Aavas Financiers BUY INITIATING COVERAGE AAVAS IN EQUITY March 24, 2021 Running its own race BFSI Longevity of profitable growth in the underpenetrated small-ticket Recommendation housing segment is a given for Aavas. Expect segment to post ~18% Mcap (bn): `189/US$2.6 CAGR through FY30, with Aavas best-suited to capitalize (~21%). Scalability hinges on niche positioning, technology-backed processes 3M ADV (mn): `246.3/US$3.4 and people. Asset quality is ensured from time-tested informal CMP: `2,405 assessment model, knowledge through local hires and in-house souring. TP (12 mths): `2,950 In periods of stress, prudent risk management DNA, diversified liquidity Upside (%): 23 profile and impressive collection infrastructure will make it stand out. Faster earnings compounding of ~21% vs <19% for peers (FY21-26E) Flags should help sustain premium valuations. Even if 1-year fwd P/B de-rates 30% (FY30), exit multiple of 4.9x implies ~15% IRR. Desired combination Accounting: GREEN of high-growth business with low construction risk makes 15%+ RoE Predictability: GREEN sustainable. Key risk: Absence of a long-term strategic shareholder. Earnings Momentum: GREEN Competitive position: STRONG Changes to this position: STABLE Catalysts Bang for the buck! AUM/disbursements posted 72%/48% CAGR between FY13-20; led by declining . >20% AUM and earnings growth in repayments (18% in FY20 vs 29% in FY14). Faster than system growth helped FY22 capture ~0.7% of HFC-HL share. Granular lending (nil developer), in-house . Normalization in 1+ DPD to <4% sourcing and LTVs of ~50% render underwriting credibility. Credit costs which spiked in FY21 to ~8.2% remained <60bps since inception. Impressive asset quality with consistent growth helped deliver >2.3% RoAA across cycles (highest amongst peers). Performance Designed to scale up AAVAS IN EQUITY SENSEX Scalability prospects are supported by: i) niche segment; ~61% self-employed; 250 ii) entrenched presence; most branches are >50km away from city centre; iii) 200 investments across people, processes and technology; iv) capital cushion with 150 best-in-class execution record. This takes it away from commodity HL segment, 100 enabling it to on-board stickier customers and accentuating its pricing power. 50 AUM growth to be highest amongst peers; help drive RoAA of >2.5% Jul-20 Jan-21 Jun-20 Apr-20 Oct-20 Feb-21 Sep-20 Dec-20 Mar-21 Mar-20 Aug-20 Nov-20 Expect 21% AUM CAGR between FY20-30 factoring ~20% repayments p.a. We May-20 factor ~25bps yield compression p.a., a higher borrowing charge (as leverage picks) and 30-35bps annual credit cost (on assets) given vulnerable borrower Source: Bloomberg, Ambit Capital research profile. With modest ~10bps improvement in opex ratio, Aavas can deliver RoAA (including off-BS) of ~2.5% in FY30. Our analysis (exhibit 79) suggests successful HFCs operate with >2x pricing power with >8x leverage. High pricing power (~4x) but sub-optimal leverage restricts RoE expansion but adds firepower. Valuations reflect opportunity, longevity and execution premium Expensive multiples must be read with Aavas’ ability to drive superior profitability (avg. RoAA of >2.5%). Effective use of analytics and asset quality focus made it stand out vs peers, justifying 100-160% premium. We value Aavas using excess return, implying valuation of 8.6x FY22E P/B. Valuations reflect i) faster earnings Research Analysts compounding (~21% EPS CAGR over FY21E-26E vs <19% for peers); ii) depth in Udit Kariwala, CFA underwriting character and iii) ability to identify and capitalize on opportunities. [email protected] Key financials +91 22 6623 3197 Year to March FY19 FY20 FY21E FY22E FY23E FY24E Net interest margin (`bn) 4.2 5.8 5.9 6.9 8.5 10.2 Pankaj Agarwal, CFA Operating Profits (`bn) 2.7 3.1 3.8 4.6 6.0 7.4 [email protected] Net Profits (`bn) 1.8 2.5 2.7 3.3 4.3 5.2 +91 22 6623 3206 Diluted EPS (`) 23.7 31.8 34.6 42.6 54.3 66.7 RoAA (incl. off-BS) (%) 3.0 3.1 2.6 2.7 3.0 3.0 Mitesh Gohil RoAE (%) 11.6 12.7 12.1 13.2 14.6 15.4 [email protected] P/B (x) 9.7 9.0 8.0 7.0 6.0 5.2 +91 22 6623 3197 Source: Company, Ambit Capital research Ambit Capital and/or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. All Investors including US Investors should not consider this report as the only factor in making their investment decision. Please refer to the Disclaimers and Disclosures at the end of this Report. [email protected] 2021-03-29 Monday 16:21:34 Aavas Financiers Narrative in charts Exhibit 1: Aavas is a good blend of