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Bajaj Finserv (BJFS.BO, Neutral): Not much steam left
Investment view
We are initiating coverage on Bajaj Finserv with a Neutral rating and
SOTP-based target price of Rs650. While we find that its finance and life
insurance businesses are turning around, we believe its valuations post
its recent rally adequately reflect the gains. Bajaj Finserv is a diversified
financial conglomerate with interests in life and non-life insurance, and
financial services including lending for two-wheelers, SMEs, distribution
of mutual funds and insurance products. On an incremental basis
management is planning to enter the asset management business and
infrastructure lending.
Core drivers of growth
For the life insurance business, we believe volume growth will likely
start picking up gradually in FY12 after three years of restructuring and
industry-driven decline. We believe most of the restructuring in terms of
cleaning up the portfolio and streamlining of channels is now reflected
and expect a 4% growth in new premiums in FY12 and 13.8% in FY13.
We expect the other key driver will be the financial services subsidiary of
the company, which should continue to deliver healthy loan growth of
47% in FY12E, 27% in FY13E, and post a hefty 82% in FY11E off a low
base. We estimate BJFN will deliver 29% growth in net profit over two
years FY12 and FY13, and this will lead to further improvement in RoE
from 8% in FY10 to 22.3% in FY11E and 22.6% by FY13E on the back of
improving leverage and falling NPL provisions.
Risks to the investment case
Downside risks: rising cost of borrowing could impact margins, given
BJFN is a wholesale borrower; impact of new regulations. Upside risk:
faster-than-expected volume growth in their life insurance business.
Valuation
Our SOTP-based 12-month target price for the company is Rs650 per
share, indicating 21% upside potential. While the company has absolute
upside potential, we initiate with Neutral rating as we have higher
upside elsewhere within our banking coverage. Further we expect
earnings from the life subsidiary to remain fairly volatile given higher
surrender on old policies, lower lapse profit post new regulations and
limited flexibility to reduce cost ratios till sales pick up. We use the
appraisal value method to value its life business and GS-Camelot based
target price to book values for the financial services and general
insurance businesses.
INVESTMENT LIST MEMBERSHIP
Neutral
Bajaj Finserv: Diversified financial services exposure
We are initiating coverage on Bajaj Finserv with a Neutral rating and SOTP-based 12-month
target price of Rs650. While we find that its finance and life insurance businesses are
turning around, we believe valuations post the recent rally adequately reflect the gains.
Bajaj Finserv is a diversified financial conglomerate with interests in life and non-life
insurance and financial services, including lending for two-wheelers, SMEs, distribution of
mutual funds and insurance products. On an incremental basis, management is planning to
enter the asset management business and infrastructure lending.
Based on our current estimates, the life insurance business accounts for 70% of the target
price. Note that as per the existing agreement between Bajaj and Allianz, Bajaj’s economic
interest in Bajaj Allianz Life insurance is 26% and in Bajaj Allianz General Insurance it is
51%, though legally it is a 74% owner in both these entities. In case of a change in the
regulations allowing higher FDI, Bajaj will sell its stake to Allianz at a predetermined
formula (16% return on investment). This agreement is valid till July 2016, after which Bajaj
will get full market value on any sale. However, the Reserve Bank of India in its circular on
“Foreign Direct Investments/Transfer of shares by way of sale” dated 4 May 2010 indicated
that any such transaction would have to be at market-determined rate. We have assumed a
51% economic value in our estimates for Bajaj as we do not expect the FDI regulations to
change beyond a 49% stake. We also believe that there could be issues in the
implementation of RBI regulations as this could get challenged.
Bajaj Finserv Lending: Turning over a new leaf
Bajaj Finserv Lending (BJFN - till now called Bajaj Auto Finance) was started 24 years ago
as a captive unit of Bajaj Auto (a promoter-owned two-wheeler manufacturer with 20%
market share). In August 2007, the promoters brought on board a new CEO who has
focused on improving profitability by re-positioning (re-aligning and diversifying products
and customer segments) and reducing risks (strengthening processes and systems). The
company now provides loans against property, secured SME financing, consumer loans
and two-wheeler loans. These years of restructuring efforts are now being reflected in
lower NPL accretion, and improving margins and profitability.
