Amid the turmoil in the banking sector and persisting growth challenges, a few non-banking finance companies (NBFCs) have continued to deliver strong performance. With focus on consumer, SME, commercial and rural lending, Bajaj Finance has been the darling of the market, quadrupling in value over the past three years. Strong fundamentals, robust opportunity in the company’s key segments, investments in technology and a sound risk management system, should keep the growth momentum intact, going ahead.

Bajaj Finance’s assets under management (AUM) and earnings have grown by a robust 35 per cent (compounded annual growth) over the past five years. The company has been able to sport a steady return on assets in the range of 3.3-3.5 per cent, thanks to the strong traction in loans, healthy margins, and good asset quality.

While the stock trades at a premium to other NBFCs, given the healthy long-term prospects, earnings are expected to grow at 25-30 per cent in the next two to three years.

At the current price, the stock trades at 5.7 times the FY19 book value; Cholamandalam Investment and Finance and Sundaram Finance trade at 3.5-4 times. The stock’s premium valuations are likely to hold up. Investors with a two- to three-year horizon can buy the stock.

Strong business

Bajaj Finance is a diversified player focussing on financing mass affluent customers with presence in consumer financing, SME financing, commercial and rural lending.

Consumer finance — entailing two- and three-wheeler finance, consumer durable, digital product, lifestyle product finance, personal loans and salaried home loans — constitutes 47.9 per cent of the company’s AUM. Active distribution at various consumer durable stores, digital product outlets etc, and product innovations have kept the growth in good stead. Its unique existing member identification (EMI) card, for instance, which enables customers to get instant finance after the first purchase, has helped it strengthen its leadership within the consumer durable space. As of December 2017, the AUM of the consumer business grew 25 per cent Y-o-Y in its B2B segment and 52 per cent in the B2C space.

Within the SME segment, the company is focused on SMEs with an average annual sales of ₹10-12 crore; the growth in this division was lower, at 16 per cent Y-o-Y in the December quarter, owing to the management’s cautious approach to lending to the segment. SMEs constitute 31.5 per cent of the company’s AUM.

Commercial lending, including vendor financing, corporate finance, financial institutions lending has grown by a strong 52 per cent Y-o-Y in the latest December quarter, constituting 13.5 per cent of the AUM.

The rural lending business that caters to the consumer and MSME segment in rural markets has been growing at a robust pace, albeit on a low base. In future, the management expects the strategy to diversify geographically and penetrate rural India to drive growth in the medium term.

Bajaj Housing Finance Limited (BHFL), a 100 per cent subsidiary of Bajaj Finance, started its operations in July 2017. The company plans to book all incremental mortgage assets in Bajaj Housing Finance by March 2018 to ensure more focus on the business.

The company’s leading presence in core segments should drive loan growth of 25-30 per cent over the next two to three years. Growing competition in fintech lending, though, needs watching, with the likes of Amazon and Flipkart etc investing in cross-financing their customers.

On the profitability front, the company has been able to improve margins over the past two to three years, thanks to the notable fall in cost of funds. While the cost of funds is likely to increase in the medium term, the ability to pass on some of this to customers, should help margins. Operating expenses to net interest income stood at 40 per cent in the December quarter. While the management expects this to inch up in the near term, it expects the ratio to stabilise at 39-40 per cent over FY19.

Under check

In a bid to bring the NPA norms on par with banks, the RBI had directed NBFCs to implement the rules in a phased manner — from 150-day cut off by end of March 2016 to 90 days by the end of March 2018.

Bajaj Finance has always been better placed than others, on the back of an already stringent asset quality norm and higher provision cover. Hence, its asset quality has been more or less steady over the last few years. Gross NPA and net NPA as of December quarter (on 90-day cut off) stood at 1.67 per cent and 0.53 per cent respectively.

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