Spandana Sphoorty Financial Limited A mixed quarter Viewpoint

Spandana Sphoorty Financial Limited (SSFL) posted mixed results for Sector: Banks & Finance Q4FY2020. On one hand, the company’s operational performance was below Result Update expectations due to the heightened COVID-19 crisis impact, its operations and collections have started and are picking up,which is a positive indicator. Standalone net interest income (NII) came below estimates, at Rs. 208 crore, Change for Q4FY2020, which was up 28.4% y-o-y and 3.4% q-o-q. Assets under management (AUM) grew by 16.2% q-o-q and 56.2% y-o-y,which would be View: Positive  healthy, considering the latter part of Q4 was impacted both for collections and disbursals due to the lockdown.Net interest margin (NIM) stood at 16.4%, CMP: Rs. 536 down 20 bps q-o-q, up 71 bps y-o-y.During the quarter ended March 31, 2020, the company has made higher provision and write-offs towards COVID-19 Upside potential: 12-14% â (accelerated provision of Rs. 129.2 crore; ~2.7% of book) and revision on the ECL model (considering higher credit cost in FY2020 due to floods etc). As a á Upgrade  No change â Downgrade result of which provisions jumped to Rs. 187 crore, which resulted in lower- than-expected PAT. By May end, all its branches became operational and Company details more than 92% of the staff resumed work. Notably, collections are picking up and SSFL has collected more than Rs. 145 crore (principal and interest) Market cap: Rs. 3,444 cr since April 20, 2020, and aims to collect around Rs. 300 crore in June. During the quarter, GNPA and NNPA stood at 0.36% and 0.07%, respectively, and 52-week high/low: Rs. 1,400/403 was marginally up on a sequential basis. However, the company has offered moratorium to all its borrowers due to which asset-quality performance is not comparable.However, the resignation of senior members of the management NSE volume: (No of 0.7 lakh is intriguing. The impact of moratorium and COVID-19 is likely to affect shares) AUM growth and credit cost for SSFL in the medium term. Factors such as well-capitalized balance sheet, stable ratings, and strong operating metrics BSE code: 542759 indicate that SSFL is well placed to ride over medium-term challenges. However, lower disbursals will impact interest and fee income. Considering NSE code: SPANDANA the changed scenario and increased uncertainties on the outlook, we have cut our estimates for FY2021E and FY2022E and target multiples. We have a Sharekhan code: SPANDANA Positive view and expect 12-14% upside potential on the stock. Key positives Free float: (No of 2.4 cr shares) Š NIM improved to 16.6% for Q4FY2020, up by 20 bps q-o-q and 71 bps y-o-y. Š Largely stable asset quality with GNPA and NNPA at 0.36% (was 0.33% in Q3FY2020) and 0.07% (was 0.04% in Q3FY2020). Shareholding (%) Key negatives

Promoters 62.6 Š ECL model has been revised upwards. Going forward, medium-term credit cost may be elevated. FII 11.6 Š Disbursals are currently stalled, and collections are also weak. Operations have been impacted due to social distancing norms and the lockdown. DII 4.7 Our Call SSFL currently trades at ~1x its FY2022E book value, which we believe is Others 21.1 reasonable considering its strong capital position (CRAR of 50+%)and steady operating parameters. A strong management and an efficient (and de-risked) business model with levers available for generating better returns offer support. Considering the changed scenario and increased uncertainties on the outlook, Price chart we have cut our estimates for FY2021E and FY2022E and target multiples. We 1500 have a Positive view on the stock and expect 12-14% upside potential on the 1300 stock. 1100 Key Risks 900 700 A prolonged recovery post opening of the lockdown, credit ratings downgrade, 500 and effect on collection efficiency may affect NIM and results of operations. 300 19 20 20 20 19 19 19 20 19 20 ------Valuation Rs cr Jan Oct Apr Sep Feb Dec Aug Nov Mar May Particulars FY18 FY19 FY20 FY21E FY22E Price performance Net interest income 345.2 655.0 849.9 686.9 798.2 Net profit 187.9 311.9 351.8 369.7 436.2 (%) 1m 3m 6m 12m EPS (Rs.) 29.3 48.6 54.8 57.6 68.0 PE (x) 18.3 11.0 9.8 9.3 7.9 Absolute 12.3 -50.1 -54.4 - Book value (Rs./share) 216.7 294.6 409.4 458.3 516.1 Relative to P/BV (x) 2.5 1.8 1.3 1.2 1.0 4.8 -38.9 -36.7 - Sensex RoE (%) 13.52 16.5 13.4 12.6 13.2 RoA (%) 4.99 6.3 5.4 4.2 3.3 Sharekhan Research, Bloomberg Source: Company; Sharekhan estimates

