Bajaj Finance Q3: Robust performance in a tough environment; buy on dips

The third quarter performance of BFL indicates it remained largely non- impacted by the sectoral headwinds like tightened liquidity and consequent rise in interest rates as it posted yet another quarter of solid net profit growth of 54 percent year-on-year (YoY). The stock is expensive, but for a reason. Investors cannot ignore this business of lending to the aspirational mass, which is in a sweet spot.

We try to address some of the most pertinent questions on investors’ mind relating to future drivers of stock performance.

What was the impact of the current liquidity crunch on BFL?

BFL tided through the recent liquidity crunch comfortably given its strong parentage, top-notch credit ratings, a well-matched mix of short-term and long term assets and liabilities and well-diversified resource profile.

In fact, BFL was one of the key beneficiaries of liquidity shift towards strong and top quality names which gets reflected in its robust loan growth during Q3. BFL’s assets book grew a solid 41 percent YoY to Rs 109,930 crore aided by an extended festive period.

Loan growth was contributed mainly by consumer lending and mortgages. The growth in securities lending was muted while robust growth in rural lending continued. As a result, the rural segment now constitutes 8 percent of the loan book up from 1 percent in 2015.

Can BFL’s loan book continue to grow at current pace?

While BFL’s Q3 performance allayed investors' fear of a slowdown, we expect sectoral concerns to moderate growth in certain segments like SME, developer financing and securities lending business in the near term. Management has always guided a loan growth rate of 20-25 percent but has been consistently beating the guidance.

Despite its high growth, Bajaj Finance’s loan book is only 1 percent of the outstanding credit and hence, we believe, conservatively it can grow at more than 25 percent especially when competition stands weakened.

Over the medium to long term, we see enough loan growth potential as BFL widens its customer base through geographical expansion and deepens customer relationship by offering additional products.

For instance, the potential to cross-sell products to its existing customer franchise of over 32 million can offer an immense growth opportunity to BFL.

BFL’s housing finance subsidiary reported strong growth in loan book and is now among the top six HFCs in the country. So mortgages could be a new growth avenue for the company. While the profitability in housing finance business generally is less as compared to other segments that BFL operates in, management is confident of delivering return on equity (RoE) of 12-15 percent in housing finance subsidiary over next two years.

Will high earnings growth sustain?

Despite the cost of funds moving up, BFL’s margins improved in Q3. The biggest concern on investors’ mind is increasing competition in retail lending space as it can compress BFL’s margins. However, BFL has managed to maintain market share in consumer durable space at above 70 percent despite a rise in competitive intensity over past 12-19 months. This demonstrates the resilience of its business model and indicates it can sustain high margins.

Even if there is modest compression in margins, BFL has levers which should cushion earnings. For instance, the cost-to-income surprised positively in the current quarter improving to 35 percent, a decline of 400 bps YoY.

So overall, we see earnings growth sustainable for BFL on the back of its vantage positioning and enough growth potential in the segment.

The big question for investors: Is the steep valuation justified, the high earnings growth notwithstanding?

Consumer financing business requires a deep feet-on-street and considerably evolved risk assessment processes, stringent underwriting norms, agile monitoring and superior collection mechanisms. With the usage of technology, Bajaj Finance has succeeded in creating all of these and built a superior franchise with significant moats.

Bajaj Finance’s stock is currently trading at FY20 estimated P/B ratio (price-to-book) of 6.3 which is a significant premium to many other NBFCs.

There is little room for a re-rating of the valuation multiple. But we feel the company can maintain high earnings growth trajectory in the near term which will lend support to the premium valuations. Having said that, steep valuation doesn’t leave much room for the lender to falter on growth or on asset quality.

While the rich valuations demand caution, the business’ unique moats make it a must own core holding among Indian NBFCs. Hence, investors should look out for any price correction opportunity to buy into the stock.

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