Spandana Sphoorty Financial Limited A strong business franchise Viewpoint Spandana Sphoorty Financials Limited (SSFL) is our preferred pick and Sector: Banks & Finance has emerged as a strong NBFC-MFI (well capitalised and improving Company Update ROEs) bolstered by strong business quality (strong risk management and diversified book). Over the years, SSFL had built its business by Change expanding access to funds/capital, while maintaining an improving rating profile and a conservative asset-quality book. SSFL’s strong risk View: Positive management and business strength are seen in its strong portfolio CMP: Rs. 1,170 quality (robust repayment rates, low GNPAs/NNPAs). In this note, we have introduced FY2022E earnings estimates and are accordingly Upside potential: 22-25% á rolling over our price target (PT) on FY2022E book value estimates. We retain our Positive view on the stock and see 22-25% upsides from á Upgrade No change â Downgrade current levels. Strong operating metrics, with levers available to further improve: SSFL Company details has high pre-tax ROA with an improving trend (at 14.6% for Q2FY2020 from 12.6% FY2019) as well. Moreover, its attractive margins (NIM at Market cap: Rs. 7,508 cr 18.6% in Q2FY2020 from 16.8% in FY2019) indicate its business model strength. Over the years, SSFL had built its business by expanding 52-week high/low: Rs. 1400/690 access to funds/capital, while maintaining an improving rating profile and a conservative asset-quality book. We believe there are significant NSE volume: (No of 1.3 lakh positive levers available to the MFI at present, with its leverage ratio shares) (large headroom to increase leverage from current 1.3x), increased BSE code: 542759 securitisation potential (PSL qualification helps) and improving trend of rating profile (cheaper cost of funds). Strong domain expertise of NSE code: SPANDANA management is also a positive, reflected in prudent cost management and high-collection efficiency. Robust risk measures (standardised Sharekhan code: SPANDANA systems, real-time monitoring, automated checks and controls built-in the system, and mandatory credit bureau checks) add to the confidence Free float: (No of on the book quality. We believe risk management and geographical 2.4 cr shares) diversification are critical for an MFI. SSFL scores well with presence across 17 states but no single state contributing more than ~19% of total AUM. Shareholding (%) Our Call Valuations – Potential to further improve return ratios: SSFL currently Promoters 62.7 trades at ~2.1x its FY2022E book value, which we believe is reasonable considering its strong capital position (CRAR at 50%), growth potential FII 8.3 and steady improvement in key operating parameters over the past two years. The company’s strong management and efficient (and de-risked) DII 20.3 business model with levers available for generating better returns make the outlook attractive. In this note, we have introduced FY2022E Others 8.7 earnings estimates and are accordingly rolling over our PT on FY2022E book value estimates. We maintain our Positive view on the stock with an upside potential of 22-25%. Price chart Key Risks 1400 1300 A credit ratings downgrade would impact borrowing costs and constrain 1200 access to capital and debt markets, which may adversely affect NIM and 1100 1000 results of operations. 900 800 700 600 19 19 19 19 19 - - - - - Valuation Rs cr Oct Sep Dec Aug Nov Particulars FY19 FY20E FY21E FY22E Net interest income (Rs cr) 655.0 904.7 1204.9 1579.0 Price performance Net profit (Rs cr) 311.9 408.1 634.4 839.0 (%) 1m 3m 6m 12m EPS (Rs) 48.6 63.6 98.9 130.7 PE (x) 24.1 18.4 11.8 8.9 Absolute -5.4 31.2 - - Book value (Rs/share) 294.6 349.3 433.3 544.5 P/BV (x) 4.0 3.3 2.7 2.1 Relative to -8.3 23.0 - - RoE (%) 16.5 18.2 22.8 24.0 Sensex RoA (%) 6.3 7.3 7.6 6.0 Sharekhan Research, Bloomberg Source: Company; Sharekhan estimates December 24, 2019 2 Viewpoint Potential for sustaining growth, diversify portfolio: As per industry estimates, the MFI sector has immense potential to grow the client base as well as ticket size per borrower. It is estimated that the micro-credit opportunity is about Rs. 5 trillion-6 trillion, considering the addressable market of low-income households in India. Microfinance Opportunity Particulars Urban Households Rural Households Total Households (Census 2011; in Mn) 78 168 Total Households in 2018 (Est; in Mn) 90 180 Target Households 52 108 Total Credit Needs (Rs. trillion) 3.2 4.5 Credit Gap ~Rs 5-6 Trillion Opportunity Source: RHP, Company, Sharekhan Research As per industry estimates, traction in disbursements is expected to sustain and the MFI industry is well on way to report portfolio growth of 20-24% per annum over the medium term. Further, ticket sizes are likely to go up in states where penetration levels are high. Overall