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SKS Microfinance (SKSM)
Banks/Financial Institutions
Business gathers positive momentum but tall order ahead. While Malegam
Committee report sets a pitch for future growth, the new business architecture will
moderate SKS’ medium-term RoEs to about 20% from earlier expectation of 30%+.
Longer-then-expected pain in AP poses risk of significant NPLs which will likely increase
pressure on near-term earnings. Valuations remain rich at 2.4X FY2012E PBR. Post the
conference call with the management, we revise estimates and price target to Rs700;
downgrade to REDUCE (from BUY).
Losses in AP loan book is the key risk
We believe that delay in resolution of the MFI dispute in the state of AP and restoration of normal
business conditions poses a risk of significant NPLs. The AP Ordinance was passed about three
months back but MFIs have not resumed disbursements and loan collection remains low at 10-
20% as compared to 95%+ in the past. The Malegam Committee report gives hope of the
resolution in the near future. Nevertheless, credit losses in the loan book appear imminent. Key
reasons—unsecured nature of the loans, limited ability of the poor to pay back pent-up loan
installments and likely deterioration in credit discipline (on the back of consistent negative
portrayal of MFIs).
In the conference call with analysts, SKS has highlighted that their interaction with borrowers
indicates that the underlying economy still remains strong though credit flow in rural AP has been
weak. SKS is fairly positive about achieving strong collections in AP after they resume business in
the state. We find it challenging to model the likely losses in the AP loan book as we don’t have
complete clarity on the timeline for the likely resolution; we are revising our projections to model
about 20% NPL levels in AP; we thus expect about 55-60% of the loans to be recovered when the
scenario normalizes. Higher-then-expected losses provide a risk our estimates.
Long-term RoE at 20%, lower growth and margins in the near term
We expect SKS to report RoE of about 20% over the medium term even as earnings over the next
few quarters will likely be impacted by credit losses in AP. We are revising our estimates down by
about 30% to factor higher NPL provisions, lower growth and non-fund based income. At our
price target of Rs700 (down from Rs950), the stock will trade at 2.4X FY2012E PBR.
Positive traction post Malegam Committee report. We believe that the Malegam Committee
report will encourage stakeholders to resume growth in the MFI sector. The committee has
recommended that banks lending to MFIs will be entitled to “priority lending” status—this will
clearly encourage banks to continue funding to MFIs.
We expect banks to selectively increase their funding support to MFIs over the next few
weeks. Banks have an appetite for priority sector assets which increases typically towards the
end of the financial year. Low (30%) exposure to AP and low leverage post the IPO makes
SKS a preferred MFI.
Loan growth traction gradual. SKS reported disbursements of Rs15 bn in 3QFY11, down
about 50% qoq. We expect the pace of business to pick up moderately hereon. We are
modeling gross loan book of Rs55 bn by 4QFY11E as compared to Rs50 bn as of December
2010. As growth picks up over the next 1-2 quarters, we expect 30% loan growth in 2012E.
Tweaking margins. The Malegam Committee has prescribed interest rate cap of 24% +
upfront fees of 1%. SKS has recently announced a reduction in interest rates on incremental
loans across India to 24%. We are modeling loan yield of 25% in our projections which
includes upfront fees.
Lower non-fund income. SKS has discontinued insurance distribution business which
largely enhanced the non-fund based activities. The income from non-fund based activities
has been about 2% of average assets in FY2010; the discontinuance of these income
streams will have significant impact on profitability. We expect income from existing
contracts to support non-fund based income for next 3-4 quarters; we are modeling nonfund
based income at 0.7% of average assets in FY2013E. Increase in fees income due to
distribution of goods etc. can provide an upside.
Key highlights of our note on SKS’ results dated January 25, 2011
SKS reported PAT of Rs341 mn, down 38% yoy.
Stable NIM and marginal qoq loan book decline (Rs50 bn from Rs54 bn in 2QFY11) due
to lower disbursements (Rs15 bn as against Rs31 bn in 2QFY11) has driven core
earnings—up 8% qoq and 59% yoy.
Non-fund based income was at Rs280 mn, marginally below Rs310 mn in 2QFY11.
Cost-to-income ratio has improved marginally to 48% from 50% in 2QFY11.
Large provisions (Rs1 bn) have pulled down reported earnings. SKS has reclassified loans
in AP as ‘monthly’ receivable loans as the AP MFI Act restricts collections on a weekly
basis. Thus, the loan portfolio in AP is still considered standard. Gross NPLs were low at
0.4% in December 2010.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
SKS Microfinance (SKSM)
Banks/Financial Institutions
Business gathers positive momentum but tall order ahead. While Malegam
Committee report sets a pitch for future growth, the new business architecture will
moderate SKS’ medium-term RoEs to about 20% from earlier expectation of 30%+.
