WATCH VIDEO - SKS Microfinance IPO  Analysis by ASHOK KUMAR

• The company has registered strong growth as the number of  borrowers continues to increase. Notably the number of members have grown from less than 4 million in March 31, 2009 to close to 6.78 million (up 72 per cent) as on March 31, 2010. The number of branches also increased by 50 per cent to 2029. 
  
  
• The total loan portfolio registered a CAGR of more than 147 per cent during the period FY 2006– FY 2010. The bottomline however increased at a CAGR of  more than 220 per cent to Rs 1,748 million during the period under review. The growth can also be attributed to the economies of scale and higher disbursement of loans that is further accentuated by higher interest charged to the borrowers. 
  
  
• Notably, the interest rate charged is as high as 31.5 per cent on an annualised basis. However, as SKS is a non-deposit NBFC, it does not have access to low cost of funds as compared to that of banks. Resultantly, the company has to pay close to 12 per cent for the loans taken by the banks. Thus its net interest margins (NIMs) have been maintained at 12 to 13 per cent, significantly higher than those enjoyed by commercial banks. 
  
  
• The business model of the company is such that the total fixed asset requirement is negligible. The working capital requirement too remains moderate  as SKS benefits from strong balance sheet liquidity due to the nature of its loan portfolios that have a maturity of less than one year. 
  
  
• However, the operating cost is higher than the cost of funds which continues to drag its bottomline. Moreover as the average size of loan is small (ranges from Rs 2,000 to Rs 50,000), the expense (operating) to loan ratio is likely to remain high.
  
  
• SKS is subject to RBIs minimum Capital to Risk Weighted Assets Ratio (CRAR) regulations and is required to create a reserve fund and transfer a sum not less than 20 per cent of its net profit every year before any dividend is declared. It is also required to maintain a minimum capital adequacy ratio of 12 per cent which should exceed 15 per cent by March 2011. As a result, the CRAR stood at 28.3 per cent for the fiscal 2010.

IPO Positives

• Market leadership position with significant expertise in the sunrise microfinance sector : SKS is the market leader in its segment of operations offering specialized financial products and services along with maintaining superior asset quality. Its diversification into various other segments such as housing loans, tapping new geographies (states – pan India presence), leveraging its distribution network and strategic alliances will only help to diversify its revenue streams. 
  
  
  Notably, the company has been leveraging its branch network to cross-sell products such as insurance and mobile phones that will have a direct bearing on the bottomline.  To start with, SKS has set up Sangam stores in Andhra Pradesh which enables small retailers to access interest-free working capital loans and products from wholesalers. The commission thus received will impact the bottomline positively. 
  
  
• Unique and Scalable business model : Microfinance as a sector carries huge potential in a country like India where large number of people are still dependant on small money lenders to meet their financing requirement. Further, the company offers loans for productive purposes which results into lower NPAs.  Moreover, the loans are only disbursed to a women member through a Joint Liability Group (JLG) approach that leads to lower default rates due to peer pressure.
  
  
  The loans disbursed by the bank also qualify for priority sector lending. As the target for total priority sector loans for domestic banks is 40 per cent of its net bank credit and 32 per cent for foreign banks, banks often rely on MFIs for lending to the priority sector. This not only boosts the capital  available to the MFI institutions but also reduces the funding cost. Moreover such assets are securitized and sold to banks at some mark up and thus improve the overall liquidity for additional funding. 
  
  
• Asset Quality : SKS uses the group lending model, which yields repayment rates of more than 99 per cent.  SKS has thus been able to manage its asset quality at comfortable levels. To put matters in perspective, despite its huge loan book, the Gross and Net NPA have remained very low at 0.33 per cent  and 0.16 per cent respectively for FY 2010.

IPO Concerns 

• High Cost of Funds : Unlike banking and financial institutions, SKS does not have access to low cost of funding and is solely dependant on bank credit and equity dilution either to the public or to PE Firms. However, as the interest rate charged by MFI’s ranges between 25-30 per cent per annum, the NIMs remain healthy. 
  
  
• Competition Risk :  The company estimates that the potential for micro-credit in India is estimated at USD 55 billion whereas the current outstanding micro loans stand at about USD 5 billion (includeing loans from moneylenders and informal sources). Though the microfinance market remains largely untapped, SKS faces direct competition from other microfinance companies in India. Moreover the entry of new players and expansion to newer areas by peers will further intensify the competition and start impacting NIMs. 
  
  
• Risk of over-leveraging by the borrowers : Instances of borrowers accessing funds from multiple lenders is the key risk faced by the company. As most of the loans are unsecured there is a higher risk of default and write-offs going ahead, especially when the company’s operations enter new geographies . However, in order to discourage such practices, SKS along with more than 30 Microfinance institutions (MFIs) set up Microfinance Institutions Network (MFIN) in December 2009 to set up a database of borrowers to ensure that the borrowing limit does not cross Rs 50,000 per borrower. 
  
  
• Vulnerable to Government Regulations : MFIs basically have social obligations in terms of making credit available to individuals who do not have access to institutional credit. However, the interest rate charged by these institutions is comparatively higher than that of banks. Meanwhile, a number of states in India have enacted laws to regulate money lending transactions by the money-lenders by putting a ceiling of 15 per cent per annum on unsecured loans. As of now, there is no clarity on the interest charged by NBFCs and adverse ruling by the government on this front could lead to significant de-rating of the stocks from MFI space.

CONCLUDING NOTES

When evaluated on traditional parameters, this IPO appears to be aggressively priced at a PE multiple of over 30 times its FY11 earnings and market cap to sales ratio of 6 times. However, with its P/B set to dip, post the IPO, that crucial parameter will be competitive.

However, considering the under-penetrated microfinance segment offering growth significant potential and SKS being set to be the only listed player in this space, there is a fair chance of a scarcity premium driving its stock price post-listing.
 

theIPOguru’s  Verdict  :

INVESTOR  TYPE

WATCH VIDEO - SKS Microfinance IPO  Analysis by ASHOK KUMAR