June 03, 2020 7 Viewpoint

Key Concall Highlights

Business update: AUM growth wasstrong and SSFL remained India’s third-largest Micro Finance Institution (MFI). The company disbursed Rs. 2,324 crore in Q4FY2020 (versus Rs. 1,390 crore in Q4FY2019), the highest in any quarter. SSFL expanded into three new districts. Except 13 districts, all other districts make up less than 1% of the overall portfolio. The 13 districts have less than 2% of the total portfolio.

Asset quality: GNPA stood at 0.36% and NNPA at 0.07%, marginally up on QoQ basis.It has set aside Rs. 59 crore as normal provisions and Rs. 109 crore for COVID-19 and other reasons. The portfolio impacted by floods etc. has been completely written off.

Liability: SSFL raised Rs.1,409 crore from direct assignment and Rs.533 crore from term loans. Cost of borrowings declined to 11.9%for FY2020 from 13.5% in FY2019.Marginal cost of borrowing declined from 11.3% to 10.2% y-o-y. NIM increased by 16 bpsy-o-y. It raised Rs. 3,777 crore through securitisation and direct assignment route during FY2020. The assigned portfolio has grown from Rs. 804 crore to Rs. 2,407 crore.

COVID-19 impact: PBT would have been Rs. 714 crore without COVID-19 provisions. Pre-tax ROA is down due to higher provisions. Presently, the company has around Rs.547 crore in cash etc. On-time collection efficiency for the quarter was 98.52%.

COVID-19 Update: SSFL stalled disbursements as a precautionary measure since March 21, 2020, and shut branch operations, suspended collections, and other operations from March 24, 2020. SSFL has sent communication to all borrowers informing changes via text messages. All other operations functioned normally. From April 15,2020, it resumed operations in a phased manner.All branches are in operations and collections are happening at present from customers who did not opt for the moratorium. Loan officers were able to reach only a few borrowers and, hence, collections were impacted due to distancing norms. Additional time spent and travel issues, among others, also added to woes. There has been significant improvement in collections in May as compared to April. So far, they have collected Rs. 145 crore and are expecting to collect over Rs. 300 crore in June. Around 91% of borrower and 90% of AUM are in rural areas. The COVID-19 impact in rural areas has been lower so far. Moreover,SSFL has extremely diversified operations and has a large chunk of borrowers in the agri and dairy segments. Borrowers in Dairy business forms ~56% of borrower base and both the activities have not been impacted. Many borrowers are in the 3rd or 4th cycle and SSFL has strong confidence on its capability to withstand challenges. In addition, SSFL has successfully navigated multiple crisis, including AP loan crisis, demonetisation, political problems and has stayed strong.

Assignment income: In Q4FY2020, SSFL raised a total of Rs. 1,942 crore, of which Rs. 1,262 crore was through Direct assignment (DA) and Rs. 147 crore was via securitisation.

Borrowing moratorium: SSFL received moratorium from 68% of its lenders, and has repaid every installment for payments due in March and April.It has availed only Rs. 40 crore. Collections on off-balance sheet book are also being transferred to lenders.

Net gain on financial instruments:The amount stood at Rs. 1,262 crore due to high direct assignment volumes during Q4FY2020, as compared to previous quarters. Q4 seasonally has high DA volumes. Generally, around 9% of value of DA is taken as upfront.

