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Second wave impact manageable

Tweak earnings to factor in lower growth and higher credit cost; ROE still at 20%

Bajaj Finance Ltd (BAF) has released its mid-quarter update highlighting the impact of the second COVID wave on AUM and provisioning. A large portion of the provisioning is likely to be upfronted in 1Q. We have tweaked our estimate based on the revised guidance. Despite an earnings cut of ~11% for FY22, ROEs are likely to be strong at 20%, and we believe the impact is likely to be transient. With the process of unlocking having commenced, the rebound may be equally strong. Reiterate Buy.

Strong customer acquisition businesses see moderation

* The company has seen sharp moderation in high-volume, low ticket size, and strong customer acquisition related businesses such as Auto Financing and B2B Financing. Volumes in these businesses were 70%/40% of the planned volumes in April/May. Moreover, with the lockdown continuing in some states, June is also likely to see moderation, although it would be better than May, in our view

* Other lines of business (largely cross-sell kind of products) had 85%/60% of planned volumes in April/May. The company expects volumes to see an uptick in June. The management expects the AUM impact to be INR40–50b (~3% of the outstanding AUM) for FY22.

Limited impact; better economic revival may surprise positively

* With the high severity of the second wave, some impact on AUM / credit cost was expected. B2B and Auto Financing contribute ~16% to the overall AUM for the company; however, their contribution to overall customer acquisitions is very high. Considering the short duration of the high-volume products, they also contribute meaningfully to fee income for the quarter.

* We see temporary moderation in these businesses and expect some part of the lost demand to be compensated by the start of the unlocking

* With good pent-up demand, we may see a positive surprise in 2H – provided there is no impact in the form of a third COVID wave or the wave is less intense in nature.

Guiding for higher provisions

* The management has guided for provisioning cost to be INR11–13b higher than earlier estimated. During the 4Q earnings call, it mentioned that the entire first COVID wave related pain was taken upfront and FY22 is likely to be near normalized levels.

Tweaking the estimates; ROEs still 20%+

* We cut our estimates by ~11% for FY22, factoring in lower AUM and credit cost. We lower our AUM estimates (by ~5%) to ~19% now. Considering the evolving liquidity situation, we expect the NII impact to be marginally lower owing to the benefit on cost of funds.

* On the back of lower volumes, we now model in lower opex as well. Hence, our PPoP estimates are largely unchanged. On the back of higher provisioning, PAT sees a downgrade of ~11% for FY22. We further tweak our FY23/FY24 estimates by ~2%, factoring in lower AUM. Despite the earnings cut, ROEs are likely to be ~20%, with superior core operating profitability.

Valuation and view

* The severity of earnings impact of the COVID second wave has been much lower than the first wave. The management is well-prepared to deal with this and compensate the lost business with the start of the unlocking process. Digital initiatives have been upfronted and are likely to provide significant benefit on the cost and growth fronts. The cross-selling of products to the existing Credit segment customer base of ~39m would be a key growth driver in FY22 as well.

* In the 4QFY21 earnings call, the management guided for achieving long-term growth guidance of 25% AUM growth and 20% ROE – if the impact of the second wave is in line with expectations. However, while the AUM growth now seems like a stretch, ROE of 20% still seems achievable on the back of strong margins and operating efficiencies.

* BAF’s return ratios have not only been consistent but are also the highest in our Coverage Universe (after that of the gold financiers). Reiterate Buy, with TP of INR6,500 (6.5x 1HFY23).

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