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* Spandana Sphoorty (Spandana) is a leading rural-focused NBFC-MFI offering income generation loans under the joint liability group (JLG) model. As of Mar’23, the company reported AUM of ~INR85b. It has over 1,200 branches spread across 18 states of India. Its top five states are MP, Odisha, Karnataka, Maharashtra and AP, which contributed ~66% to the AUM mix as of Mar’23.

* Spandana has a strong rural footprint, with the rural portfolio accounting for ~87% of its total AUM. It has an average ticket size (ATS) of ~INR35K. The company reported an 18% AUM CAGR over FY19-FY23 and going forward, we believe AUM growth will be driven by healthier customer acquisitions.

* FY22 and FY23 were watershed years for Spandana due to several disruptions (including a settlement with its ex-MD, Ms. Padmaja Gangireddy). However, it was able to manage those disruptions with the support of its promoter Kedaara Capital (~48% stake), which infused INR2.9b capital in CY22.

* In addition to Covid, changes in its senior management team led to deterioration in asset quality. However, the company has already taken write-offs in FY23 and addressed the stress by selling portfolios to asset reconstruction companies.

* It is now a stronger company with a new management team led by Mr. Shalabh Saxena (MD/CEO). The company has refined its processes by adopting right tools and technologies. The new management team has fortified governance and risk controls, strengthened senior/middle management teams and scaled up multiple technology initiatives (including geo-tagging of customer houses and center meeting locations) to further refine the JLG processes.

* Spandana had to rework very hard on its liability relationships and has made considerable progress with both private and even some public sector banks (PSBs). It is strongly capitalized and has a CRAR of ~37% (standalone) as of Mar’23.

* We estimate a ~34% CAGR in AUM over FY23-FY25, driven by strong customer acquisitions. We believe that the company will now pivot from consolidation to growth phase and will do it with tighter control over asset quality. Spandana currently trades at 1.2x FY25E P/BV for RoA/RoE of 4.3%/15% in FY25E. Given the strong opportunity in the microfinance sector, we think that the company is poised for a rerating if it executes well on its stated goal of quality growth. We initiate coverage on Spandana with a BUY rating and a TP of INR865 (1.5x FY25E P/BV).

From consolidation to growth with ~34% AUM CAGR over FY23-FY25E

* Spandana management has made very good progress towards each of the identified priorities of a) scaling up its technology infrastructure to deliver end-to-end paperless processes, b) strengthening the risk management and controls and c) reinforcing the senior and middle management.

* The harmonized regulations for microfinance, near normalization of collections efficiency and the continued robust demand are big tailwinds for the MFI sector. We expect Spandana to capitalize on it and deliver a ~34% AUM CAGR over FY23-FY25E. It will now transition from consolidation to growth phase.

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