Cost-to-income has come down: Growth has come from existing branches and districts and SSFL has not opened many new branches, or new geographies. Growth of operating costs and employeecount grew by 24%, portfolio grew by 56%y-o-y. Growth has come from existing branches and borrowers.Cost-to-income ratio can go down further. The average loan outstanding per branch is Rs. 8 crore-9 crore for the industry versus Rs. 6.7 crore for SSFL. Once it catches up with the industry,cost-to-income will reduce further.

Resignation of key management personal: The CFO and company secretary have resigned due to personal reasons.

June 03, 2020 8 Viewpoint

ECL provisions: SSFL had to update the ECL model for FY2020. Earlier model had losses for FY2019 considered. Because of floods, etc, provisions there were instances where borrowers missed the first two installments but were repaying later. Hence, the requirement in stage 1 (now 0.82% on Stage 1) has increased but stage 2 and 3 requirements have come down. As per the ECL model, SSFL is not required to write-off more than 60dpd, but SSFL has proactively completely written off that book completely.

Moratorium: In rural areas,about 80% of borrowers (over 6 lakh borrowers) that the company was able to meet; or about 5.5 lakh borrowers have repaid. The company reported issues in reaching out to borrowers. Most borrowers have been preferring to pay installments. In urban areas,borrowers would likely be availing the moratorium. Co officials Could not go and meet ~20% of the borrowers, so only assuming they will take moratorium. It is estimated that 20% of borrowers (in urban areas) may avail additional moratorium. Branches such as Ahmedabad, Bhopal, Indore, and Pune, which are facing lockdowns,are places where co was unable to contact borrowers. Some borrowers in non-essential work or agriculture have been completely impacted and,hence, they are likely to have taken the moratorium.

Installments paid by borrowers: Some borrowers have paid all installments, while others have paid only 1-2 installments. SSFL is expecting to collect Rs. 300 crore in June, while disbursals have not yet resumed. MFI disbursals have not yet started, Co will aim to do Rs 300 crore this month.

Expected collections: SSFLhas assumed a 50% collection efficiency, but actual experience is much higher.In April, there was no business, May witnessed only collections and no disbursements. June started doing some business. SSFL expects Rs.600 crore per month of disbursals from September.

Yield on assets: SSFL is charging 21.5% interest rate from borrowers right now. Till December 2019, SSFL had the old AP portfolio, which has been completely written off. Hence, during January-March,SSFL had a 100% interest-generating portfolio. The company then reduced interest rates and is currently charging 21.55%. Cost of borrowing is falling for SSFL, and with conservative leverage margins are expected to be sustainable.

Impact of Cyclone Amphan: SSFL views that the impact of Cyclone Amphanwill not be much in Odisha, where SSFL has a significant presence.

Collecting from individual members: SSFL is conducting group meetings now instead of centre meetings. Right now, because of social distancing, SSFL is doing smaller group (8-10 people) meetings at present. If within a group,five people want to repay and other five do not, then SSFL collects from the borrowers who are willing to pay.

Cost of borrowings: SSFL is raising money through NCDs etc., as well as new lenders. Cost of funds is coming down due to diversification; off-balance sheet financing also helps in reducing costs. Of late, the company has been working on offshore funds, but they are fairly high. So cost of borrowings is not expected to go down.

Consumer loans: Around 5% of borrowers or 1.5 lakh borrowers out of 25 lakh borrowers would be having consumer loans, whichare running with SSFL.

Collection picking up: Management expects to collect more than Rs. 300 croreby June, of which ~35% (which is Rs. 105 crore) will be transferred to lenders who have done off-balance sheet financing.Almost 91% of SSFL’s borrowers are in rural areas. The classification is based on place of residence, etc.

Borrowers unaffected by the lockdown: Around 57% of borrowers have utilised loans for the dairy business, 23% are self-employed, and remaining are service providers (maids, work as agriculture labourers, etc).

