>BAJAJ FINANCE LIMITED: Company is focusing on sweating the current network instead of expanding it

Bajaj Finance Limited (BFL), a subsidiary of Bajaj Finserv Ltd., is a leading and diversified NBFC in India. We like BFL due to its diversified portfolio, strong growth and healthy asset quality, and strong management. The company has a well-diversified portfolio bouquet with loan book spread across nine business lines and balanced in terms of scale and profitability. BFL has exhibited strong growth momentum with 75% CAGR growth in AUM over the last three years. The company has maintained healthy asset quality with net NPA of 0.3% in FY12E. Over the years, BFL has built pan-India presence, covering 225 points across India and more than 4,000 distribution partners and dealers. We recommend ‘BUY’ on the stock.


■ Growth momentum to continue
AUM increased by 75% CAGR during the last three years from INR 2,539 crores in FY09 to current levels of INR 11,919 crores, expected to go to INR 16,000 crores by FY13E; the key contributors to growth are strong traction in existing businesses and entry into new segments. Within existing businesses, Consumer Durables and Mortgages business has strong momentum. The addition of Infrastructure Financing and Construction Equipment businesses will assist BFL in maintaining growth momentum; growth has been widespread with number of new loans disbursed increasing from 5,94,000 in FY09 to 17,19,000 in 9MFY12.


■ Strong return ratios
During the last three years, return ratios have improved significantly - RoA has improved from 1.3% in FY09 to 3.8% in FY12E, while RoE has jumped from 3.2% in FY09 to 24.1% in FY12E. With interest rates expected to peak out, we do not see any risk in margins in the near future. There will be marginal dip in return ratios with the scale up of new, low-margin businesses like Infrastructure Financing, but it will assist in gaining scale. BFL will maintain its stance of keeping leverage around 6x.


■ Healthy asset quality
Over the past three years, there has been significant improvement in asset quality. Gross NPA ratio has reduced from 4.90% in FY10 to current levels of 1.3% in FY12E. During last two years, net NPA ratio has come down from 2.2% in FY10 to current levels 0f 0.3%. Long-term sustainable net NPA ratio is expected to be 60-75 bps. The provision coverage ratio has increased from 55% in FY10 to current level of 81%.


■ Outlook and valuations: Positive; ‘BUY’
On the back of 75% CAGR in AUM over the last three years and launch of new business lines like Construction Equipment and Infrastructure Financing, we expect PAT CAGR of 75% during FY10-13E, with RoE in excess of 22%. At current market price of INR 810, the stock is trading at 1.6x FY12E and 1.3x FY13E P/BV. We recommend ‘BUY’ with a target price of INR 1000, an upside of 23%.



Investment Rationale
■ Diversified loan book
Over the years, BFL has moved from financing only Bajaj Auto vehicles to a well-diversified loan
book. The loan book has been divided into three main categories:
1) Consumer Finance – Consumer Durable Financing, 2-Wheeler (2W) and 3-Wheeler (3W)
Financing, and Personal Loan
2) SME Business – Mortgages (including loan against property), Small Business Loan and Loan against Shares
3) Commercial – Construction Equipment Financing, Infrastructure Financing and Secured Vendor Financing


Currently, Mortgages business (including loan against property) has highest weight of 32% in the aggregate loan book, while 2W and 3W financing comes second at 22%. The management aims to maintain equal weight across three categories. The addition of new businesses, Construction Equipment Financing in FY11 and Infrastructure Financing in FY12 will lead to further diversification of loan book; this diversification will help provide stability and BFL will be able to maintain balance between scalability and profitability.



■ Growth momentum to continue
AUM increased by 75% CAGR during the last three years from INR 2,539 crores in FY09 to current levels of INR 11,919 crores, expected to go to INR 13,000 crores by FY12E and INR 16,000 crores by FY13E. Growth momentum has been strong across all business verticals. Normally, Q1 and Q3 are strong quarters for the company due to robust rural demand as well as Consumer Durables (mainly Air Conditioner and Refrigerator) demand in Q1 and festive season in Q3.



The key contributors to growth are strong traction in existing businesses and entry into new segments. Within existing businesses, Consumer Durables and Mortgages business has strong momentum. The addition of new business lines, Infrastructure Financing and Construction Equipment, will help BFL maintain growth momentum, expected to continue due to the huge opportunity in existing businesses and addition of new categories.



■ Strong distribution network
Over the years, BFL has built a robust distribution network pan-India with strong distribution reach of more than 225 points of presence, and more than 4,000 distribution partners and dealers.


Post FY09 downturn, the company has focused on shoring up the distribution network by removing weak distributors and dealers, clearly visible in the decline of Sales Finance – Dealers from 4,500 in FY09 to 2,000 in FY10, and 2W – Dealers/ASCs from 1,400 in FY09 to 1,275 in FY10. The exit of weaker dealers from the system has made BFL’s distribution network more robust and is expected to fare well in uncertain times.