Post restructuring, we project BJFN will continue to deliver healthy loan growth of 47% in
FY12E, 34% in FY13E, and a hefty 82% in FY11E off a low base and after significant
restructuring. While the credit market and segment Bajaj Finserv caters to remains underpenetrated,
the company believes it best to moderate growth under the current economic
environment, a sensible strategy in our view. We estimate BJFN will deliver 29% growth in
net profit over FY12 and FY13, and this will lead to a further improvement in RoE from 8%
in FY10 to 19.6% in FY11E and 22.6% by FY13E on the back of improving leverage and
falling NPL provisions. We estimate BJFN will contribute 25% of Bajaj Finserv’s
consolidated earnings (post increase in ownership from 44% to 50%).
We have valued BJFN at Rs129/share of Bajaj Finserv based on the GS CAMELOT model,
implying 2.25X FY12E P/B and 11X FY12E P/E. This implies a implied value of Rs1,023 for Bajaj
Finserv Lending (which is also listed) vs. the current market value of Rs647per share. During its
trading history, Bajaj Finance is trading at 1.5xFY12E P/BV and 7.8 FY12E P/E. However, similar
companies (M&M Finance and Shriram) trade at 2.5X to2.7X P/E and 10.3 to 11.5X P/B on FY12
consensus estimates. With BJFN’s RoE improving, we believe this subsidiary of Bajaj Finserv
should be rerated. Key risks: (1) rising cost of borrowing could impact margins, given BJFN is a
wholesale borrower; (2) foray into infrastructure sector lending where BJFN has no experience,
is non-retail in nature and requires large balance sheet size and restricts ability to leverage up
significantly (as seen in the case of IDFC).
Two-pronged restructuring yielding results
Since FY08, Bajaj Finserv Lending (BJFN.BO) has undergone a restructuring exercise with
the key focus areas being: (1) rationalization of current operations, while continuing to
invest in technology, people and systems; and (2) identification of customer and product
segments. Alongside, BJFN intends to focus on cross-selling opportunities to enhance its
profitability.
(1) Rationalized operations, while investing to strengthen its systems:
In FY07, BJFN was lending from 400 locations, which has been consolidated to 63. Also,
dealers have been rationalized from about 12,000 in FY08 to 1,500 as of FY10.
However, BJFN has continued to invest in augmenting its personnel (several hired
from private sector and foreign banks) and strengthening its systems and processes.
The company has invested in technology and building its brand presence over the
period. Consequently, cost ratios have continued to trend up at 8% of average assets in
FY10 vs. 5.1% in FY08. ESOPs have also been issued with 2% outstanding of total
equity vs. total approved limit of 5%.
Efforts to improve asset quality: Over FY07-09, BJFN’s gross NPLs increased by a
100% CAGR to 16.6% of outstanding loans in FY09. NPLs were particularly high in the
two-wheeler and the computer financing businesses. During the period, BJFN entered
into a contract with Bajaj Auto that any credit loss in excess of 3% on the two-wheeler
book would be funded by them. Effective April 2010, there is no such arrangement in
force. The company has exited the computer financing business, and a one-off
provisioning cost of Rs210mn taken in FY2010. Subsequently, asset quality for BJFN
has been improving with gross NPLs down by 24% yoy in FY10 and net NPLs have
continued to decline, down from 3.6% in FY10 to 1.1% in Q3FY11.
(2) Identified customer and product segments strategy:
BJFN has decided to de-risk by moving up the customer value chain, focusing on mass
affluent and affluent customers in all segments (except two-wheeler financing). It has also
diversified its product mix and is now providing:
a) Two-wheeler loans – continue to constitute 22% of BJFN’s disbursements in 9MFY11.
Of Bajaj Auto’s two-wheeler sales 30% is financed, with 80%+ being funded by BJFN.
b) Consumer durable loans – high-value items/premium segment at 0% interest rate,
higher subvention from manufacturers at 8% vs. 5% earlier.
c) SME loans – companies with annualized turnover of Rs150mn-500mn, with insurance
being mandatory stapled to the loan, enabling BJFN to earn 2% fees.
d) Loans against securities (LAS) – minimum loan size of Rs5mn.
d) Mortgages – self-employed only.
e) Infrastructure finance: focus on corporate loan not project loans.
