Bajaj Finance Limited

An important question that was asked in the recent concall- how do you see the behavioural risk of people coming out in the coming months, buying things on zero cost EMI loans? In my opinion, this remains one of the key important business drivers. Atleast for me, lockdown has taught the importance of bifurcation between discretionary/ non discretionary spending. Expenses in April/ May kind of set a benchmark on how a household could be run. And have been hearing the same form many of my friends/ relatives. Atleast for now, it appears to me that conserving cash remains a key goal for many and would think twice before taking up non discretionary spending.
With the above premise, if I can dissect BAF-

what can go right?

  • Franchise of BAF, which will drive lot of low cost funding by many players ( banks etc) to BAF
  • ability to drive down opex and mitigate drop in profit margins
  • new growth levers identified by company like gold loans, high growth in medical loans
  • risk analytics driven lending approach to target the right customer for high cross sell

what can go wrong?

  • rise in delinquencies
  • prolonged delay in rise in consumer spending ( could be one of the key trackers for me in various sectors like auto sales, electronic goods sales, real estate).
  • another aspect, I keep thinking - temporary change in mindset of people to go for cash purchases rather than avail any sort of debt driven purchases.
  • another black swan event like massive lay offs in some of the industries, which could lead to drop in demand and rise in NPAs ( unaccounted for as of now)

On a probability scale, things that could go wrong in this sector does appear to me to play out in next few quarters and impact the sector as a whole. So, am expecting further fall from current levels. Would wait out patiently to dip into the stock at lower levels, if it ever happens. To me, in the current times an omission error is much pardonable rather than a commission error. I could be completely wrong in my above analysis and hence, pls do your own due diligence.

Disc: no holdings. Not an investment advice. Pls do your own due diligence.

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Further impact for lenders if interest is tinkered…

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My thoughts on Bajaj Finance - Positives, Negatives and how I am thinking about valuation.

What Warrant Buffet said on Financials/Lenders: Lenders sell the most commoditized item: Money. In such a commodity-like business, only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels.
Bajaj Finance is a classic case of how an NBFC overcame the advantages that banks may have due to lower cost of funds for banks over the years. It kept on adding new product lines over the years and in the process finding some niche areas and creating new income streams and focusing on cross sell. It has been mining its increasing customer franchise (now at 42.6M) products like health card, health insurance. It came up with innovative products like “zero interest EMI” in consumer durables space, a space that was initially ignored by Banks.

Positives

  • Liquidity is not an issue for BAF – Survival is not an issue. Its liquidity surplus is very strong with overall liquidity surplus of ₹ 20,900 crore as of 15 May 2020 on consolidated basis.

  • Consolidated borrowing mix for Money Markets: Banks: Deposits: ECB stood at 42%: 38%: 17%: 3%. BAF has a well-balanced liabilities profile. It is witnessing sharp decline in borrowing rates.

  • Enough fire-power in the PnL and balance sheet to absorb credit shocks. The above chart compares Bajaj Finance with some other NBFCs in terms of ability to absorb credit shocks measured by % of credit cost needed before tier 1 capital would come down to level below which NBFC would want to raise money.

Overall, some of the attributes which makes me feel that Bajaj Finance will survive and come out in a reasonably strong position from this crisis are –

  • High Pre-provisioning operation profit margin
  • Strong capital position
  • Access to funding. It has been raising money at low rates post liquidity support announcement measures.
  • Ability to accelerate and decelerate lending across different products depending on outlook as exhibited in previous crisis.
  • Management’s agility and ability to innovate and react to new reality.
  • Lower competition for those who survive with good balance sheet post this crisis. Not only that the larger players who survive the current crisis would be able to grow faster with lesser risk post the crisis due to lower competition.

I am not trying to mistake the current crisis with IL&FS crisis or demonetization. Covid-19 is by far the biggest crisis that any lender has faced. But what we have seen is that BAF came out stronger post some of the earlier crisis.

We have also recognized that Bajaj Finance has by far the best disclosures (significantly better than all the top banks). While this is not an enough reason to become positive, it speaks good about the management and the group.

