JP Morgan
SKS Micro-Democratic Theft; Borrow But Need Not Repay
We cut our PT on SKS to Rs 200 from Rs 550, accompanied by deep earnings cuts and loss forecasts for FY12. We think the Andhra Pradesh portfolio is seeing more losses and the business model has weakened elsewhere too. Recent regulatory changes are not as positive as the street thinks. We fear that SKS' may need more capital. Maintain Underweight – the risk-reward payoff is unappealing.
• Asset quality risks increasing. We expect AP collections to fall to 25% (3Q11 - 43%), triggering large writeoffs in FY12 – SKS' disbursements freeze is bound to affect collections adversely. We also raise credit cost assumptions ex-AP, to 3.5% (from 2.25%) - channel checks indicate high inflation is impacting borrower finances. If the 3Q blip in West Bengal (95% collections) becomes a trend, there are downside risks to forecasts.
• New RBI rules still restrictive. The RBI recommendations may not translate to the AP government relaxing provisions of the APMF Act.
The final RBI rules are less restrictive than the original Malegam committee recommendations, but are still capable of stifling growth in
the sector. At the very least, the cost of compliance and data collection is likely to be very high, while ticket size expansion has been capped.
• Capital at risk. We now forecast a large loss (Rs7bn) in FY12, driven by the AP write-offs. This is expected to shrink equity by 40%, bring
equity/assets down to a precarious 22-23% and probably entail a recap –unless SKS gets relief on NPL accounting. We expect a return to profits in FY13, with ROEs normalizing at ~14% in FY14.
• Not cheap enough. The stock's at 2.7x PB and normalized ROEs are ~15%. Mcap/assets at 0.6x is at a ~80% premium to NBFC peers. We now value SKS at ~1.3x FY12 book, using Gordon growth for the "good bank" and writing down the AP losses as a "bad bank". We still see negative surprises and further downside: retain UW.
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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