sticky customer profile and calibrated risk spectrum Shubham Low Aptus India S Aadhar MOFS Vastu Shriram HFFC MGMA Aavas MUTH Medium Repco Income profile GRUH CanFin High 20 30 40 50 60 70 80 Largely semi-formal Largely informal Customer segment (% of self-employed) Source: Company, Ambit Capital research estimates *Note: Size of the bubble indicates AUM. Note**: MGMA- Magma Housing, Shriram- Shriram Housing, India S- India Shelter Finance, GRUH – Home loan portfolio of Bandhan Bank, MOHF- Motilal Oswal Home Finance, HFFC - Home First Finance Company, MUTH - Muthoot HomeFin Exhibit 2: Reach from city – Aavas’ geographical reach renders pricing power and is relatively less exposed to competition Aptus Value Housing- Rs32bn Aavas Financiers- Rs78bn Grihasakti- Rs43bn Home First Finance- Aadhar Housing- Rs36bn Rs114bn Mahindra Home- Rs79bn CanFin Homes- Repco Homes- Rs118bn Magma Housing- Rs207bn Rs33bn 20-50 km >50 km Gruh Finance- CITY 20 km Rs181bn Shriram Housing- CENTRE Rs23bn Manappuram home- GIC Housing- Rs128bn Rs6bn Vastu Housing- (retail) Rs18bn Shubham Housing- India Shelter Finance- Rs17bn Rs17bn Source: Company, Ambit Capital research *Note AUM used is for FY20 Exhibit 3: Aavas’ ticket size is low Exhibit 4: 1/3rd customers new to credit Exhibit 5: Aavas’ pricing power is high Average ticket size - (Rsmn) Share of new to credit Pricing power: (NII-opex-credit 60% customers cost)/avg. assets - (FY20, %) 2.0 8.0 1.5 40% 6.0 1.0 4.0 0.5 20% 2.0 0.0 0% 0.0 HFFC Vastu Aptus Aavas Repco GRUH MUTH Shubh… MOHF MGMA HFFC Vastu CanFin Aptus PNBH Aadhar Aavas FY14 FY15 FY16 FY17 FY18 HDFC Repco LICHF MOHF FY19* FY20* CanFin Aadhar Source: Company, Ambit Capital research Source: Company, Ambit Capital research; *assmp Source: Company, Ambit Capital research March 24, 2021 Ambit Capital Pvt. Ltd. Page 24 Aavas Financiers Exhibit 6: Aavas has built a completely in-house sourcing model and has amongst the lowest LTV ratios 40% LICHF 50% Aavas 60% CanFin Repco GRUH PNBHOUSI 70% HDFC Loan to value ratio 80% 20% 30% 40% 50% 60% 70% 80% 90% 100% % of loans sourced in-house Source: Company, Ambit Capital research; *Note: Size of the bubble represents average HL ticket size Exhibit 7: Aavas’ state/city expansion has been based on creeper approach; we expect Aavas to enter at least Telangana, Andhra Pradesh, Karnataka and Jharkhand by FY30 Source: Company, Ambit Capital research estimates *Note: Number in brackets represents number of branches in that state of the respective entity March 24, 2021 Ambit Capital Pvt. Ltd. Page 25 Aavas Financiers Exhibit 8: Aavas has a superior underwriting character Underwriting practices Business practices Exposure to developer loans, land financing No sales target for first three years to a NIL and high ticket LAP new branch in a new state Separate teams for sales, credit and Ex posure towards single homes ~80% collections Exposure towards self-owned/self-constructed ESO P programme for senior and mid- >90% properties level employees Prefers to recruit outside mortgage Of loan applications are approved on an finance sector ensuring team is free ~33% average fr o m biases and eazy to mould Incentive of sales team linked to 1 day Cases are sourced in-house ~100% overdue performance High on analytics. Uses predictive Cases with only agricultural income rejected ~100% modelling. All data is geotagged Of business done in first three weeks of the Aavas monitors performance of ~70% month vs ~50% for peers customers that it rejects Source: Company, Ambit Capital research Exhibit 9: Aavas has cushion to absorb >8x of average credit cost; highest amongst peers 12 4x MUTH 10 MGFL 8x BAF 20 - Aptus 8 Vastu SHTF FY18 - 6 Aavas CIFC Repco MMFS HFFC SUF 4 CanFin Aadhar 2x MGMA 2 LICHF PPOP/AAUM PPOP/AAUM PNBHOUSI 0 0.0 0.5 1.0 1.5 2.0 2.5 Credit cost/AAUM - FY18-20 Source: Company, Ambit Capital research *Note: Size of the bubbles indicates size of AUM (not as per scale) Exhibit 10: ALM profile stacks best amongst peers Exhibit 11: Set to deliver RoA of ~2.8% between FY21-26E ALM gap (years) RoAA (%) RoAE (%) - RHS 4.0 25 -4.2 -3.3 -3.5 -3.6 3.5 20 -2.5 -2.7 3.0 3.1 -1.3 3.0 3.0 3.0 2.9 -1.0 -1.0 3.0 15 2.7 2.8 2.6 2.5 2.3 2.4 10 0.7 2.3 2.1 2.0 5 HFFC Vastu Aptus Aavas HDFC LICHF REPCO Aadhar CANFIN FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY24E FY25E FY26E PNBHOUSI Source: Company, Ambit Capital research;*Note:- FY20 data Source: Company, Ambit Capital research;*Note: RoA is including off-B/S March 24, 2021 Ambit Capital Pvt.