[T.S.R:16508] SKS MicroFinance-Destruction Of A Business Model, Downgrade To Sell (Citigroup)

Downgrade from Hold to Sell

— We downgrade SKS from a Hold to Sell (3M) with a Rs605 TP despite a sharp stock correction. The current regulatory imbroglio has unraveled more sharply than expected and will likely leave a trail of impact on earnings, growth and asset quality even if resolved quickly. If it prolongs, the impact could be higher, with possibilities of further downsides to the stock. We are cutting earnings 41-52% over FY11-13E to factor in reduced lending rates, higher funding costs, lower growth and increasing credit cost requirements medium term. 

Impact of new AP Regulations — The Microfinance Bill has recently been passed in the AP Assembly and, if enacted, could impact: a) NIMs – SKS has reduced its effective lending rate by around 2% and funding costs are also likely to go up as banks get increasingly risk averse; b) Loan growth – Incremental disbursements have still not resumed in AP and slowed down elsewhere; c) Asset quality – even a quick resolution will likely result in 10-20% NPLs in AP (25% of book) and more in case of delays; there is no contagion yet, but stoppage of incremental credit can lead to higher NPLs elsewhere as well; and d) Access to funding – Banks are increasingly becoming risk averse, suggesting funding will be tighter and costlier, so the next 2-3 quarters do not look kind to earnings/growth. 

Is the MFI Model Bust? We believe Not — All may not be lost for the MFIs. Our recent field trip suggests – a) Strong underlying business economics (and demand) and b) Large distribution reach, which others have found hard to replicate. We believe these could lead to MFIs modifying business models to focus more on: a) Asset-light lending (tie-ups with banks?), b) Distribution of varied financial (and non-financial products). We believe SKS is relatively better positioned than peers due to a) Higher capital and b) Geographically more diverse loan book, but the benefits will likely accrue only after the pain has been digested. 

Clearer picture to emerge by end FY11, would avoid till then — We believe a clearer picture on regulations (and government priorities) is likely to emerge by  end FY11. Given likely near-term pain, we would like to avoid the stock for now.

 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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