While competitive intensity for Microfinance loans in Urban India is rising, our analysis indicates that rural India is still under-penetrated and less competitive. As per the Association of Community Development Finance Institutions (Sa-Dhan), the share of urban borrowers in microfinance loans has increased from 33% in FY13 to 62% in FY16. We believe that rural India provides stronger growth potential and Bharat Financial Inclusion Ltd (BHAF) is the best placed among listed microfinance companies (MFIs) to leverage this given its leadership in rural market (rural constitutes 75% of loan book in FY16 vs 40% for industry). This coupled with lower ticket size and robust growth in active borrower base would drive a strong AUM growth of 43% CAGR over FY16-19e for BHAF.
Asset quality to remain stable; political & regulatory intervention key risks
Sharp rise in microfinance loans have led to some concerns on indebtedness of borrowers. We also believe that regulatory and political intervention (from state government or local officials as was seen during the Andhra Pradesh Crisis of 2010) risks are higher for MFIs as compared to banks. However, we expect GNPLs to stay at <1% as BHAF has been disciplined on its lending practices –(i) loans are given only to women in Joint Lending Groups (JLGs) (ii) 99% of loans are income generating (iii) lending is restricted to customers who have taken loans from maximum two financiers (including BHAF). We also expect regulatory and political environment to remain benign given government/RBI focus on financial inclusion.
ROEs to stay at 24%+; Operating profit growth at 48% CAGR over FY16-19e
We factor in capital raise of R7.5 bn and consequently, our FY17 BV per share is revised upwards by 25%. We are also revising our estimates of profit before tax (PBT) by 18%-54% in FY17-FY20e as we factor in higher growth and capital raise. FY17 EPS estimates would be boosted by negative effective tax rates but we expect tax rates to normalise to 34% by H2FY18. RoEs would remain in 21-23% range in FY18E-20e.
Valuation: Upgrade to BUY
We upgrade BHAF from Neutral to BUY as we turn more constructive on its medium term growth potential. We raise our PT from R525 to R1,000 (implying 17.5x FY18 P/E and 3.7x FY18 P/BV) as we (i) roll-over to FY18 (ii) raise our PBT estimates by 18%-54% in FY17-20E (iii) factor in capital raise and lower COE (due to fall in G-sec yields). BHAF is our preferred play among Indian MFIs as we believe long term growth potential is higher in under-penetrated rural market where BHAF is a market leader. While robust growth has raised some concerns on asset quality for MFIs, the risks are lower for BHAF given its approach to lending.
What priced in?
Market is expecting strong loan and earnings growth from microfinance companies including BHAF in FY17/FY18 and this has resulted in sharp rally in last
12 months. However, we believe that market is still not differentiating between growth potential of rural and urban based MFIs.
MFIs growing faster than SHGs
In India, microcredit is primarily delivered by two channels: (i) SHGs, through the Self-Help Group—Bank Linkage Programme developed by the National Bank for Agriculture and Rural Development (NABARD); and (ii) NBFC-MFIs (like BHAF) and specialised banks (like Bandhan and Equitas), which are focused on providing credit to lowincome households. Post the AP crisis in 2012, NBFC-MFIs have reported robust growth and gained market share over SHGs. As per NABARD and Sa-Dhan, loan book of NBFC-MFIs has grown by 63% CAGR over FY13-16 vs 13% for SHGs.
BHAF – A play on less crowded rural markets
While urban areas have been the key growth drivers in recent years and competitive intensity is rising as urban based MFIs are increasing their distribution network and loan book, we believe that rural market remains relatively less penetrated and competitive. Our interaction with leading urban focused MFIs also indicate these companies are unlikely to focus on rural market in near to medium term. As most large MFIs are converting to small finance banks, we expect these urban focused MFIs to focus on their core market only. As a result, we believe that MFIs with a strong rural distribution network would continue to report robust loan growth in the medium term. BHAF is a market leader in this segment and has a strong distribution network of 1,368 branches in 16 states.