Burying the hatchet of demonetization
While there is little doubt that demonetization was black swan event for the microfinance industry, the slower than expected pace of improvement in collections over past six months has dented the confidence of investor community. The sentiment has further been soured by the farm loan waivers announced by various states and most MFIs / SFBs including Bharat Financial Inclusion (BFIL) are corrected to levels where risk reward might be favorable. At this juncture, it may be worth-while to separate the wheat from chaff and look at things objectively:
1) Political risk real, some losses inevitable
It's almost six months since demonetization exercise ended but few districts in Maharashtra, Madhya Pradesh and Karnataka continue to remain politically charged. Despite their best efforts, most MFIs operating in these areas are not able to collect their over dues and may have take write-offs eventually. The only way for MFIs to mitigate this risk is to have geographically diversified operations. We estimate that well run MFIs may report 3% to 5% of AUM as losses while the not-so-well-run MFIs may lose up to 10% of their portfolio in the aftermath of demonetization.
2) Separation between the men and boys among MFI players already visible
The extent of damage caused by demonetization to MFIs has been different for different players. Well run MFIs like BFIL and Ujjivan who had good control over their operations, could engage better with the customer and return back to normalcy in a few months. Our field visits have brought to light multiple instances of BFIL being able to recover its money from villages where others struggle to even ensure attendance by their members! Clearly, the benefits of "being close to customer" and "running tight operations" have come to fore in the aftermath of demonetization.
3) Strong players looking to diversify income streams over next few years
While we do not subscribe to the view that JLG model has no future in India, we believe that it's time for MFIs / SFBs to leverage their existing customer base to diversify into other areas. While Equitas has already taken the lead in this regard, Ujjivan too has set targets to have 50% of loan book contribution from non-MFI businesses. BFIL too has diversified into 2-wheeler and micro housing and is looking to create an additional income stream from its retail pilot (details in subsequent pages).
4) Stick to strong players, risk reward favorable at current prices
Give the diversified geographic presence, strong control over operations and healthy capital position, we expect BFIL & Ujjivan to re-bound strongly in H2FY18. Valuations have corrected to reasonable levels and risk reward has turned favorable. Maintain BUY on BFIL and upgrade Ujjivan to BUY rating. At the same time, we downgrade Equitas to HOLD given the weak earnings trajectory on account of running down of the microfinance book
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