Bajaj Finance: Buy

Fresh investments can be considered in the stock of Bajaj Finance, a diversified non-banking finance company (NBFC) that focuses on consumer financing segments.

After learning its lessons the hard way in FY-08, Bajaj Finance restructured its business by diversifying into consumer finance, and shutting down loss-making branches. These measures, together with technology integration to reduce operation risks, led to the company enjoying a more diversified business profile with lower rate of delinquencies.

Besides low valuations of its stock, the company now sports superior net interest margins (17.7 per cent for the year ended March 2011), with low net NPA ratio at 0.8 per cent and high levels of capital adequacy (20 per cent). At its current price of Rs 617.5, the stock is trading at 1.41 times its estimated FY12 adjusted book value.

The price-to-FY12 earnings multiple works out to a low 7.3 times. At this P/BV valuation, it is trading at a discount to peers such as Shriram City Union and Cholamandalam Investments. The current price to book appears undervalued, given the high return on equity (18.2 per cent) and strong earnings growth expectation.

Underperformance

While stocks of NBFCs, in general, have underperformed due to sharp rise in borrowing costs, deposit-taking NBFC stocks such as Bajaj Finance also fell on account of higher capital adequacy requirement recently spelt out by the RBI. This would mean that Bajaj Finance may have to raise equity by FY-13. However, given the company's high rate of earnings growth, this is unlikely to dilute the per share earnings.

Bajaj Finance has come a long way from being a captive financier of Bajaj Auto's customers, to widen its presence in consumer durable financing, mortgage financing, vendor financing, construction equipment financing and SME lending. Currently, the company has 63 branches and also leverages on another 2,500 Bajaj Auto and consumer durable dealerships.

Business

The diversified nature of the company's business ensured that no segment contributed more than a quarter to the overall disbursements for the year ended FY11. Consumer durable segment is the biggest contributor, followed by vehicle and mortgage financing.

Given the levels of inflation and high rate of interest, there exists a risk of discretionary consumer spending moderating in the near-term which, in turn, may moderate the disbursement growth. Disbursements fell from Rs 2,774 crore in December 2010 to Rs 2,487 crore in March 2011.

However, rising income levels of the consumers may partly limit expected decline in credit demand from customers.

Bajaj Auto's focus on high-end vehicles, which are less sensitive to interest rates, may also support disbursements. Focus on infrastructure financing, construction equipment financing and SME financing would also aid loan book growth. Management expects infrastructure financing to be 10 per cent of assets under management by March 2012.

Disbursements grew at 96 per cent annualised rate during the period FY09–FY11. The net profit of Bajaj Finance grew by 169 per cent compounded annually during the same period while The net interest margin of Bajaj Finance fell from 18 per cent in Q3FY11 to 15.4 per cent in the March quarter, in line with other NBFCs. This was due to sharp rise in wholesale borrowing costs and rising leverage. The base rate hikes of banks would put further pressure on net interest margins.

However, the company's hike in its lending rates is yet to be fully reflected in its income. Added to this, there is further scope for hike in lending rates. Once this effect comes into books, it may prevent further margin compression.

Nevertheless, the spread may come under pressure as competition rises, given that banks have come back to the consumer lending segment. This would reduce the pricing power of NBFCs, including Bajaj Finance. Business growth, though, is unlikely to be hurt for Bajaj Finance given its presence across business segments and geographies.

Asset quality

Bajaj Finance's net NPA fell from 7 per cent in FY08 to 0.8 per cent by end of March 2011 thanks to higher provision coverage and improved credit appraisal processes.

Rising interest rates and inflation may play spoilsport, going forward, as Bajaj Finance's loan book is exposed to economic downturns. Nevertheless, given sound credit risk management the NPA levels may not go to historic levels.

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