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Buy Bajaj Finance Ltd For Target Rs.6,750

Asset quality and growth show transitory pain; return ratios remain high

* Bajaj Finance (BAF)’s 1QFY22 PAT was up 4% YoY / down 26% QoQ to ~INR10b (27% miss). While NII at INR37b (5% miss) was up 12% YoY, opex was largely in-line. Provisions came in at INR17.5b v/s our estimate of INR15b. The company aggressively wrote off ~INR9.2b worth of loans and kept COVID overlay provisions at INR4.8b, leading to high provisions.

* The GNPL ratio increased from 1.8% to 2.96% QoQ. BAF wrote off ~INR9.2b (60bp of AUM). PCR declined to 51% (down ~710bp QoQ) on GS3 and 174bps on GS1&2. BAF utilized COVID-related overlay of INR3.6b in 1QFY22, with the COVID management overlay declining to INR4.8b. Net slippage was high at ~INR30b (2% of AUM) as the company did not restructure a large number of loans in one-time restructuring (OTR) 2.0.

* Barring any new COVID disruption, we expect BAF to deliver ~21% AUM growth in FY22E and a 25% CAGR thereafter. We expect margin improvement with a) lower negative carry as excess liquidity normalizes, b) decline in Cost of Funds from a borrowing mix change, and c) the asset mix shifting toward high-yielding assets. We keep our credit cost for FY22E largely unchanged at 2.6% and marginally increase it for FY23E. We cut our estimate for FY22/FY23 by 11%/5% to factor in lower NII. We estimate ~4.8% RoA / 23% RoE over the medium term. BAF’s return ratios have not only been consistent but are also the highest in our Coverage Universe (ex-gold financiers). Given the strong recovery in Jul’21 and the healthy progress made in the digital transformation program (including wallets/payments), we reiterate Buy, with Target Price of INR6,750 (7x 1HFY24 BV).

Customer acquisition healthy; AUM growth to revert to pre-COVID levels

* In 1QFY22, BAF acquired ~1.9m new customers and booked 4.63m new loans. Despite the COVID lockdowns, new customer additions are in line with the company guidance of a 7–8m annual addition run-rate of new customers.

* AUM grew 4% QoQ to INR1.59t (15% YoY). The loan mix changed in favor of commercial loans (short-term IPO financing of ~INR30b) with lower disbursements in consumer B2B due to the lockdowns.

* The management is positive about delivering healthy AUM growth in FY22 (quarterly AUM growth similar to pre-COVID levels) – provided there are no new large-scale lockdowns due to another COVID wave.

Excess liquidity starts to normalize; CoF may see further benefit

* BAF reduced the excess liquidity on its balance sheet to INR108.6b (~8% of borrowing v/s ~12.5% QoQ). Further benefit is expected on cost of funds, led by normalization in the liquidity buffer and a change in the borrowing mix (increased CP proportion). Spreads (calculated) declined ~115bp QoQ to 10.5% on lower yield on AUM (down 120bp QoQ), weighed by higher interest reversals of INR4.6b (INR2.98b QoQ) on stressed loans. Cost of funds (reported) declined ~30bp QoQ to 7.1%.

* The share of bank borrowings declined 100bp to 31%, offset by 100bp gains in the share of deposits (21%). The total deposits book grew ~39% YoY to INR280b, and the share of retail deposits remained stable QoQ at 77%.

Forward flows into GS2/GS3, with RBI OTR pool at INR13b (0.8%)

* GS3 loans increased ~120bp QoQ to ~3.0%, with PCR of 51%. Write-offs stood at ~INR9.2b. The non-overdue OTR book stood at INR12.9b. BAF has provision cover of ~18% on the OTR book.

* Non-OTR Stage 2 assets stood at ~INR61b, against which there is an ECL provision of INR14b (23%).

* The average EMI bounce rate in 1QFY22 was approximately 1.08x 4QFY21. The bounce rate for Jul'21 has improved to 0.96x 4QFY21. Jul'21 has been marginally better than even Mar'21.

* The management guided that it would endeavor to deliver GNPA of 1.7–1.8% and NNPA of 0.7–0.8% by Mar’22. This would translate into credit costs of INR42–43b in FY22.

Highlights from management commentary

* The Auto Finance (AF) segment was the most impacted and contributed to the large portion of asset quality deterioration during the quarter. Auto Finance is collateralized lending, wherein the asset can be repossessed. Hence, if there are no more lockdowns, it expects to be able to claw back the asset quality in the AF segment. Even in this segment, the bigger stress is seen in the 3W business (30% of the AF business), which has been more severely impacted.

* Very few requests have been reported under OTR 2.0 thus far. Bounce rates plunged in Jun/Jul’21, resulting in fewer OTR requests under RBI OTR 2.0.

Other highlights

* Core AUM growth in 1QFY22 stood at ~INR41b (excluding INR29.8b of IPO Financing), largely on account of urban and rural B2B businesses dialing down. In the absence of a third wave, BAF expects the quarterly AUM growth rate for the remainder of the year to be at pre-COVID levels.

* BAF would apply to the RBI for the Payment Aggregator (PA) and Bharat Billpay Operating Unit (BBPOU) licenses.

* Consumer App: This would go live in Oct–Nov'21. Merchant One App: Phase 1 would go live in Jan'21. This is the new version of the retail EMI avatar. Insurance/Investment marketplace: This would go live by 31st Oct'21.

Valuation and view

Despite the transitory deterioration in asset quality and resultant high credit costs, 1QFY22 was a decent quarter for BAF.

Customer acquisitions and new loans booked were healthy even in a pandemic-disrupted quarter. COVID-related disruptions are known unknowns, and the quantum of impact on disbursements / asset quality is difficult to ascertain. In the context of the strong recovery seen in Jul’21, we expect BAF to be able to deliver pre-COVID levels of quarterly run-rate in AUM growth for the remainder of FY22. Provided there is no new COVID wave, we expect BAF to contain credit costs at ~2.6% in FY22.

Margins are likely to see a sharp improvement in FY22 on a) lower cost of funds, b) reduced liquidity, and c) a favorable base due to interest reversals. We update our estimates to factor in the underperformance in 1QFY22 and expect BAF to deliver ~4.8% RoA / 23% RoE over the medium term. Given the positive outlook, we maintain our BUY rating with TP of INR6,750 per share (7x 1HFY24E BVPS).

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