In addition to giving direct loans, the company has also tied up with Central Bank of India
to part-source loans (SME and loans against property) for a sourcing and administrative fee.
While the NPLs will be shared in proportion to the loan share, the responsibility for the
collection of loans will continue to rest with BJFN.
Key catalysts/challenges/risks
In our view, profitability for BJFN is likely to improve from current low levels from
diversified product mix, decline in credit costs and increase in leverage. We estimate RoEs
will increase to 22.6% by FY13E from 8% in FY10, while delivering a PAT CAGR of 29% over
FY11E-13E. However, BJFN faces the following challenges/risks, in our view:
1) Wholesale funded: BJFN is a wholesale funded company, which implies higher
interest rate risk and volatility. In the current tight liquidity environment, spreads/NIMs
will be under pressure as short-term rates have risen by 350-550bp over the last year.
We have factored in margin compression of 260bps between FY11 and FY13 in our
estimates.
2) No unique proposition: BJFN is vying for business in a highly competitive segment,
which implies pressure on sustainable profitability. The risk is somewhat mitigated by
the company’s diverse product mix, which also helps shield against cyclicality and
customer segmentation.
3) Untested new process and systems: BJFN has invested in processes and systems
over the last two years, which are yet to be tested through a business cycle while the
company is growing its loan book at a rapid pace.
4) Potential capital requirement: Given a high rate of growth in the offing, on our
estimates the company may require capital by FY12E to sustain current growth levels.
Bajaj General Insurance: More profitable than peers
Bajaj Allianz General insurance company (BAGIC) has established a more profitable
presence in an industry assailed by challenges from intense pricing competition, post
removal of tariff protection. Low operating expenses, a focus on retail, and restraint
on growth vs. market share are the key reasons for the relatively better performance,
in our view. We have valued BAGIC at Rs35/share of Bajaj Finserv, based on 1.04X
FY12E P/B. Key risk is that competition in the sector will likely lead to structurally low
profitability in this business.
BAGIC has chosen to calibrate the pace of growth vs. its competitors to maintain
profitability. Over FY06-FY10, BAGIC has grown premiums at 32% vs. 48% for private
companies and 12% for the industry. BAGIC’s market share has remained largely
stable at 6%-7% over the period. Motor insurance dominates BAGIC’s business with a
67% share of total premiums, followed by health which is at 15%. Given the lossmaking
group business, Bajaj has maintained its focus on retail business which
contributed 65% of total premium income as of 9MFY11.
Bajaj Allianz Life Insurance: Focus on quality rather than quantity
Change in strategy led to lower volumes, market share: Over the last three years,
Bajaj Allianz Life (BAL) Insurance has made significant changes to its business strategy. In
the initial phase of its growth, the company was aggressive in marketing its singlepremium
products (55% of premiums in FY06), charging customers higher allocation costs,
paying high commissions and selling products through channels that were not focused on
quality. This strategy led to a sharp growth in premium income between FY2004 and
FY2008 and gain in market share to 10.7% from 1.2%, and BAL become number two private
player after ICICI Prudential Life. After a change in CEO in 2007, BAL has taken a significant
turn from focusing on market share to building quality and a stronger business model.
This has led to a 17% decline in premium income (between FY2008 and FY2010) and
further 11% ytd drop, resulting in market share loss to 3.8% ytd 2011 vs. 10.7% at the peak
in FY2008. We believe the company is unlikely to regain the number two position but will
likely remain amongst the top five players given its franchise and focus on quality, which
will likely play a key part in building long-term business models.
