When SKS Microfinance announced the launch of its IPO in late March, the BSE Sensex, India’s bellwether market index stood at just above 17,600. Today, it is hovering around the 18,000 mark – up by almost 2,000 points, or 12.5%, from its recent low of 16,022 in May.
Meanwhile, the low end of the price range that SKS’ share is expected to fetch, is more than 20% above the price that was talked about when the company filed its draft prospectus.
If the share price holds true to the current price band, SKS’ post-issue market capitalization would range between INR61bn to INR71bn and its fully diluted issued capital would stand at 71.9 million shares. Now, considering that SKS made a net profit of INR1.75bn for the year ended March 2010, the Price Earnings (PE) Multiple would range between 35 to 40 times that of historical earnings.
This effectively means that SKS’ PE multiples are far ahead of mainstream banks and financial services companies. While SKS’ valuations are based on its high historical growth – the company’s net profit has grown at a CAGR of 223% over the past four years – it has to be recognized that this has come about during a period of high evolution for the sector, and may not be sustainable over the long term, according to a New Issue Monitor report.
So, how realistic are these valuations?
“These valuations are extremely high considering the valuations at which banks and other NBFCs (Non-banking Financial Companies) are traded,” according to the report.
The same sentiment is echoed by Abbas Merchant, Senior Assistant Vice President of Research at Jaypee Capital Services, which has been in the news for putting out an “Avoid” recommendation on the SKS stock.
However, Abbas is quick to note: “Actually, we like their business model and we like what they are doing. But the stock is very steeply priced, which is the only reason for our ‘avoid’ rating.”
“Probably they are trying to price it higher because there is no near comparison in the listed space,” he adds.
Another senior equity analyst, who wished to remain anonymous, believes that the valuation “seems a bit stretched” in the near-term, considering that SKS is a company providing unsecured loans to poor people. There are good NBFCs and banks that give out secured loans, also with good NPA (non-performing asset) levels, and they are quoting at far lower levels, he says.
“But give the company about two years to scale their business and the company will be in a different orbit.”
Indeed the microfinance sector, more so in India than in other places, seems to be on the cusp of something significant. There are many positives about the sector, beginning with the fact that it’s one that lends to a group of people that have been underserved, neglected, or left to the mercy of local money lenders.
“The investor community is extremely gung-ho. I expect a fairly significant amount of traction for the SKS IPO because there are no sectors in the country now that are growing at such a pace,” says Vineet Rai, Founder and CEO of Aavishkaar, a Mumbai, India-based social investment company.
According to the senior equity analyst, SKS’ biggest strength is its branch network and borrower base, which is “an envy of even FMCG companies” who consider SKS and other large MFIs as potential distributors of their products.
He recommends the company focus on enhancing its product line by leveraging these advantages – like a scenario where an SKS loan officer would sell water purifiers and mobile phones to her clients, while lending them the money to do so – which would diversify product risk, bring down operating costs, and push up profit margins, all at the same time.
Jaypee Capital’s Abbas agrees that the opportunity for SKS to use its network to distribute financial services and FMCG products is huge. “They have the first-mover advantage and the opportunity to scale,” he says.
According to Inverting the Pyramid, an annual industry report published by Intellecap (which also publishes Microfinance Insights), there is a massive demand gap in micro credit in India. The industry’s total loan disbursements worth about INR200bn (~US$4.5bn) only manage to scratch the surface of the market, which is valued at INR2400bn (~US$53bn).
Dismissing concerns that SKS-style growth may not be sustainable in the long run, Rai says:
“There are very few sectors, anywhere in the world, which have such a huge demand-supply gap, which means you have the leverage or the ability to continue to scale at a pace that is unheard of. Even if they slow down by 50%, they still would be one of the fastest growing companies.”
“I can tell you I’m buying it at that price with my personal money. I believe, regardless of the valuation, if the sector is good and the company is good, then the valuation will be good,” Rai adds.
Abbas too waves off concerns about SKS’ ability to sustain its current growth rate, stating that the market understands the company’s present growth is from a low base and that it “will obviously grow at a more matured level. So, that is not a concern.”
However, there are other downsides to worry about. Such as the company’s Portfolio-at-Risk (PAR) figure that has already taken a hit and is susceptible to further spikes, as the company expands into regions like Bihar, Orissa and Jharkhand, according to the senior equity analyst.
These states happen to be much worse off, in terms of poverty, demographics and geographical diversity, than the South where SKS started off, and will be a much more challenging market for the company to function and succeed in. For instance, [SKS] is facing problems, according to the senior analyst, in Chhattisgarh and Uttarakhand where their PAR is higher than in the South, and the more they grow in such regions – many of which are affected by local tribal insurgencies—the higher the company’s NPAs will rise.
The kind of growth rate SKS has enjoyed so far “is difficult to maintain going forward. Banking on their distribution network rather than looking to maintain their microfinance growth is the way to go. If the loan book doesn’t dry out, the profitability won’t go down. Providing more loans on different products would increase their revenues even if borrowers won’t grow at the same pace.”
Another common refrain about the risks SKS faces going forward is the company’s interest rate levels, which range between 26%-28%, and whether it can compete with other players like Regional Rural Banks (RRBs), which charge an interest rate of roughly 9% for agricultural loans and around 15% for personal loans.
It remains to be seen if they can maintain their high rates, because their costs are pretty high and their margins are about 4%-5%, Abbas notes.
Zerodha (Trading & Demat Account)
RHP
