In 2017-18, Bajaj Finance Ltd raised Rs 4,500 crore from investors through a qualified institutional placement (QIP) that valued the company at six times its book value for that fiscal year. The non-banking financial company’s valuation easily trumped that of big private sector banks and very few analysts were willing to assign a sell rating to the stock. After all, the lender promised to grow its book by 25 percent every year and it didn’t just deliver on that promise, it over-delivered many times.
It was a growth stock that no one wanted to miss. It was a bet on India’s consumption story, and it was considered a winning one.
Fast forward to today. The Pune-headquartered consumer loan lender’s assets under management (AUM) still boasts of a 25 percent growth, a decade-long track record that only broke during the pandemic year. It is still valued around six times its book value for the fiscal year.
But the stock has lost roughly 20 percent in the past one year and at least seven brokerages have a sell rating on it. In 2022, its shares underperformed the Nifty for the first time in 14 years.
Is this a temporary rough patch or are investors convinced that Bajaj Finance is past its prime?
Analysts at Investec Securities sum up the challenges for the stock in their latest report. They point out that growth from here on would be slower simply because the lender has reached critical mass in terms of market share in active customers. “BAF has de-rated over the past two years on account of market concerns on growth slowing down, management change and regulatory concerns. However, despite the derating, we find the stock is still expensive,” the report said. Investec warns that current valuations price in an earnings per share growth of 25 percent for the next three years, which is hard to achieve.
A constellation of factors has come together to work against Bajaj Finance’s prospects. India’s banks have again become a great alternative to gain exposure to the financial sector. Banks are giving a tough fight in unsecured lending, a segment that is central to Bajaj Finance’s business model. While competition is not new for the NBFC, it isn’t the same as before. The heated competition comes when the domestic consumption story has slid into uncertainty post the pandemic. Lastly, factors such as management continuity and talk of a banking licence have also kept investors anxious.
No longer banking on Bajaj
Ambit Capital, one of the brokerages with a sell rating on Bajaj Finance, believes that the valuations do not justify the prospects of the lender. In fact, Ambit goes on to say that the lender’s loan book growth won’t exceed 20 percent in the coming years. India’s big private sector banks are poised to give a similar growth for a cheaper consideration. "As growth slows down to about 20% for Bajaj Finance over fiscal 2025–2042, we expect the valuation premium over banks to reduce," Ambit analysts said in a note.
Indeed, one of the key factors behind Bajaj Finance’s stock-losing investor love is the re-emergence of banks as the go-to exposure to India’s financial sector.
They have moved on from the low-growth and weak profitability years with a strong capital base, enough insurance against credit risk and a corporate environment that almost guarantees fast-paced credit growth. Banking sector loan growth has surged to 16 percent now from the single-digit numbers reported three years ago. It makes sense for investors to buy HDFC Bank at a reasonable multiple of three times FY24 book value or a Kotak Mahindra Bank stock at a multiple of 2.8 times against buying Bajaj Finance at six times.
With a considerably deleveraged corporate balance sheet and the government’s push for private investment, banks are salivating at the prospect of sustained double-digit credit growth in the medium term. Banks can get more bang for every buck they lend because of a rising interest rate cycle and their access to cheap public deposits. On the other hand, Bajaj Finance may command aggressive rates while borrowing from banks and the markets, but it cannot beat banks consistently on margins.
Should Bajaj Finance become a bank?
Ironically, turning into a bank would work against the NBFC, according to Akshay Ashok, an analyst at Prabhudas Lilladher. “Becoming a bank could be more adverse to the stock because a lot of surveillance comes in,” he said. Ashok added that the cost towards maintaining regulatory ratios such as cash reserve ratio would also eat into the lender’s earnings in the short term. To be sure, the lender’s management has indicated that morphing into a bank is not an active consideration.
Assault from multiple sides
While banks are gaining from their access to deposits, they are also giving Bajaj Finance tough competition in the unsecured consumer lending business.
Unlike a decade ago where banks predominantly were corporate lenders, almost every bank is now focused on retail loans. What’s more is that lenders such as HDFC Bank have become aggressive in unsecured loans and rural business, segments they historically shunned.
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It is not just banks but the potential entry of deep-pocketed conglomerates such as the Reliance Group that has investors worried about the growth prospects of Bajaj Finance.
In a November 2022 note that followed Reliance Industries Ltd’s (RIL) announcement to demerge its financial business, Macquarie Capital analysts had flagged the risk of Jio’s entry for incumbents.
“While it is too early to take understand the exact customer segments and target markets that Jio Financial plans to cater to, it seems clear that it will be focused on consumer and merchant lending, which is the mainstay of NBFCs like Bajaj Finance and fintechs like Paytm,” the report said.
“RIL has demonstrated its hunger for attaining scale in the past in other businesses, and in our view, can pose a significant growth and market-share risk for players like Bajaj Finance and Paytm with whom it could be competing head-on,” it added. The brokerage has an underperform rating on the stock.
“Jio has KV Kamath on board, a veteran banker. This clearly shows they are not messing around and are serious about scaling the lending business,” said an analyst requesting anonymity. “Everyone is waiting anxiously for what Jio would do and where all it would disrupt,” he added.
Meanwhile, Bajaj Finance can be hurt enough by aggressive bankers and even other non-bank peers. HDFC Bank and ICICI Bank have increased their share of unsecured lending in their loan book manifold although the banks remain cautious. Long-time conservative lender Kotak Mahindra Bank has begun testing the waters for unsecured lending.
Bajaj Finance managing director Rajeev Jain has acknowledged this intense competition in several analyst interactions. The management’s pithy response has been that if given a choice between growth and margin, the lender would choose the latter.
Returns ahoy
In the eyes of the investor, it is a battle of return ratios. So far, Bajaj Finance has trumped the most valuable banks on return on equity and return on assets. As Investec analysts point out, banks have high visibility on return ratios now. Analysts at Goldman Sachs expect HDFC Bank’s return on assets to be 2 percent for FY24, which is nearly double the ROA in FY22. Bajaj Finance’s ROA on the other hand is seen steady at 4.7 percent, as per the foreign brokerage’s April 7 report.
What can Bajaj Finance do to justify its premium valuation?
Ashok of Prabhudas Lilladher believes that the lender’s business update for Q4FY23 is a great start. Bajaj Finance reported its highest-ever quarterly increase in customer franchise during Q4 and its AUM grew 27 percent year-on-year. “Customer accretion is extremely important for Bajaj. How well they can cross-sell products and market the new products and improve the activation rate will help,” he added.
Over the past couple of years, the quarterly customer accretion rate has slowed for Bajaj Finance. The NBFC’s strong point is its franchise to which it can cross-sell products and boost income. This is showing fatigue although the management’s comments continue to be sanguine.
The verdict on the stock is still optimistic as 23 brokerages have a buy rating. That said, its premium valuation relative to banks remains a deal breaker among analysts. In March, the stock saw the highest number of monthly downgrades, as our analyst tracker showed. The sentiment towards Bajaj Finance is yet to turn around.
Disclosure: Moneycontrol is a part of the Network18 group. Network18 is controlled by Independent Media Trust, of which Reliance Industries is the sole beneficiary.
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