Valuations: The headwinds at the industry level are likely to leave strategies dynamic for
all insurers, including BAL, in our view. We believe the market is pricing in worst-case
scenario in margins, and better execution on containing costs and improving
productivity/persistency could act as positive catalysts for price performance. Using the
appraisal value method (Embedded value + Structural value) and assuming NBAP margins
of 12% and NBAP multiple of 14X, we have valued Bajaj Finserv’s stake in BAL at
Rs470/share (70% of the target price). We estimate BAL’s EV at Rs95.7bn vs. capital
invested of Rs21.4bn.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Bajaj Finserv (BJFS.BO, Neutral): Not much steam left
Investment view
We are initiating coverage on Bajaj Finserv with a Neutral rating and
SOTP-based target price of Rs650. While we find that its finance and life
insurance businesses are turning around, we believe its valuations post
its recent rally adequately reflect the gains. Bajaj Finserv is a diversified
financial conglomerate with interests in life and non-life insurance, and
financial services including lending for two-wheelers, SMEs, distribution
of mutual funds and insurance products. On an incremental basis
management is planning to enter the asset management business and
infrastructure lending.
Core drivers of growth
For the life insurance business, we believe volume growth will likely
start picking up gradually in FY12 after three years of restructuring and
industry-driven decline. We believe most of the restructuring in terms of
cleaning up the portfolio and streamlining of channels is now reflected
and expect a 4% growth in new premiums in FY12 and 13.8% in FY13.
We expect the other key driver will be the financial services subsidiary of
the company, which should continue to deliver healthy loan growth of
47% in FY12E, 27% in FY13E, and post a hefty 82% in FY11E off a low
base. We estimate BJFN will deliver 29% growth in net profit over two
years FY12 and FY13, and this will lead to further improvement in RoE
from 8% in FY10 to 22.3% in FY11E and 22.6% by FY13E on the back of
improving leverage and falling NPL provisions.
Risks to the investment case
Downside risks: rising cost of borrowing could impact margins, given
BJFN is a wholesale borrower; impact of new regulations. Upside risk:
faster-than-expected volume growth in their life insurance business.
Valuation
Our SOTP-based 12-month target price for the company is Rs650 per
share, indicating 21% upside potential. While the company has absolute
upside potential, we initiate with Neutral rating as we have higher
upside elsewhere within our banking coverage. Further we expect
earnings from the life subsidiary to remain fairly volatile given higher
surrender on old policies, lower lapse profit post new regulations and
limited flexibility to reduce cost ratios till sales pick up. We use the
appraisal value method to value its life business and GS-Camelot based
target price to book values for the financial services and general
insurance businesses.
INVESTMENT LIST MEMBERSHIP
Neutral
Bajaj Finserv: Diversified financial services exposure
We are initiating coverage on Bajaj Finserv with a Neutral rating and SOTP-based 12-month
target price of Rs650. While we find that its finance and life insurance businesses are
turning around, we believe valuations post the recent rally adequately reflect the gains.
Bajaj Finserv is a diversified financial conglomerate with interests in life and non-life
insurance and financial services, including lending for two-wheelers, SMEs, distribution of
mutual funds and insurance products. On an incremental basis, management is planning to
enter the asset management business and infrastructure lending.
Based on our current estimates, the life insurance business accounts for 70% of the target
price. Note that as per the existing agreement between Bajaj and Allianz, Bajaj’s economic
interest in Bajaj Allianz Life insurance is 26% and in Bajaj Allianz General Insurance it is
51%, though legally it is a 74% owner in both these entities. In case of a change in the
regulations allowing higher FDI, Bajaj will sell its stake to Allianz at a predetermined
formula (16% return on investment). This agreement is valid till July 2016, after which Bajaj
will get full market value on any sale. However, the Reserve Bank of India in its circular on
“Foreign Direct Investments/Transfer of shares by way of sale” dated 4 May 2010 indicated
that any such transaction would have to be at market-determined rate. We have assumed a
51% economic value in our estimates for Bajaj as we do not expect the FDI regulations to
change beyond a 49% stake. We also believe that there could be issues in the
implementation of RBI regulations as this could get challenged.
Bajaj Finserv Lending: Turning over a new leaf
Bajaj Finserv Lending (BJFN - till now called Bajaj Auto Finance) was started 24 years ago
as a captive unit of Bajaj Auto (a promoter-owned two-wheeler manufacturer with 20%
market share). In August 2007, the promoters brought on board a new CEO who has
focused on improving profitability by re-positioning (re-aligning and diversifying products
and customer segments) and reducing risks (strengthening processes and systems). The
company now provides loans against property, secured SME financing, consumer loans
and two-wheeler loans. These years of restructuring efforts are now being reflected in
lower NPL accretion, and improving margins and profitability.