Longer-then-expected pain in AP poses risk of significant NPLs which will likely increase
pressure on near-term earnings. Valuations remain rich at 2.4X FY2012E PBR. Post the
conference call with the management, we revise estimates and price target to Rs700;
downgrade to REDUCE (from BUY).
Losses in AP loan book is the key risk
We believe that delay in resolution of the MFI dispute in the state of AP and restoration of normal
business conditions poses a risk of significant NPLs. The AP Ordinance was passed about three
months back but MFIs have not resumed disbursements and loan collection remains low at 10-
20% as compared to 95%+ in the past. The Malegam Committee report gives hope of the
resolution in the near future. Nevertheless, credit losses in the loan book appear imminent. Key
reasons—unsecured nature of the loans, limited ability of the poor to pay back pent-up loan
installments and likely deterioration in credit discipline (on the back of consistent negative
portrayal of MFIs).
In the conference call with analysts, SKS has highlighted that their interaction with borrowers
indicates that the underlying economy still remains strong though credit flow in rural AP has been
weak. SKS is fairly positive about achieving strong collections in AP after they resume business in
the state. We find it challenging to model the likely losses in the AP loan book as we don’t have
complete clarity on the timeline for the likely resolution; we are revising our projections to model
about 20% NPL levels in AP; we thus expect about 55-60% of the loans to be recovered when the
scenario normalizes. Higher-then-expected losses provide a risk our estimates.
Long-term RoE at 20%, lower growth and margins in the near term
We expect SKS to report RoE of about 20% over the medium term even as earnings over the next
few quarters will likely be impacted by credit losses in AP. We are revising our estimates down by
about 30% to factor higher NPL provisions, lower growth and non-fund based income. At our
price target of Rs700 (down from Rs950), the stock will trade at 2.4X FY2012E PBR.
Positive traction post Malegam Committee report. We believe that the Malegam Committee
report will encourage stakeholders to resume growth in the MFI sector. The committee has
recommended that banks lending to MFIs will be entitled to “priority lending” status—this will
clearly encourage banks to continue funding to MFIs.
We expect banks to selectively increase their funding support to MFIs over the next few
weeks. Banks have an appetite for priority sector assets which increases typically towards the
end of the financial year. Low (30%) exposure to AP and low leverage post the IPO makes
SKS a preferred MFI.
Loan growth traction gradual. SKS reported disbursements of Rs15 bn in 3QFY11, down
about 50% qoq. We expect the pace of business to pick up moderately hereon. We are
modeling gross loan book of Rs55 bn by 4QFY11E as compared to Rs50 bn as of December
2010. As growth picks up over the next 1-2 quarters, we expect 30% loan growth in 2012E.
Tweaking margins. The Malegam Committee has prescribed interest rate cap of 24% +
upfront fees of 1%. SKS has recently announced a reduction in interest rates on incremental
loans across India to 24%. We are modeling loan yield of 25% in our projections which
includes upfront fees.
Lower non-fund income. SKS has discontinued insurance distribution business which
largely enhanced the non-fund based activities. The income from non-fund based activities
has been about 2% of average assets in FY2010; the discontinuance of these income
streams will have significant impact on profitability. We expect income from existing
contracts to support non-fund based income for next 3-4 quarters; we are modeling nonfund
based income at 0.7% of average assets in FY2013E. Increase in fees income due to
distribution of goods etc. can provide an upside.
Key highlights of our note on SKS’ results dated January 25, 2011
SKS reported PAT of Rs341 mn, down 38% yoy.
Stable NIM and marginal qoq loan book decline (Rs50 bn from Rs54 bn in 2QFY11) due
to lower disbursements (Rs15 bn as against Rs31 bn in 2QFY11) has driven core
earnings—up 8% qoq and 59% yoy.
Non-fund based income was at Rs280 mn, marginally below Rs310 mn in 2QFY11.
Cost-to-income ratio has improved marginally to 48% from 50% in 2QFY11.
Large provisions (Rs1 bn) have pulled down reported earnings. SKS has reclassified loans
in AP as ‘monthly’ receivable loans as the AP MFI Act restricts collections on a weekly
basis. Thus, the loan portfolio in AP is still considered standard. Gross NPLs were low at
0.4% in December 2010.
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