Recent regulatory development bodes well for largest incumbent SKS Microfinance (SKSM). RBI doubled ticket size of one year loan to Rs 30,000; SKSM a clear beneficiary as 70% of its loans fall in this category: This will help boost AUM growth without incurring additional cost thereby driving operating efficiencies. Opex to AUM to improve to 6.3% in FY18 from 8.9% in FY15.
* SKSM to gain market as competitive intensity comes down—~54% of the industry is now small finance bank (SFB); management bandwidth of these entities will be channelised towards setting up banking operations. Moreover not obtaining a licence is positive for medium term earnings, as it removes overhang of dilution, regulatory costs and large opex in initial years, which would have resulted in low single digit RoEs (return of equity).
* Competitive positioning to improve on back of lowest lending rates in the industry due to optimised borrowing profile, superior credit rating and business correspondent opportunities in tie-up with large banks.
* Stable and supportive regulatory environment with RBI as the sole regulator abates possibility of any AP-like backlash.
* Presence in a highly underpenetrated industry (est. size at R4.5t in FY16 with just 15% penetration), high growth potential, strong management expertise and low competitive intensity provides +40% AUM/ profit growth for next three years.
* Current valuation of 3.6x/2.9x FY17e/18E P/BV (price-to-book value) is attractive. Initiate coverage on SKSM with a Buy rating and target price of Rs 589 (21% upside).
Multiple near-medium term triggers: SKS Microfinance failed to obtain SFB licence. While this creates uncertainty over long term (+5 years), the recent RBI announcement for MFI (Micro Finance Institution) sector bodes well for SKSM viz. (i) RBI doubling the limit of one-year loan from Rs 15,000 to Rs 30,000 will enable higher growth (ii) Assessment of PSL requirement for banks will shift from annual basis to quarterly basis from FY17—This would have twin benefits (i) would help further bring down funding cost for SKS and (ii) most large MFIs now SFBs won’t participate in securitisation, hence SKS would be preferred entity for banks and (iii) SKS has witnessed sharp decline in cost of funds, and it has passed on the benefits to borrowers. In our view these incremental developments bode well for SKS maintaining a strong growth momentum.
Migration to SFB an uphill task for competition; SKSM to gain: Not obtaining SFB licence is positive for SKSM as (i) it removes massive overhang of dilution (ii) no regulatory costs such as CRR/SLR requirement (iii) will not have to incur massive opex to set up bank and (iv) competitive intensity to come down as ~54% of the industry is now SFB—this should help SKSM to further gain market share.
Competitive positioning to improve
(i) SKSM has 400bp funding cost benefit over other MFIs (including SFB licencees); while bank licence would help raise CASA deposits it will be negated by regulatory costs and high opex. Any material benefit would take at least five years. (ii) NBFC-MFI can tie-up with a universal bank or a payment bank and become a business correspondent to offer same level of services. (iii) Management bandwidth and high level of customer engagement will remain a cornerstone of success.
Political risk reduced significantly
Immunity from any AP-like political backlash was one of the strongest arguments for conversion to an SFB. However, post introduction of the NBFC-MFI category in 2011 with various safeguards, political risk is no longer a major issue. Moreover post the AP crisis SKSM’s strategy has been to reduce the political risk by spreading operations to various geographies.
Regulatory environment supportive for the sector
Regulatory framework, credit infrastructure, technology and supportive regulations have put the microfinance industry back on track. Regulations post AP crisis have made the business model stable and sustainable. Moreover that RBI has given most SFB licences to MFIs reiterates the regulator’s positive stance on the MFI sector.
Expect +42% PAT CAGR; Premium valuation to sustain; Initiate with BUY
Presence in an underpenetrated industry, high growth potential, profit visibility and strong performance across operating parameters, had aided a stock re-rating in the last two years. In our view near-to medium term growth and profitability will remain highest in the sector. We initiate coverage with a buy rating with a TP of Rs 589 (21% upside).