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Investors, Sanjiv Bajaj aur COVID-19. Can their love last?

Bajaj Finance has been an investor favourite but can they put the COVID stress behind and live happily ever after

"While we are hopeful to get back to 85-90% soon, it is unclear when we will get to 100% economic activity." — Sanjiv Bajaj, Chairman, Bajaj Finserv

As the pandemic forced everyone to work out of the confines of their homes, Bajaj Finance (BFL) chairman Sanjiv Bajaj cheekily told a TV anchor, “Clearly, the joyful moment is the amount of time that I have been able to spend at home. But I do not know if it is joyful for my wife and kids, or my father!” The soft-spoken 50-year-old was candid enough to admit that at times they did get fed up with each other. “But it has just made us open up,” mentioned Bajaj. This pragmatism has also reflected in the way Bajaj has been able to build the consumer finance business with a close-knit team. While Citi veteran Nanoo Pamnani, who helped Sanjiv build the financial services business post its demerger from Bajaj Auto, passed away this February, more than 75% of the management team has been around for about 7-18 years, which analysts believe partially explains the sustained business performance over the period.

Not surprising, foreign portfolio investors (FPIs) have been bullish on the stock as a proxy to India’s growing appetite for consumer financing. As of June 2020, FPIs held 21.24% compared with 7.26% held by domestic mutual funds. The stock has surged 8.5x over the past five years from 410 to 3,475 and that is after having retraced from an all-time high of 4,923 in February. Post the pandemic, the key question now is will Bajaj Finance continue to be an investor favorite?

With nearly 43 million borrowers and a loan book of 1.38 trillion, BFL has emerged as the poster boy of retail credit. So much so that analysts believe BFL is a Goliath that is too big to fail.

“One of the key reasons behind the strong growth in AUM (assets under management) is the expansion in distribution channel. As a result of high upfront investments in distribution, technology and processes to compete in the relatively low-ticket size, high volume business, competition has remained benign for Bajaj Finance despite the company consistently delivering highly profitable growth (which should ideally attract competition),” mentions Raghav Garg, analyst, Nirmal Bang Securities in his report.

BFL’s growth has also been accompanied by strong operational metrics. “BFL is perhaps the most diversified NBFC in the country that has consistently delivered strong performance across fronts,” opines Darpin Shah, who tracks the stock at HDFC Securities. Over FY13-FY20, BFL’s AUM showed CAGR of 35%, RoAEs averaged 19.6%, even as Gross NPAs stayed at 1.7%.

The company’s growth has been driven by its consumer finance and SME lending business that today accounts for 34% of the total AUM at $18.4 billion, and the other big constituent is mortgages that accounts for 33% of the AUM at $6.1 billion. Against an average credit loss of 2%, the company has delivered spread of 7% over the past three years. “We think the spreads and profitability are of superior quality. Going forward, consumer finance is expected to remain the mainstay for the company. Excluding the mortgage piece, the remaining portfolio makes a net interest margin of 13.5-14%,” points out Garg, who believes the three key tenets that have kept the value-creation engine well-oiled at the NBFC are product innovation, cross-sell and focus on existing customers.

“What differentiates Bajaj Finance from competition is its finance offerings, which are product-wise as opposed to plain vanilla/blanket finance offered by competitors,” adds Garg. For instance, the company had three separate verticals – durables finance, digital-product finance, and lifestyle finance – under retail in FY15. Today, it has many more offerings such as e-commerce consumer finance, e-commerce seller finance and warehousing receipt finance (under rural). In FY18, it entered the housing finance business through a subsidiary, Bajaj Housing Finance, whose book size is $4.2 billion (part of mortgages business). “We work across 40 product lines at Bajaj Finance. Many have already started firing and others are expected to soon,” points out Bajaj.

Focus on existing customers has been an integral part of the company’s go-to-market strategy. Decoding the strategy, Garg explains that at the entry level, the company offers consumer durable loans, which is followed by a business loan and then by a home loan. In fact, since FY13, the share of business from existing customers has increased from 40% to around 70% (See: Deep mining). Over the long term, the management wants existing consumers to contribute over 70% of the business.

More importantly, borrowing from HDFC Bank’s playbook, BFL has also ensured better risk underwriting. Loan losses on existing customers are one-third that incurred on a new customer. “Hence, adjusted for risk, cost of an existing customer is lower. This means that during bad times, limiting business only to existing customers should help cushion credit costs,” points out Garg.

Current tense
While its past performance has been stunning, during the lockdown, the stock hit a 52-week low of 1,783 in May. Though it has since bounced back, the big concern around BFL is whether COVID-19 will put a spanner in the works and end its stellar run.

With the lockdown yet to be completely lifted, all estimates indicate a significant contraction in the economy. “It is still early to forecast how long the economic impact of this pandemic will last. While we are hopeful about getting back to 85-90% soon, it is unclear when we will get to 100% economic activity,” Bajaj told Outlook Business.

For now, BFL has pro-actively provisioned 23.5 billion for bad loans, of which 10.8% of loans are under moratorium (See: Extra cover). The NBFC has converted 86 billion worth of term-loans into flexi-loans, where the borrower has to service only the interest cost. These flexi-loans at 455 billion account for 33% of total AUM. Even though management allayed concerns over the move stating that the flexi-loan product earns higher RoE than normal loans and that the product was being offered since 2013. Mahrukh Adajania, analyst, Elara Securities, is sceptical of the move as she feels it is a precursor to things turning nasty.  “If the product was good, the management should have disclosed details in the previous years and not waited till concerns started emerging on borrowers using this product to refinance existing loans,” mentions Adajania.S Sreenivasan, chief financial officer, Bajaj Finserv, the holding company, is not too worried. “After the first moratorium, the people who opted for second moratorium was a much smaller percentage and now that moratorium period is over, people are paying up and I don’t think there have been that many negatives as far as our retail consumers are concerned.”

