Add SKS Finance: says Kotak Sec

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Micro loans create macro impact. We believe SKS Microfinance is well-positioned to
capture the latent demand in microfinance. A meticulously-planned and scalable
business platform, proven track record of maintaining low NPLs and proactive
management will likely drive 60% loan book CAGR between FY2010 and FY2013E. We
initiate coverage with an ADD rating and target price of Rs1,400.


High growth at SKS
We believe SKS is poised for high growth with its highly scalable platform and strong grasp of the
business environment. The management has been proactive in rapidly scaling up its branch
network and expanding its product portfolio to distribute third-party products and services.
We believe SKS will continue to outperform the industry and hence trade at a premium to peers.
We initiate coverage on SKS with an ADD rating and target price of Rs1,400.
Strong growth potential for MFIs
A large part of the Indian population is not covered by the formal banking system, thereby
providing immense potential for microfinance institutions (MFIs). MFIs have maintained high
collection efficiency (over 95% for the past two years) despite lending to the ‘bottom of the
pyramid’ segment. We believe MFIs are likely to become one of the strongest ‘change agents’ for
the poor given (1) the effectiveness of their ‘joint liability model’ that capitalizes on peer pressure
within the group to improve loan discipline, (2) relatively lower interest rates (as compared to local
moneylenders) and (3) professional management.
Financials: High growth and RoE
We expect SKS to deliver 60% EPS CAGR between FY2010 and FY2013E and medium-term RoE in
excess of 30% on the back of high (about 15%) gross spreads, low NPLs (below 1%) and nonfund-
based income. However, low operating leverage (as a backdrop of current expansion) and
overhang of recent equity issuance could temper near-term RoE.


Key risks: Conflict between stakeholders, competition and regulatory changes
(1) In the past, MFIs were NGOs. The ‘for profit’ MFI model followed by SKS requires it to
strike a delicate balance between the interests of capital market participants (shareholders,
banks and other borrowers) and those of its customers (the poor)—this model would face
testing times during calamities and prolonged economic downturns. (2) Unsecured loans
tend to have high losses given defaults (LGD); the short tenure makes growth more
dependent on branch expansion and client acquisition. (3) The entry of new players can
disrupt the business landscape if appraisal standards are compromised, instigating rate wars
and inducing diversion of loans towards consumption. (4) Changes in regulations on loan
securitization can affect profitability.