client growth is expected to be 8-10% and loan outstanding per borrower is expected to increase by 12-15%. Thus, we believe the MFI industry, which has been posting high-growth trajectory of late, has the potential to grow further in the medium term. SSFL’s endeavours to augment its product offerings to get a larger wallet share of its borrowers has led to the launch and expansion of three new products – Loans Against Property (AP, Telangana and TN), Housing Loans (AP, Telangana and TN) and Business Loans (across India). These products have scaled to Rs. 48.45 crore within a short span and we expect it to grow further due to the huge potential available in these markets. Augmenting product offering, tempered with deep customer understanding: In order to cater to the segment of customers graduating to a level above microfinance and, therefore, needing a higher ticket-size loan, SSFL has introduced business loans across its operating geographies. For these loans, the appraisal is based on the customers’ business in terms of cash flow. The loans are used for meeting working capital requirements, purchase of machineries and livestock among others. Moreover, the MFI has launched LAP to business, self-employed and salaried people with regular income and owned mortgage-free house. SSFL started offering LAP at 15 branches in A.P, Telangana and Tamil Nadu and is planning to expand further. December 24, 2019 3 Viewpoint Financials in charts Gross AUM Growth Declining Cost to Income 10,000 45.0% 9,000 40.0% 8,000 35.0% 7,000 30.0% 6,000 25.0% 5,000 20.0% 4,000 3,000 15.0% 2,000 10.0% 1,000 5.0% - 0.0% FY17 FY18 FY19 FY20E FY21E FY17 FY18 FY19 FY20E FY21E Source: Company, Sharekhan Research Source: Company, Sharekhan Research Reduced Cost of Borrowings Well Diversified Borrowing Mix 16.5% Others 1% 16.0% 15.5% Banks 35% 15.0% 14.5% Debt 14.0% Securities 46% 13.5% 13.0% 12.5% 12.0% NBFCs FY17 FY18 FY19 18% Source: Company, Sharekhan Research Source: Company, Sharekhan Research Growth in net worth ROE to improve 3000 24% 2500 22% 2000 20% 1500 18% 1000 16% 500 14% 0 12% FY17 FY18 FY19 FY20E FY21E FY18 FY19 FY20E FY21E Source: Company, Sharekhan Research Source: Company, Sharekhan Research December 24, 2019 4 Viewpoint Outlook Strong metrics, improving credit profile present a strong outlook: SSFL is a strong and attractive NBFC- MFI, well placed in terms of business quality (strong risk management and diversified book), high growth and providing comfort on asset-quality trends. SSFL has built upon expanding its access to funds/capital, helped by an improving rating profile and a conservative asset-quality book and leverage. We believe there are significant positive levers available to the MFI, with its leverage ratio, increased securitisation potential (PSL qualification helps) and improving trend of rating profile (providing access to cheaper cost of funds). SSFL, being an MFI player, has an advantage as its loans qualify for the PSL category, for which there is healthy appetite from banks etc. We believe a growing and rising pool of securitised assets will help further ease the cost of funds for SSFL. However, the recent lower direct assignment income (in Q2FY2020) and higher credit cost (partly due to protests in Eastern India) would be near-term key monitorables. Strong domain expertise of management is also a positive, reflected in prudent cost management and high-collection efficiency. Robust risk measures (standardised systems, real-time monitoring, automated checks and controls built on the system, and mandatory credit bureau checks) add to the confidence on the book quality in the medium term. Valuation SSFL currently trades at ~2.1x its FY2022E book value, which we believe is reasonable considering its strong capital position (CRAR at 50%), growth potential and steady improvement in key operating parameters over the past two years. The company’s strong management and efficient (and de-risked) business model with levers available for generating better returns make the outlook attractive. In this note, we have introduced FY2022E earnings estimates and are accordingly rolling over our PT on FY2022E book value estimates. We maintain our Positive view on the stock with an upside potential of 22-25%. Peer Comparison CMP P/BV(x) P/E(x) RoA (%) RoE (%) Particulars Rs/Share FY20E FY21E FY20E FY21E FY20E FY21E FY20E FY21E Spandana Sphoorty 1170 3.3 2.7 18.4 11.8 7.3 7.6 18.2 22.8 Aavas Financiers 1870 7.0 6.1 56.2 45.2 4.0 3.8 13.3 13.6 CreditAccess Grameen 767 3.9 3.3 24.7 18.7 5.3 5.4 17.0 19.1 Satin Credit Care 195 0.7 0.6 4.2 3.1 3.0 3.4 17.9 20.2 Source: Company, Sharekhan research, Bloomberg estimates December 24, 2019 5 Viewpoint About company Spandana Spoorthy Financial Limited (SSFL) is a leading, rural focused NBFC-MFI with a geographically diversified presence in India.