Commenting on the flexi-loans, Rajeev Jain, managing director, Bajaj Finance, explained during the Q1FY21 earnings call that given the lockdown, the company decided to convert some of its existing customers with no overdue and good repayment track record from term-loan to flexi-loan for a switch fee that fetched the company 1.35 billion during the quarter (See: Bridging the gap). Adajania, though, questions in her report, “Why a customer would want to pay higher yields and fees in a challenging environment by converting from a normal loan to a flexi product is a big doubt.”

CFO Sreenivasan defends Jain’s stance on the flexi-loans. “It’s not that you lend money and, if they don’t pay, you hound them for collections. We have to support them in these testing times and once their business succeeds, we will get our money back. There will be temporary problems, but we are aware of that.”

Bajaj was quoted as saying, in another interview, that that over two-thirds of the consumers who availed of the moratorium had never bounced (missed an instalment) with BFL earlier. It was seen an indication that the consumers, especially SME borrowers, were focusing on conserving liquidity by retaining cash instead of making the payments. “Almost 30% took a moratorium in the first couple of months. It came down to low teens in the last two months because as cities and businesses started opening up, people started paying,” Bajaj said.

As a result, the consolidated moratorium book is now at 217.05 billion, which is 15.7% of total AUM as against 385.99 billion, which was 27.1% of AUM as on April 30. Given the health fears post the lockdown, the company is also mining its 43 million customers to sell them fee-generating products such as health card, health insurance and so on. The company successfully managed to sell 533,000 health cards, and generated 350 million in net fee income during Q1FY21.

Batten down the hatches
During Q1FY21, as a measure of prudence, the company provided for 14.50 billion of contingency provision taking the total provisioning to 23.50 billion. In addition, BFL has also provided for 6.23 billion of estimated credit loss (ECL), taking the overall provisioning to around 30 billion, aggregating to 13.7% of the consolidated moratorium book as of June 30. “Unlike banks, NBFCs have to provide for ECL. While we are conservative and have provisioned, if the business environment turns out to be much better than expected, it will be written back,” explains Sreenivasan.While the management is dealing with the situation one quarter at a time, analysts maintain that given its aggressive provisioning, low Gross NPA of 1.4% and strong liquidity – CAR of 26.5%, BFL will continue to remain an investor favourite. The NBFC is sitting on 206 billion of cash and SLR investments of 25.50 billion, which represents 19.25% of its total borrowing. BFL’s liability sources are well-diversified, with bank borrowings constituting the largest at 40%, followed by money market funding at 36%, and retail deposits at 17%. In Q2FY20, the company had raised ECBs, which constitute 4% of overall borrowings as of Q1FY21. Its deposits book stood at 200.61 billion, a year-on-year growth of 33%, making up for 17% of consolidated balance sheet. “Corporate vs retail mix stood at 70:30 in line with our stated strategy to reduce the lines on corporate deposits,” stated Jain.

Of its total borrowings of 995 billion, 114 billion has a maturity of over five years, 126 billion has a maturity bucket of three to five years, 435 billion is in the one to three-year bucket, 134 billion is in the six months to a year category and the balance is less than a year. While the company’s average cost of borrowing is 8%, it has managed to recently raise fresh bank funding at lower rates. “We raised at sub-6% as banks from being risk-averse have slowly started opening up funding to NBFCs,” mentions Sreenivasan. Garg of Nirmal Bang states that compared with its peers (13 NBFCs, including housing finance companies) BFL has lower cost of borrowing than most others (See: Good credit).

The company is also looking to cut costs. The NBFC reduced its operating expenditure by 2.96 billion in Q1FY21. Besides a pay cut ranging from 5% at junior level to 17.5% at the senior level for the current year, the company has stopped incentives till September. Bajaj is quite confident that the focus on cutting flab and looking at every aspect of the business will pay off in the long run. “We are going much beyond cutting some costs by completely tearing down all major internal processes and reinventing them for the future. This will have multiple benefits beyond cost,” opines Bajaj.

Even as BFL is focusing on its existing customer franchise, Bajaj says the management would be playing it safe.  “We have already tightened credit appraisal and will monitor performance of new loans to decide how to finetune it going forward; this is a continuous activity for us,” reveals Bajaj, even as management has guided AUM growth of 10-12% for FY21. That said, new loans booked during Q2FY21 was 3.6 million as compared to 6.5 million in Q2FY20, as the NBFC acquired 1.2 million new customers. AUM growth for Q2FY21 was 1.3% compared to the same period last year.

Nirmal Bang’s Garg expects provisioning to consume 56% of operating profit in FY21 compared with the earlier average of 20%, leading to suppressed ROE. “Segment-wise, auto finance, sales finance and SME business are likely to throw up higher NPA challenges and provisioning requirements. We are building in asset quality recovery only from Q3FY22 onwards. The company should get back to 20% ROE trajectory by H2FY22,” mentions Garg.

While Elara’s Adajania is bearish on the stock with a target price of 2,900 given its expensive FY22 valuation of 4.6x P/ABV, HDFC Securities’ Shah is bullish with a target price of 3,643, valuing it at FY22 P/ABV of 4.9x.

Bajaj meanwhile is confident that BFL will ride out the storm. “Our solid business model has been a saviour. This will help us come out of the current pandemic only stronger. We are still a small part of the industry and, hence, the opportunity is limitless.”

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