SKS Microfinance (SKSM.BO) Sell: Asset Quality Concerns Not Alleviated ::Citi Research

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SKS Microfinance (SKSM.BO)
Sell: Asset Quality Concerns Not Alleviated
 Higher credit costs lead to larger than expected losses in 2Q FY12 — SKS’ losses
expanded to Rs3.8bn in 2Q, driven by higher credit costs on its Andhra Pradesh (AP)
loan portfolio. While its non-AP portfolio remained largely stable (on loan yields and
asset quality), the AP regulatory environment is a key business constraint.
 Lowering earnings, reducing TP to Rs155 — We are revising our earnings estimates
down to factor in higher credit losses in 1H FY12 and reducing our target price to
Rs155 (from Rs200), benchmarked now at 1.2x Adjusted BV (after incorporating losses
from the AP book, net of tax benefits). Persistent regulatory overhang continues to
meaningfully impact SKS’ business prospects; the longer the impasse in AP continues,
the lesser is the likelihood of recoveries from this portfolio. Maintain Sell (3H).
 AP and WB recoveries still low, could hurt more — SKS’ AP loans are Rs8.2bn
(32.8% of loans), down from its peak of Rs15bn a year ago (post ~Rs5.5bn of writeoffs,
provisions and marginal recoveries). Incremental recoveries continue to be low for
AP (~10%) and WB (~85%). We expect low eventual recoveries in AP (~15%), given
the unsecured nature and long repayment gaps (over 1 year for most loans).
 Likely capital raising near term — SKS has sought shareholder approval for
incremental capital issuance of Rs9bn. At current stock prices, this would lead to 42%
dilution for existing shareholders. While this would support capital adequacy and
liquidity management, the current weak capital markets could lead to delays.
 Expected MFI Bill a positive, but delays a key risk — We believe the proposed MFI
Bill, if enacted, would be a positive for the MFI sector (removes the AP Ordinance and
its inherent constraints). The Bill is expected to be presented in the coming months;
however, given the uncertain political environment, risks of delays cannot be ruled out.
Moreover, we believe the road to profitability for SKS will still be long and gradual, and
it is too early to turn positive on the stock.