 1,00,000 , is allowed to borrow 100,000 â Rough repayment yearly works out 40,000. This is a negative to me.

- Total book size â 3195 Crores; 1/3rd works out to roughly 1000cr â What is the likely impact here?

Other key items to watch out for:

- Un - availed deferred tax liability â 506cr (will be helpful to offset future tax payment)`

- Cash + Investments of about 908Cr in the books

- Healthy CAR of 34.6%

- This means, enough room to grow, without any incremental cash needs.

Some long term questions:

1. RBI is moving towards facilitating having small banks vs MFIs, thereby having more elbow room to regulate. This might have significant impacts to SKS â Likelyhood of this happening â not in the next 3-5 yrs.

2. Scalability â Already discussed in the above threads. Quite possible to scale. Already they have a diversified portfolio. In one of my presentations I have read 80% of India still does not have access to credit market. (One would still have to find out the addressable market out of 80%) This is a fast growing industry. I agree, that as long as SKS doesnât chase break-neck speed growth it is safe.

There is only one another listed company in this space(that I could find), SE Investments(much much smaller than SKS) and was trading at a P/BV of 3.51.

There is enough scope for relative B/V improvement in the next 2 yrs vis--vis peers in the NBFC industry. But the question still remains. Is it a 2-3 year story/is it a healthy 10 yr story?.

Quality of the investment depends on the quality of assumptions one makes. If the assumption is a fair one, it will result growth. Please comment on my above assumptions too!.

My views may be biased. Looking forward to hear a different view than mine on this. Views/Diagreements are more than welcome. Atul/Other boarders, please share your thoughts.

Thanks,

Ravi.S

Disc: Invested in very small quantities. Still contemplating, if this is worthy of a meaningful allocation.

17

A couple of corrections to my post above:

Correction # 1 FALLING INTEREST RATES

SKS will NOT benefit from fall in interest rates as RBI’s mandate for the industry is to follow the lower of the following rates:

1). Margin Cap of 10 % above cost of borrowings

SKS cost of borrowing is around 13.5-14% (see above post). so 13.5%+10%(margin cap)= 23.5%

2). Average Base rate of top 5 commercial banks x 2.75

The average base rate of most of the top banks is around 10%, so that is around 10x2.75 = 27.5%

The lower of the above is 23.5% and here SKS has a margin-cap of 10%. So their spread will usually be maintained around 10% and SKS wont benefit from falling interest rates

Correction # 2 Price/Book Value:

The book value quoted in the above post is 79.2 But that doesn’t factor in the Deferred Tax Assets worth 506 Crores(Present Value - 21 /share discounted at 13.5%).

So the actual book value is roughly 100 and the Price/BV - 5

The below url was available in SKS website. Found it very useful.

http://www.sksindia.com/downloads/Earnings%20Update%20Q3-FY15.pdf

Thanks,

Ravi.S

Disc: Invested in very small quantities. Still contemplating, if this is worthy of a meaningful allocation.

18

SKS has come out with a very good set of numbers :blush: Good to see the company has turned around. 49% PAT growth compared to Q4 2014.

The company’s projected PAT growth of 25% for next FY. And the icing on the cake is the company still has a Deferred Tax Asset of 489 crores. (should save quite a good amount on tax for the next couple of years).

Source: Bse website

"The Company has posted a net profit of Rs. 405.351 million for the quarter ended March 31, 2015 as compared to Rs. 271.146 million for the quarter ended March 31, 2014. Total Income has increased from Rs. 1473.769 million for the quarter ended March 31, 2014 to Rs. 2262.004 million for the quarter ended March 31, 2015.

The Audited results for the Year ended March 31, 2015

The Company has posted a net profit of Rs. 1876.644 million for the year ended March 31, 2015 as compared to Rs. 698.510 million for the year ended March 31, 2014. Total Income has increased from Rs. 5448.353 million for the year ended March 31, 2014 to Rs. 8030.656 million for the year ended March 31, 2015."

Thanks,
Ravi S
Disc: Invested - 5% of my p/f

1 Like
19

Ravi S

Great post. I will like to add a few development that may have impact on profitability

  1. full impact of MAT from q1fy16
  2. full impact of standard asset provisioning in Fy16

Both will knock off between 1 to 2% from RoA. Both of these were insignificant in 2014-15, thus almost 20 to 30% incremental operating profit growth will not translate into the bottom line gains in 2015-16.

Luckily the average asset during FY 14-15 were around 2800 cr. and sks is exiting 2014-15 with asset base of 4100 cr. So it is safe to assume that SKS will be able to maintain profitability in Fy16.
However, to achieve management guidance of 235 cr net profit the average asset base has to increase by another Rs.1000 cr to Rs. 5000cr. Which means and exit asset base of over Rs. 6000 cr, a growth of about 50%. Clearly management think it is possible when they gave guidance.

But this is break neck speed and will require sks to grow above industry growth rate which I do not like. Also for last few years SKS was sitting pretty with its second largest position in the industry but towards the end of last year it was almost dislodged from that position by Janalashmi. it will be interesting to see what will be SKS management’s reaction, will they compete with Janalashmi or give up second position?

The joker in the pack is the small bank licence. If it comes through then the entire scenario changes.

Disc: Invested in SKS.

1 Like
20

Hi,
Any idea how the market scenario would change after banking licence. (say, SKS gets the licence.)