SKS Microfinance - IPO Analysis

Investors with a high risk appetite can consider subscribing to the Initial Public Offer (IPO) of SKS Microfinance, one of the largest microfinance NBFCs in India.



Presence in the under-penetrated micro-financing segment offers immense growth potential. The company has over 2,000 branches across 19 States, a more diversified presence than any other microfinance institution (MFI) in India and is better equipped to leverage future growth opportunities.

Investors may consider this IPO at Rs 724 per share or below. At this price the company may realise Rs 1,260 crore from this IPO.

At a price-book value of 3.5 times post-offer, the stock would trade at Rs 724. The PE ratio at this price would be 26 times. Over the last 15 months, the company has raised funds from private equity investors at Rs 300/share.

SKS Microfinance has a high capital adequacy ratio (of 28.3 per cent which may further improve to excess of 40 per cent post-offer) and strong risk-management systems which address two concerns MFI are facing today — access to capital and maintenance of asset quality.

The net non-performing asset ratio as of March 31, 2010, was 0.16 per cent. SKS' conservative provisioning on standard assets and high NPA provisioning reduces the inherently high credit risks in this business, to some extent.

Innovative Business Model

SKS' loans are disbursed only to women, primarily for income-generating activities due to which the credit risk is low. SKS adopts a Joint Liability Group (JLG) approach to lending, with each group consisting of five members giving mutual guarantee to each other. Each centre has around 5-7 JLGs, which again guarantees the combined loans mutually.

SKS has a diversified sector and geographic profile. The sector-wise disbursements as of March 31 2010, saw trade (includes small retailers) dominate with 29 per cent of the total outstandings, followed by livestock (26 per cent) and services (20 per cent).

Most of the portfolio comes under ‘priority lending' norms of the RBI, enabling the sale of this portfolio to other mainstream lending institutions; this also reduces funding costs for SKS to that extent. SKS has geographically diversified its lending portfolio, with Andhra Pradesh contributing only 29 per cent, compared to 100 per cent in 2005.

Demand-supply gap

A CRISIL report on MFIs in September 2009 estimated an addressable market of Rs 1,20,000 crore for microfinance.

A report put out by Sa-Dhan, an association of MFIs, suggests that total credit disbursed by way of microfinance was Rs 35,000 crore in 2009. These data show the potential this sector holds and why strong growth may continue over the next 3-4 years.

Financials

SKS' gross loan portfolio and net profits has grown nearly eleven-fold with profits expanding by 23 times over a five-year period ending March 2010. A flat rate of 12.5-15 per cent a year plus a 1 per cent processing fee (translating into a compounded rate of 25-28 per cent) is charged on these loans.

While the yields are high, so are operating costs. Operating costs are higher than interest costs and are likely to remain so. However, SKS' cost-income ratio fell to 52 per cent for 2009-10 from 62 per cent the preceding year and may show moderation with the company scaling up.

The interest spread stood at an exceptional 12 per cent for 2009-10, thanks to its high yields. Return on assets too is high at 4.3 per cent and may further improve as the operating costs moderate. The borrowing profile of SKS, like other institutions, is skewed towards banks.

However, it has supplemented bank funds with market issuances, in addition to securitisation of its loans. It can further tap this mode given its investment-grade ratings.

SKS' average loan size is small, but is trending up as it expands repeat customers. Further, there is scope for margin expansion as SKS leverages its branch network to cross-sell products such as insurance and mobile phones which contribute directly to the bottom-line.

SKS has also set up Sangam stores which enable small retailers to access interest-free working capital loans and products from wholesalers, which SKS' own network distributes. For this, SKS receives a 2.3 per cent commission from the wholesaler. This project is yet to be implemented outside Andhra Pradesh.

Revenues may get a further boost from its intent to extend housing loans to loyal customers. While the effective rate is attractive at 21 per cent, the secured nature and higher equity for such loans may reduce credit risk while maintaining high returns.

The Risks

In spite of trying to match the asset-liability profile, SKS lends at a fixed rate, with increases in cost of funds not passed on. Over-leveraging by the borrowers is a key risk, as there have been instances where borrowers accessed funds from multiple lenders. To discourage members approaching several MFIs simultaneously, the ‘Micro Finance Institution Network', a group of MFI-NBFCs, is planning to set up a database of borrowers to ensure that the borrowing limit doesn't cross Rs 50,000 per borrower. Another concern is the seasonality of the earnings, which are back-ended to the second half of the year. Given that the MFI loans are to low income groups, during natural calamities, the loan portfolios may result in NPAs due to the inability of the borrower to pay.

However, according to the management, recovery does tend to pick up once a moratorium period is extended. Retaining a skilled workforce is a challenge (SKS has attrition rates upwards of 25 per cent), which may expand the already high operating costs, given substantial costs involved in training employees.