Negatives/Concerns

  • Constrained environment which limits economic transactions for longer time than expected – Business conditions do not reverting to normalcy for the entire year, leading to demand depression. One near term development that may take place is that due to short tenor of large chunk of loans and very low disbursements in Q1, AUM fall in Q1 may be higher (even though at this stage, I would expect flattish AUM growth for full year and BAF to catch up in the 2H).
  • Extension of Moratorium by 3 Months – RBI has extended moratorium on repayment of loans till Aug 31, 2020 in order to help borrowers manage cash flows better. There is a risk that this may hamper the credit culture and may lead to defaults. In some cases, we have come across reports where certain customers have been unhappy with Bajaj Finance as they have had to pay high interest rates on the zero EMI loans.
  • Lower business will put pressure on fees in FY21 – Fees (from 54% YoY growth in FY20) should see a significant decline YoY in FY21 (baking 30%+ YoY decline) due to lower loan origination fees, moderation in cross sell fees and decline in card related fees. Insurance distribution will provide some support.
  • Higher share of unsecured loans and rise in share of high yielding assets over the years. This is a genuine concern which is why stock has corrected by over 50% and to address this one will have to build higher credit costs. It also needs to be noted that this is what gave BAF higher PPoP margin.
    I have taken note that even if adjust for Covid-19 provisions of INR9b (0.6% of loans) that company built in Q4 results, the credit cost still doubled between FY19 and FY20.
  • Some top banks have been able to narrow the gap on some of the strengths that Bajaj Finance had. Many banks with their NBFCs, small finance banks have got into small ticket lending in consumer durables category where BAF has an edge. Having said that BAF is also getting into newer products. For example, Gold loan is one area where BAF has been investing.

Valuation
Bajaj Finance has been generating best in class RoA/RoE post its restructuring in FY09. For FY21, I would expect RoA/RoE to dip to ~2%/10% (bear in mind that Bajaj Finance leverage is lower so that is the reason for lower multiplier on RoA) driven by loss provision of 4.5% of AUM. For credit loss, I have assumed ~100% increase compared to FY20 levels. The credit cost has also been backed with the assumption that if 1/3rd of morotorium loans were to slip and building an appropriate LGD depending on the product segment. Baked in 100% increase in credit costs from FY20 level which already included INR9b of Covid-19 provision. This would bring the RoA to ~2%.
FY22 numbers are erring on conservative side. Leverage is on the lower side.

While credit cost should come down in FY22 from FY21 level, it may still be elevated if the economy is in doldrums, there is high unemployment rate and elevated stress level at SME level. Even if we assume, loan loss provisions of 3% in FY22 and some NIM contraction over FY21/FY22 from FY20 levels due to higher liquidity buffer and lower incremental lending to unsecured, RoA/RoE in FY22 can be 3.7%/17.7% which will be best in class. Should the credit costs start normalizing by FY23 (loan loss provisions reaching 2% of assets), BAF may reach RoA of 4.15% and RoE of 20%+ by FY23E.

For reference, HDFCB makes an RoA of ~1.8-1.9% and may make RoA of ~1.4-1.5% in FY21. Prior to Covid-19, Bajaj Finance traded at 70-75% premium to HDFC Bank owing to higher RoA and growth. This premium has now collapsed to ~35% currently with correction in valuation multiple of both HDFC Bank and BAF.

I believe that in the longer term, bank structure may have some advantage over the NBFC and hence I am inclined to give Bajaj Finance similar valuation multiple (and not a premium at this stage of the crisis) to HDFC Bank despite the higher RoA for BAF. One also has to recognize that Bajaj Finance in its current business model has not weathered the same number of crisis that HDFC Bank has weathered.

Overall, I may be inclined to start staggered buying once the current price comes somewhat below ~3x FY22 ABV knowing that the lenders who survive this crisis with a decent balance sheet will benefit disproportionately post the crisis.

Disclosure: Not Invested

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Lot of adverse publicity for Bajaj Twins because of aggressive recovery tactics

Bajaj Finance IBN24

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My opinion is the day moratorium is announced, people who have a capacity to pay stop payments. The people who are gathered there appear to be well off and does not appear that they can’t pay EMIs.The NBFCs are again intermediaries picking up debt and providing small ticket loans.They can not forego interest or principal payments else it would be a collapse of whole financial system.
The media needs just some masala to amplify and vomit without understanding .
As a shareholder, we need to appreciate efforts of the company in recovery else these blue chips will go down the drain some day and common man will not get credit at liberal terms.
Disc: Have little equity exposure to Bajaj twins and fixed deposits.