Post restructuring, we project BJFN will continue to deliver healthy loan growth of 47% in
FY12E, 34% in FY13E, and a hefty 82% in FY11E off a low base and after significant
restructuring. While the credit market and segment Bajaj Finserv caters to remains underpenetrated,
the company believes it best to moderate growth under the current economic
environment, a sensible strategy in our view. We estimate BJFN will deliver 29% growth in
net profit over FY12 and FY13, and this will lead to a further improvement in RoE from 8%
in FY10 to 19.6% in FY11E and 22.6% by FY13E on the back of improving leverage and
falling NPL provisions. We estimate BJFN will contribute 25% of Bajaj Finserv’s
consolidated earnings (post increase in ownership from 44% to 50%).
We have valued BJFN at Rs129/share of Bajaj Finserv based on the GS CAMELOT model,
implying 2.25X FY12E P/B and 11X FY12E P/E. This implies a implied value of Rs1,023 for Bajaj
Finserv Lending (which is also listed) vs. the current market value of Rs647per share. During its
trading history, Bajaj Finance is trading at 1.5xFY12E P/BV and 7.8 FY12E P/E. However, similar
companies (M&M Finance and Shriram) trade at 2.5X to2.7X P/E and 10.3 to 11.5X P/B on FY12
consensus estimates. With BJFN’s RoE improving, we believe this subsidiary of Bajaj Finserv
should be rerated. Key risks: (1) rising cost of borrowing could impact margins, given BJFN is a
wholesale borrower; (2) foray into infrastructure sector lending where BJFN has no experience,
is non-retail in nature and requires large balance sheet size and restricts ability to leverage up
significantly (as seen in the case of IDFC).
Two-pronged restructuring yielding results
Since FY08, Bajaj Finserv Lending (BJFN.BO) has undergone a restructuring exercise with
the key focus areas being: (1) rationalization of current operations, while continuing to
invest in technology, people and systems; and (2) identification of customer and product
segments. Alongside, BJFN intends to focus on cross-selling opportunities to enhance its
profitability.
(1) Rationalized operations, while investing to strengthen its systems:
In FY07, BJFN was lending from 400 locations, which has been consolidated to 63. Also,
dealers have been rationalized from about 12,000 in FY08 to 1,500 as of FY10.
However, BJFN has continued to invest in augmenting its personnel (several hired
from private sector and foreign banks) and strengthening its systems and processes.
The company has invested in technology and building its brand presence over the
period. Consequently, cost ratios have continued to trend up at 8% of average assets in
FY10 vs. 5.1% in FY08. ESOPs have also been issued with 2% outstanding of total
equity vs. total approved limit of 5%.
Efforts to improve asset quality: Over FY07-09, BJFN’s gross NPLs increased by a
100% CAGR to 16.6% of outstanding loans in FY09. NPLs were particularly high in the
two-wheeler and the computer financing businesses. During the period, BJFN entered
into a contract with Bajaj Auto that any credit loss in excess of 3% on the two-wheeler
book would be funded by them. Effective April 2010, there is no such arrangement in
force. The company has exited the computer financing business, and a one-off
provisioning cost of Rs210mn taken in FY2010. Subsequently, asset quality for BJFN
has been improving with gross NPLs down by 24% yoy in FY10 and net NPLs have
continued to decline, down from 3.6% in FY10 to 1.1% in Q3FY11.
(2) Identified customer and product segments strategy:
BJFN has decided to de-risk by moving up the customer value chain, focusing on mass
affluent and affluent customers in all segments (except two-wheeler financing). It has also
diversified its product mix and is now providing:
a) Two-wheeler loans – continue to constitute 22% of BJFN’s disbursements in 9MFY11.
Of Bajaj Auto’s two-wheeler sales 30% is financed, with 80%+ being funded by BJFN.
b) Consumer durable loans – high-value items/premium segment at 0% interest rate,
higher subvention from manufacturers at 8% vs. 5% earlier.
c) SME loans – companies with annualized turnover of Rs150mn-500mn, with insurance
being mandatory stapled to the loan, enabling BJFN to earn 2% fees.
d) Loans against securities (LAS) – minimum loan size of Rs5mn.
d) Mortgages – self-employed only.
e) Infrastructure finance: focus on corporate loan not project loans.
