Bajaj Finserv gets rated Reduce; Kotak says it is the best play on 2 key NBFC themes

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Published: October 21, 2017 1:21:11 AM

We expect Bajaj Finance to deliver 3.3-3.6% RoA and about 20% RoE over FY2018-20E period. The company will likely deliver 32% EPS CAGR over FY2017-20E on the back of 38% loan book growth, said Kotak.

Bajaj Finserv stocks, kotak on Bajaj Finserv stocks, Bajaj Finserv stock market, Bajaj Finserv NBFC themes, general insurance, NBFC, Bajaj Finance, growth visibility, EMI loans, EMI loans industryWhile the outlook for Bajaj Finance is positive, high valuations behind coverage being initiated with ‘Reduce’ rating.

Bajaj Finserv is the best play on two key NBFC themes viz. general insurance and retail lending. Consistent underwriting profits and high RoE make Bajaj General the best pick in the sector. Superior growth, innovation and profitability drive our positive view on Bajaj Finance. Retain Add on Bajaj Finserv with target price of Rs 5,600 (Rs 4,700 earlier); we initiate coverage on Bajaj Finance with a Reduce rating, due to high valuations, and a target price of Rs 1,700.

Best NBFC & general insurance play
Bajaj Finserv provides the best play on the two key non-bank finance themes, viz. general insurance and retail NBFC. With consistent underwriting profits, Bajaj General is the best player in the industry; it reported its best ever combined ratio of 89% in Q2FY18. Bajaj Finance has already established itself as one of the largest and fastest growing NBFCs (Rs 721 bn of loan book, up 38% y-o-y in Q2FY18) with consistently high profitability. Bajaj Life will likely continue to face challenges in delivering high EV growth even as topline has been impressive in recent quarters (32% individual APE growth in Q2FY18).

We prefer Bajaj Finserv over Bajaj Finance
We retain Add rating on Bajaj Finserv with target price of Rs 5,600. In our September 2019-based SOTP, we value Bajaj Life Insurance at 1.2X EV, Bajaj General Insurance at 4.5X book and 24X earnings and Bajaj Finance as discussed below. We initiate coverage on Bajaj Finance with Reduce rating and target price of `1,700. At our September 2019 RGM-based target price, Bajaj Finance will trade at 4.5X book and 24X earnings.

Strong medium-term growth visibility; inherent profitability higher
We expect Bajaj Finance to deliver 3.3-3.6% RoA and about 20% RoE between FY2018-20E. The company will likely deliver 32% EPS CAGR between FY2017-20E on the back of 38% loan book growth.

Bajaj Finance’s underlying business is getting increasingly more profitable over the years due to large volumes, increase in cross-sell franchises that earn significantly higher RoE — this is offset by investments in medium-term growth and hence its reported RoA has ranged from 3.1-3.3% between FY2014-17. Bajaj Finance’s RoA and RoE would have been higher, if the company had not invested or invested less in growth.

With strong performance across operating matrices, high profitability, ability to constantly evolve and innovate its business model, we believe that Bajaj Finance is the best player amongst NBFCs. However, current valuations are rich even after factoring the virtues of the business model and hence we prefer to play the theme through Bajaj Finserv.

Several drivers for next leg of growth
Bajaj Finance has shared its plans to fuel its next of leg of growth. New products such as digital lending and small ticket EMI loans. These are more challenging to lend given the small loan size and high risk. Over the last few years, the company has put in considerable efforts to assess these loans; repayment trends in its large customer franchise (23 million) have helped the company crack this business model. Over the last four quarters, its six-month delinquencies in this segment have reduced to 1.2% from a peak of 3.8% in Q2FY17. Our discussion with competing players suggests that while they are working hard to catch up, Bajaj Finance has been constantly refining and bettering its appraisal skills and hence the gap between Bajaj Finance and other players stays.

Given the fact that these are loans to existing customers, the cost of origination is low. Coupled with low credit cost, we believe that Bajaj Finance’s profitability in this segment is significantly higher than company average. Thus, this is a segment which is fast growing, is difficult for competition to catch up with, plus Bajaj Finance has a low credit cost and low operating expenses.

Bajaj Finance is keen to expand its footprint across the country: It plans to expand its reach to 2,000 towns (1,031 in September 2017 and 292 in March 2015. Its rural business made up 6% of the total loans in Q2FY18 and will likely increase to 15% by FY2020e. Unlike other NBFCs, Bajaj Finance’s focus on rural India is on the mass affluent, i.e. it lends to a similar set of customers (as in its consumer or business vertical) but in interior India.


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