Guidance: SSFL expects a normalised ROA of 11% for the next two years. The company would be taking a 2% credit cost for the next two years. So far, SSFL has projected a collection efficiency of 50%, but it is confident of collecting much more.

COVID-19 provisions: SSFL has taken Rs. 129 crore COVID-19-related provisions for FY2020, which is 2.7% of the on-balance sheet book. The company expects COVID-19 to be more severe as compared to earlier problems; hence, management has taken higher provisions. June 03, 2020 9 Viewpoint

Capacity of borrowers to take additional loans: As borrowers are not being shown as overdue, technically they can avail additional loans due to moratorium.However, in practice, any borrower who has taken moratorium may be less likely to be able to avail credit from MFIs at present.

Borrower base: Around 32.5% borrowers are unique to SSFL, while around 67% of borrowers have loans from more than two lenders (including MFIs and small finance banks etc.).

Resuming centre meetings: SSFL is planning to resume centre meetings from July 1, 2020, but it will have to select other venues where social distancing norms can be followed. SSFL has been collecting installments, but it has not started to collect accrued interest, so far; however, it will start to collect from July. Remaining 18 lakh borrowers had availed moratorium, so it has accrued interest for them. The second moratorium extension has not actually been given so far. Borrowers are looking to get back to their business and are not looking for a repayment holiday. They are rather hoping to take loans to restart their business and start earning, stated SSFL.

Pricing of Credit: RBI inspection report was for FY2019, and SSFL made a Rs. 13.5 crore provision for that during Q4FY2020.

Results Rs cr Particulars Q4FY20 Q4FY19 YoY % Q3FY20 QoQ % Total Revenue from operations 421.1 259.1 62.5 343.6 22.6 Interest Income 290.8 251.0 15.8 286.2 1.6 Commission and Incentive Income 16.7 3.3 403.8 8.2 104.7 Net gain on fair value changes 108.6 3.8 2,783.7 46.8 131.9 Others 5.1 1.0 408.3 2.4 114.3 Finance cost 82.2 88.7 -7.3 84.4 -2.6 Net Interest Income (NII) 208.5 162.3 28.5 201.8 3.4 Other Income 8.8 3.3 166.3 8.5 4.5 Total Income 430.0 262.4 63.9 352.0 22.1 Net Total Income 347.7 173.7 100.2 267.6 29.9 Operating expenses 59.2 48.2 22.7 55.0 7.7 Employee benefits expense 47.5 36.3 30.7 41.0 15.8 Depreciation and amortization expense 2.3 2.0 13.8 2.2 4.5 Other expenses 9.4 9.9 -4.8 11.8 -19.8 Pre-Provisioning Profit 288.5 125.5 129.9 212.6 35.7 Provisions 187.4 21.3 781.2 41.5 351.2 PBT 101.1 104.2 -3.0 171.1 -40.9 Tax 23.6 33.2 -28.9 45.0 -47.5 Current Tax 40.7 0.3 11,607.2 24.6 65.5 Deferred Tax -17.2 32.8 -152.2 20.4 -184.3 PAT 77.5 71.0 9.1 126.1 -38.6 Source: Company; Sharekhan Research

June 03, 2020 10 Viewpoint

Outlook SSFL witnessed strong sequential AUM growth considering the latter part of Q4 was impacted both for collections and disbursals due to the lockdown.However, management indicated that the situation is normalising gradually, but still business operations may be impacted (disbursals stalled, collections picking up but likely to normalise by September) and social distancing norms making operations challenging. SSFL’s operational cost efficiencies, strong risk management, diversified book, and well-managed assetquality are key positives. We believe there are significant positive levers available to the company with its leverage ratio, increased securitisation potential (Priority sector qualification helps), and improving trend of rating profile (providingaccess to cheaper cost of funds. A growing and rising pool of securitised assets will help further ease the cost of funds for SSFL. The resignation of senior members of management is intriguing. Moreover, the moratorium and COVID-19 are likely to impact AUM growth and credit cost for SSFL in the medium term. Factors such as well-capitalised balance sheet, stable ratings, and strong operating metrics indicate that SSFL is well placed to ride over medium-term challenges. Though near-term challenges exist, we believe that the strong domain expertise of the management, prudent cost management and robust risk measures (standardised systems, real-time monitoring, automated checks and controls etc) will help SSFL tide over medium term challenges. Valuation SSFL currently trades at ~1x its FY2022E book value, which we believe is reasonable considering its strong capital position (CRAR of 50+%) and steady operating parameters. A strong management and an efficient (and de-risked) business model with levers available for generating better returns offer support. Considering the changed scenario and increased uncertainties on the outlook, we have cut our estimates for FY2021E and FY2022E and target multiples. We have a Positive view on the stock and expect 12-14% upside potential on the stock.

