Why the Equitas stock is near the bottom, and may be worth a look
Coming on the back of a huge underperformance (a decline of 13.5 percent against 23 percent rise in the Nifty), the stock of Equitas Holdings is close to its 52-week low. Besides the transition to a small finance bank and the associated challenges, the jolt to its micro finance portfolio (MFI) post demonetisation and the spate of loan waivers and political interference that brought the “moral hazard” problem to the fore also added further pressure to its financials.
Consequently for the small bank, disbursements fell and NPAs (non- performing assets) soared. While in the quarter gone by there are nascent signs of growth picking up, the pain is not over yet, although the end may be near.
However, there is a strategic shift in business that beckons attention. The task of de-risking and diversifying the asset book is underway, while the same stands to supress return ratios, it will nevertheless lend stability to earnings. Signs of improvement should be visible from FY19.
The stock trades at 1.95X FY19 book. The current weakness could be a good starting point for accumulation.
The quarterly performance
While the pain is still visible in the numbers, it is also heartening to note that loan growth is picking up and the incremental growth in the loan book is driven by the non-MFI portfolio. The management plans to adopt a strategy whereby no product assumes excessive share in the portfolio.
The company nevertheless has been putting risk management in place especially in terms of de-risking the asset book and the share of micro finance business has been coming down steadily.
The other key positive takeaways from the otherwise lacklustre result are the relative stability in operating expenses and slight improvement in the ground reality for the MFI (stability in the collection ratio) business.
What are the long-term drivers of the business?
Catering to the bottom of the pyramid with a diversified offering – The company intends leveraging its MFI network to expand the business but offer a diversified product suite to reduce dependence on any product. The share of unsecured lending has already come down to 39 percent and is likely to fall further.
The share of the MFI portfolio would be pruned to about 30 percent by FY18 and 15 percent by FY20. The focus is on acquiring customers and broadening the non-MFI product bouquet through the launch of new products such as LCV, dealer financing, and business loans for the formal segment and rolling out existing products from more branches.
Pressing the accelerator on garnering deposits – The new bank is garnering deposits at a steady clip and deposits now constitute 42 percent of total borrowing (with low cost CASA at 11.9 percent). Funding costs show a declining trend that should shield margins in light of the asset book moving away from ultrahigh-yield products.
With a falling cost of funds it will be much easier to build a de-risked business without compromising on return ratios.
Asset quality, the pain point – While asset quality didn’t provide much comfort, it is worth noting that of the “principal at risk” in the micro finance book of Rs 176 crore, Rs 140 crore is already a part of gross NPA.
With respect to MFI book, of the overall PaR (principal at risk) portfolio of Rs 176 crore, the bank has already provided Rs 76 crore, and expects recovery to the tune of Rs 20 crore, thereby leaving it with an incremental hit of Rs 75-80 crore. The collection efficiency (of ex-par customers) at > 99.9 percent suggests limited pain going forward. Hence, the bank is a couple of quarters away from complete peaking-out of this issue.
Cost/income ratio: The worst may be behind it: Following its conversion to a small bank, the cost-to-income ratio of Equitas has been on the higher side owing to the roll-out of liability branches, associated recruitment and investment in technology. This, coupled with the sudden decline in earnings, has led to a sudden spike in cost/income ratio. The company expects cost/income ratio to stabilise at the current level and gradually decline from FY19 as the assets starts becoming productive.
We expect FY19 to be a year of recovery post the dip in FY18. The bank is well capitalised (CAR 34.3 percent) and will not be constrained by capital to grow once it puts its house in order. The stock looks reasonably valued at 1.95x FY19 book and the current weakness may be considered for accumulating the stock for a gradual turnaround.
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