Stock Fundamentals

Why the stock of Equitas Small Finance Bank is a good investment

Keerthi Sanagasetti BL Research Bureau | Updated on May 22, 2021

While there may be near-term headwinds, superior fundamentals provide comfort

The stock of Equitas Small Finance Bank (SFB) has lost 15 per cent since its high in early March. The stock seems an attractive bet for the long term, given the healthy growth in its diversified loan book. That apart the bank is also set to benefit from the ongoing ramp up in its retail deposits.

Besides, the SFB’s current valuations too are reasonable at just 2 times its FY21 book value. While its direct peers Ujjivan SFB and Suryoday SFB trade lower at 1.5-1.9 times their book value (at the end of December 2020), Equitas SFB commands a higher valuation given its relatively less risky business model. While Ujjivan SFB and Suryoday SFB (the latter currently has a much smaller loan book), currently enjoy better return on assets (ROA) – greater than 2 per cent (as of December 2020), any deterioration in asset quality can dent their return ratios. This is because only 25 per cent of each of their portfolio is secured. In the case of Equitas SFB, about 81 per cent of the loan book consists of secured loans. In FY21, despite the pandemic having hampered the collection efficiencies, Equitas SFB posted a RoA of 1.8 per cent in the March 2021 quarter, with GNPAs (Gross Non Performing Assets) at 3.59 per cent.

Healthy fundamentals

The bank’s gross advances grew 39 per cent CAGR (Compounded Annual Growth Rate) over FY18 to FY20, to ₹15,367 crore. In FY21, the SFB too resorted to cautious growth amidst the uncertain times– the advances grew 17 per cent y-o-y to ₹17,925 crore. About 45 per cent of the loan book consists of small business loans (including housing loans) and micro finance comprises another 18 per cent. Vehicle finance (25 per cent), MSE Finance (7 per cent) and loans to NBFCs (4 per cent) constitute the remaining.

Catering to unbanked customers, the SFB enjoys higher yields on assets (19 per cent plus till FY20). That apart, a ramp up in retail deposits has also helped bring down the cost of funds for the bank—deposits now comprise 77 per cent of its total borrowings. Further, about 34 per cent of the bank’s deposits are low-cost CASA deposits. In the fourth quarter of FY21, following a 55 basis points (bps) drop in its cost of deposits, the bank’s cost of funds fell by 57 bps (y-o-y).

Pandemic impact

Given its exposure to low-ticket sized and unbanked customers, the bank’s collections took a hit in the aftermath of the lockdown in FY21. However, the scenario improved towards the end of the fiscal. Post the Supreme Court’s judgement on NPA recognition (on moratorium book), the bank’s GNPA were at 3.59 per cent in the March 2021 quarter, down from 4.16 per cent in the December 2020 quarter (proforma). Further about 2.4 per cent of the bank’s loan book was restructured under the RBI’s framework. The bank’s provision coverage ratio stood at 58.6 per cent in FY21. However, cumulative provisions on the bank’s balance sheet including standard, floating and provisions for NPA, cover about 71.9 per cent of the bank’s bad loans.

While the spike in NPAs was lower than anticipated, the net interest margin (NIM) of the bank took a hit. Despite a drop in the bank’s cost of funds, the NIMs fell 197 bps y-o-y to 7.57 per cent in the fourth quarter of FY21, owing to the interest reversals on bad loans.

Risk mitigators

Given its focus on niche unbanked segments and presence in over 17 states and union territories, the SFB is poised for growth in the long term. However near term risks persist for the bank. While the bank saw a return to normalcy in the March 2021 quarter, in terms of its collection efficiency, the second wave of the pandemic and the consequent partial lockdowns in various parts of the country, could further hamper the collections. In April 2021 with a surge in covid infections, the bank already saw a drop in overall billing efficiency (percentage of EMIs collected for that month) to 88.12 per cent, compared to 94.46 per cent in March 2021. With further lockdowns being imposed in subsequent months, the coming quarters could see a further deterioration in asset quality, thereby impacting the margins and return ratios in the near to medium term.

While the lockdown this year may not be as severe as the last year, the impact on collections may be harder following the financial burdens wrecked by the pandemic. However, we gain comfort from one, the higher share of secured book in Equitas SFB’s portfolio and two, return to normalcy may not be far-fetched, as was observed in FY21.

The bank’s geographical concentration (Tamil Nadu, Maharashtra and Karnataka constitute 54, 13, and 10 per cent of the advances, respectively) is also a dampener – given the surge in Covid cases in these states.

Another major overhang for the stock comes from the RBI’s mandate on dilution of promoter holding. While the RBI’s internal working group has opined for the removal of sub targets of dilution in the promoter stake, the extant guidelines mandate a dilution for the bank by September 2021. Equitas Holdings (promoter entity) currently holds about 81.98 per cent stake in the bank, which has to be brought down to 40 per cent by September 2021 (further to 30 per cent and 26 per cent, respectively by September 2026 and September 2028).

However, the management is contemplating several possibilities to bring down the promoter holding in a less dilutive manner (for existing shareholders) - such as merger with the group’s housing finance arm.

These risk factors seem to have been already priced in the stock. Besides, given the current economic scenario and its capital adequacy of 24.18 per cent, the bank’s loan book is well poised for growth, which may lead to a re-rating, if the asset quality exhibits such resilience, in the coming fiscals as well.

Published on May 22, 2021

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