One year forward PBV (x) band

3.5

2.9

2.3

1.7

1.1

0.5 19 20 20 20 19 19 19 19 20 20 ------Jan Oct Apr Sep Feb Dec Aug Nov Mar May

PBV

Source: Sharekhan Research

Peer Comparison CMP P/BV(x) P/E(x) RoA (%) RoE (%) Particulars Rs/Share FY21E FY22E FY21E FY22E FY21E FY22E FY21E FY22E Spandana Sphoorty 536 1.2 1.0 9.3 7.9 4.2 3.3 12.6 13.2 Satin Credit Care 58 0.2 0.2 1.3 1.0 2.4 2.6 17.4 19.4 Source: Company, Sharekhan research, Bloomberg estimates

June 03, 2020 11 Viewpoint

About company Spandana Spoorthy Financial Limited (SSFL) is a leading, rural focused NBFC-MFI with a geographically diversified presence in India. It has a pan India presence across 18 states and has been operating as an NBFC since 2004 and NBFC-MFI since 2015. The company offers income generation loans under the joint liability group model (JLG), predominantly to women from low-income households in Rural Areas. As of March 31, 2020, SSFL was the third largest NBFC-MFI in India with an AUM of Rs. 6,829 crore, 25+ lakh members and 1,010 branches. It has The NBFC-MFI was impacted but has successfully emerged stronger post the AP MFI crisis and boasts of healthy margins and Return ratios.

Investment theme Spandana Sphoorty Financial Ltd (SSFL) has reported strong CAGR growth in AUM (~74%) and Borrowers (~35%) over FY17-FY20 period indicating a strong growth momentum. Over the years, SSFL had built upon expanding its access to funds/capital, while seeing a gradually improving rating profile trend and a conservative Asset quality book and leverage. We believe that there are significant positive cushions available to the MFI, with its leverage ratio, increased securitization potential (PSL qualification helps) and also improving trend of rating profile (providing access to cheaper cost of funds) all of which can help support its long term return ratios further. Strong management quality is reflected in the robust Risk measures (standardized systems, real-time monitoring, Automated checks and controls built on the system, Mandatory credit bureau checks) etc which are key positives and will help company tide over near-term challenges.

Key Risks A prolonged recovery post opening of the lockdown, credit ratings downgrade, and effect on collection efficiency may affect NIM and results of operations.

Additional Data

Key management personnel Deepak Calian Vaidya Chairman Padmaja Gangireddy Managing Director Mr. Satish Kottakota Chief Financial Officer Source: Bloomberg

Top 10 shareholders Sr. No. Holder Name Holding (%) 1 Valiant Mauritius Partners Ltd 6.0 2 JM FIN INDIA FUN 5.2 3 JM FINANACIAL INDIA FUND II 5.0 4 Helion Venture Partners LLC 2.4 5 Bajaj Allianz Life Insurance Co Lt 1.7 6 Royal Bank of Canada 1.4 7 Goldman Sachs Group Inc/The 1.2 8 Edelweiss ALT Investment OPP 1.2 9 Bajaj Holdings & Investment Ltd 1.1 10 Vendidandi Vijaya Sivarami 1.1 Source: Bloomberg

Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

June 03, 2020 12 Know more about our products and services

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