Bajaj Finance Ltd (BFL) is a play on rising consumer spending, which is expected to grow manifold on rising disposable income. BFL has metamorphosed itself from Bajaj Auto’s finance arm to a diversified NBFC, where its loan book from Bajaj Auto is expected to reduce from current levels of about 30% to 23% by FY12.

The company has expanded its presence primarily from two-wheeler financing to consumer durables, SME loans and other secured loans. It has plans also to foray into infrastructure financing. Diversification into other secured assets business will likely enhance the quality of loan book.

High-yielding consumer durable financing business and secured loans business are expected to show CAGR (compound annual growth rate) of 42% and 100%, respectively, during FY10-FY12e. Total disbursal and loan book will exhibit CAGR of about 50% during the same period,which provides reasonable visibility to BFL’s earnings.

BFL credit rating of FAAA/Stable from Crisil is the highest in the whole industry. This helps the firm reduce its borrowing costs. The balance sheet of BFL is well capitalised and the tenure for a majority of borrowings is more than two years, which will help contain the cost of funding in case short-term rates rise.

We believe BFL is the best bet in the NBFC space in the wake of high disbursal growth, foray into new business areas, improving asset quality and resulting RoE (return on equity) expansion. The stock is currently trading at 13x/11x of FY11e/ FY12e earnings and 2x/1.7x of FY11e/FY12e adjusted book value, which is at around 25-40% discount to valuations of industry leaders.

However, our earnings estimates are fairly conservative as compared to consensus view by 20% in FY12e. Favourable interest rate scenario and business mix improvement provide upside risk to our estimates. Therefore, we recommend Buy with a 12-month target price of Rs 918 (2.3x P/ABV [price/adjusted book value] FY12e, 34% upside).

BFL’s average duration of its borrowings remain healthy at more than two years. However, any spike in short-term interest rates may increase BFL’s cost of funds on incremental borrowings required to grow its loan portfolio, which can temper margins in the short term. The NBFC business is strongly linked to the general economic condition and any kind of distress on the same will have undesirable consequences on the business prospects of the company.

?Motilal Oswal