Citi on SKS microfinance: Initiate at Hold: Priced for Growth

Initiate at Hold: Priced for Growth
 We initiate coverage with a Hold/Medium Risk (2M) rating and a Rs1,435 target
price — India’s microfinance players have seen a strong demand for their services
– small ticket, socially integrating loans delivered at the doorstep. The market is
large, model-scalable, and returns are potentially higher but so too are the risks
(socio-political, regulatory, apart from lending risks). It has been successful in
many parts of the emerging world, but Indian scale is large and its for-profit
version is as yet unproven. The Indian experience could well be a touchstone of its
success, for lenders, borrowers as well as for equity investors.
 SKS: First amongst equals — SKS' strong balance sheet, wide distribution,
professional management and robust operating processes have set it apart from
peers. It is the market leader, has grown rapidly and is likely to maintain the
momentum (est 56% loan CAGR over FY10-13E), asset quality has remained
impeccable (NPLs of 0.3%) and returns have started to move up (est ROAs of 7-
8%, ROEs of 26%+ by FY12E). In sum – a sound business in an exciting market.
 Valuations: High growth + high returns = high multiples? — Indian financials with
strong franchises/unique strengths have long enjoyed sustained high multiples.
Microfinance offers higher growth, higher returns but also higher risks – a) No
entry barriers (unlike pvt banks), b) Easy availability of capital (likely supply of
more paper), c) Political/regulatory risks (possible cap on lending rates) and d) As
yet unproven cross-cyclical asset quality record. We see growth momentum
supporting high valuations, and asset quality a more dominant driver than returns.
 Hold (2M) with a Rs1,435 target — Our EVA based target of Rs1,435 is
benchmarked off 4.0x 1Yr Fwd P/BV - top end of private banks, implying 19x Fwd
P/E a 10-20% premium to market. Globally, there’s a wide valuation range for
microfinance players (PBV: 2-5x, PE: 9-16x), suggesting business performance
determines valuations rather than preset benchmarks.