In addition to giving direct loans, the company has also tied up with Central Bank of India
to part-source loans (SME and loans against property) for a sourcing and administrative fee.
While the NPLs will be shared in proportion to the loan share, the responsibility for the
collection of loans will continue to rest with BJFN.
Key catalysts/challenges/risks
In our view, profitability for BJFN is likely to improve from current low levels from
diversified product mix, decline in credit costs and increase in leverage. We estimate RoEs
will increase to 22.6% by FY13E from 8% in FY10, while delivering a PAT CAGR of 29% over
FY11E-13E. However, BJFN faces the following challenges/risks, in our view:
1) Wholesale funded: BJFN is a wholesale funded company, which implies higher
interest rate risk and volatility. In the current tight liquidity environment, spreads/NIMs
will be under pressure as short-term rates have risen by 350-550bp over the last year.
We have factored in margin compression of 260bps between FY11 and FY13 in our
estimates.
2) No unique proposition: BJFN is vying for business in a highly competitive segment,
which implies pressure on sustainable profitability. The risk is somewhat mitigated by
the company’s diverse product mix, which also helps shield against cyclicality and
customer segmentation.
3) Untested new process and systems: BJFN has invested in processes and systems
over the last two years, which are yet to be tested through a business cycle while the
company is growing its loan book at a rapid pace.
4) Potential capital requirement: Given a high rate of growth in the offing, on our
estimates the company may require capital by FY12E to sustain current growth levels.
Bajaj General Insurance: More profitable than peers
Bajaj Allianz General insurance company (BAGIC) has established a more profitable
presence in an industry assailed by challenges from intense pricing competition, post
removal of tariff protection. Low operating expenses, a focus on retail, and restraint
on growth vs. market share are the key reasons for the relatively better performance,
in our view. We have valued BAGIC at Rs35/share of Bajaj Finserv, based on 1.04X
FY12E P/B. Key risk is that competition in the sector will likely lead to structurally low
profitability in this business.
BAGIC has chosen to calibrate the pace of growth vs. its competitors to maintain
profitability. Over FY06-FY10, BAGIC has grown premiums at 32% vs. 48% for private
companies and 12% for the industry. BAGIC’s market share has remained largely
stable at 6%-7% over the period. Motor insurance dominates BAGIC’s business with a
67% share of total premiums, followed by health which is at 15%. Given the lossmaking
group business, Bajaj has maintained its focus on retail business which
contributed 65% of total premium income as of 9MFY11.
Bajaj Allianz Life Insurance: Focus on quality rather than quantity
Change in strategy led to lower volumes, market share: Over the last three years,
Bajaj Allianz Life (BAL) Insurance has made significant changes to its business strategy. In
the initial phase of its growth, the company was aggressive in marketing its singlepremium
products (55% of premiums in FY06), charging customers higher allocation costs,
paying high commissions and selling products through channels that were not focused on
quality. This strategy led to a sharp growth in premium income between FY2004 and
FY2008 and gain in market share to 10.7% from 1.2%, and BAL become number two private
player after ICICI Prudential Life. After a change in CEO in 2007, BAL has taken a significant
turn from focusing on market share to building quality and a stronger business model.
This has led to a 17% decline in premium income (between FY2008 and FY2010) and
further 11% ytd drop, resulting in market share loss to 3.8% ytd 2011 vs. 10.7% at the peak
in FY2008. We believe the company is unlikely to regain the number two position but will
likely remain amongst the top five players given its franchise and focus on quality, which
will likely play a key part in building long-term business models.
Valuations: The headwinds at the industry level are likely to leave strategies dynamic for
all insurers, including BAL, in our view. We believe the market is pricing in worst-case
scenario in margins, and better execution on containing costs and improving
productivity/persistency could act as positive catalysts for price performance. Using the
appraisal value method (Embedded value + Structural value) and assuming NBAP margins
of 12% and NBAP multiple of 14X, we have valued Bajaj Finserv’s stake in BAL at
Rs470/share (70% of the target price). We estimate BAL’s EV at Rs95.7bn vs. capital
invested of Rs21.4bn.
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