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Agreed sir. From an investor perspective I appreciate BFL efforts in getting back dues. If they encourage moratorium, or behave liberally, they will just end up with a huge pile of bad loans and nothing else. The same media will then play story of how a well-managed NBFC went bust!

I guess one of the basics of investing is to put yourself into the shoes of the business/company you are investing in and see how you would be running it vs what they are doing. And in this case I would be doing the same what BFL is doing, which is trying to minimize bad debts.

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Doesn’t look good for Bajaj Finance. The video has almost 1500 comments and almost all of them are from customers of Bajaj finance who claim to be aggrieved by the company’s policies.

When the company charges high interest rate during moratorium period for customers who availed of zero interest loans, there is a huge perception-reality mismatch in the mind of those customers which makes them feel they have been cheated, although BFL is indeed well within their rights to charge interest on those loans during the moratorium period.

Unfortunately, In India, if too many people protest against something, then often, the bureaucracy and even the judiciary tend to side with the public. We’ve seen this scenario play out before with the Noida Toll Bridge Company.

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second part of the video looks even more interesting.

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I watched the video for about 8-10 mins and it seems the person shouting with the mike did not even make an attempt to understand what the charges were for. It seems to be a case of trying to make a mountain of a mole as it the case with a lot of these hindi ‘news’ channels.

I have wasted 8-10 mins on this which I will never get back and am writing so that others also don’t waste their time and give these attention hungry reporters views that they seek.

For an investor, these kind of news involving a handful of disgrunted customers, employees etc don’t make any difference. In case one wishes to form an opinion, the sample of customers has to be representative of the population. Bajaj fin has a few million customers.

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Bajaj family is very vocal against the government in recent times. I’m not seeing any other business houses doing this and not sure how appreciative this government for constructive criticism. as a investors, do we need to be concerned about promotors going political?

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Just to add here that it’s not waived but deferment of EMIs .Since any NBFC or bank pays interest on sources of deposits, it has to charge interest to remain afloat.Regarding high interest rates being charged, it is to discourage the customers from availing the scheme, else even those who can afford will not pay and there is a strong possibility of A-L mismatch of the company leading to various complications.

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My Take on BFAL Q4 and some behavioral Insights :wink:.

q4_FY20_Results.pdf (3.5 MB) JM-Fin-BajajFinancial-May19-2020 Final Version.pdf (1.1 MB)

ACES UP Your Sleeve.docx (146.7 KB)

Regards
Sunny

Disclosure: Proud Minority shareholder.

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Thanks, good viewpoints and Insights.

While they will do well, survive and thrive someday.

Will market get them to a valuations that have a meaningful returns in short to med term fromnl current prices, considering

  1. Sectoral de-rating for NBFCs and Banks
  2. Consumer discretionary taking it on chin
  3. Demand supply being tilted to high supply for fin sector
  4. Performance need to be demonstrated in next 2 qtrly results to convince mr Market - and that may justify current levels probably given growth vs Balance sheet mindset of mgmt for FY 20

No doubt one of the best in their own space, if opportunity cost and funds are not prohibitive - attractive for long term

Trimmed position to tracking in recent bounce back. On sidelines for sometime.

Please go through Uday Kotak’s latest interview. He is extremely negative on Unsecured Consumer Retail and MSME loans

We all know the state of Housing loan…

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I used to wonder what would happen if anyone defaults given the way they have been hawking their loans. They would bombard their customers in the normal circumstances and we are in the extra ordinary situation. For a small ticket borrower, the situation has changed from no interaction with the lender to coercive collection. I think coercion won’t work with many customers in these circumstances. The business model is based on low cost fintech way of disbursement along with automatic collection. It remains to be seen if it can go back to old school ways of collections without getting bruised or significant jump in opex. However, I don’t think anyone would like to default on these small sized repayments but they might need time to make repayments.

Sanjeev Bajaj on Ticking Time Bomb…NPA

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IC Report on BFAL by Nirmal Bang. Added my comments.

Bajaj-Finance-Initiating-Coverage-12-June-2020.pdf (1.4 MB)

Regards
Sunny

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