■ Strong return ratios
BFL has transformed from captive 2W Financing and Consumer Durable Financing to a fullfledged NBFC covering non-retail business. Currently, the company maintains a healthy mix of profitability and growth. Consumer Finance business with expected IRR of 22-25% will provide profitability, while SME Business and Commercial will offer growth.


Consumer Finance, comprising Consumer Durable Finance, Personal Cross-Sell and 2/3Wheeler financing has ~22-25% IRR. Interestingly, BFL is one of the few successful players in the Consumer Financing business.


The company’s market share represents 9% of the consumer durables industry. The expected IRR in consumer durable business is ~24% with average duration of four months. Another strong forte is its 2/3W financing business, which accounts for ~24% of Bajaj Auto’s domestic sales in the geographies where BFL operates . The expected IRR in 2/3W business is ~23%.


Personal Loan Cross–Sell, constituting 6% of overall portfolio, has IRR in the range of 22-23%. SME business segment is divided into two parts – Assed backed loans and unsecured loans. Asset backed loans i.e. mortgages and loan against shares provides IRR in the 12.5-13.5% range. Unsecured loans i.e. small business loan provides IRR in the 18-19% range.


The Commercial segment comprising construction equipment financing, infrastructure financing and secured vendor financing will provide 12.5-13% IRR.



BFL started its Construction Equipment Financing business in FY11. Currently, the company has decided to go slow in this segment as management believes that risk return dynamics are unfavorable at this point in time. Over a period, each of the three segments are expected to hold 1/3rd share of the aggregate loan book. This balance across segments will help the company maintain a proper balance of profitability and scale.



Over the last five years, return on average asset has improved from 1.3% in FY09 to 3.8% in FY12E, one of the key contributors being efficiency built in operating expenses.




■ Healthy asset quality
BFL’s asset quality has improved significantly over the last three years. Net NPA has come down significantly from 5.5% in FY09 to current levels of 0.25%. Over the last few years, BFL started involving dealers in credit disbursement. Subsequently, dealers are entitled to receive incentive on account of credit loss remaining below estimates. The involvement of dealers for cash collection in lieu of fee has helped in keeping loan losses under control in 2W and 3W financing business.


In addition, the focus on sweating the existing distribution rather than increasing it will help BFL maintain better control over asset quality. Furthermore, in the Mortgage segment, the company is focusing on affluent customers who were less impacted during the downturn.



■ Asset liability management
BFL has efficiently managed the balance between asset and liability duration. The average duration of assets is 16-17 months, while that of liabilities is 18 months. Recently, the company ventured into Infrastructure Financing; currently, infrastructure book is INR 596 crores loan book. Out of this, ~40% of book is corporate loans and balance is project financing. With an increase in the Infrastructure loan book, especially project financing book (which is long duration book), some pressure on asset liability management could follow. Since the book has been well balanced between short and long-duration loans, we believe that the company will be able to manage asset-liability balance effectively.


■ Efficient operations
BFL has shown significant improvement in operational efficiency. The operating expense-toasset ratio has come down from 8.3% in FY09 to 6.3% in FY12E.



The company is focusing on sweating the current network instead of expanding it, which implies that the business per branch will increase. As a result, going forward, the operating expenses will remain under control.


■ Capital adequacy ratio
Currently, BFL has capital adequacy ratio of 17.3%, of which Tier I constitutes 14.5%. The company has issued 60 lakh warrants on preferential basis to promoters at a conversion price of INR 650 per warrant. Post conversion, promoter stake will go up from 56% to ~62%. The funding from promoters will take care of capital requirement for the next 15 months.



Valuation
On the back of AUM growing 75% CAGR over the last three years and the launch of new business lines like Construction Equipment and Infrastructure Financing, we expect PAT CAGR of 75%, during FY10-13E, with RoE in excess of 22%. At current market price of INR 810, the stock is trading at 1.6x FY12E and 1.3x FY13E P/BV. We recommend ‘BUY’, with a target price of INR 1000, an upside of 23%.



Key Risks
■ Scale up in Infrastructure book will put pressure on return
BFL launched its Infrastructure Financing business in FY12. Currently, Infrastructure Financing book is 5%. On account of the scale of the book, aggregate return ratios will reduce. Since Infrastructure book is long-term in nature, it will exert pressure on maintaining asset-liability balance.


■ Increase in NPA
BFL reported net NPA of 0.3% in Q3FY12. At such low levels, NPAs may be difficult to sustain over longer period. If there is slowdown in retail segment, then NPA might increase. Sustainable net NPAs are expected to be around 0.6-0.7% in the long term.











RISH TRADER