Bajaj Finance Ltd.: Investment Thesis – Part 2

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While in the previous post, i spoke about the fundamentals and business aspects of Bajaj Finance Ltd. (BFL), in this post, we’ll go through company’s behaviour during downturns, ending with thoughts on its valuation.

Risks

Apart from Gross NPAs, which market participants have a key eye on, its very difficult to understand the troubles brewing inside lending businesses. What we can simply do here is understand how the company navigated during the downturns historically –

Year Event Industry Impact GNPA reported Comments / Actions
2013 Taper Tantrum Credit Freeze n/a BFL started to maintain a liquidity reserve @4% of borrowings. No impact on financials.
2016 Demonetization. higher credit losses in 2w and LAP. increased from 1.36% to 1.68% total hit of INR 120 crores on a 58,000 crore loan book. Recovered fully in 90 days.
2018 IL&FS default Liquidity freeze in domestic debt markets 275 crores w/off – 9 bps NPA no problems faced in refinancing its borrowings.
2020 Covid crisis high credit cost due to a 4 month lockdown along with moratorium 2.9% GNPA with Auto book 11.5%. BFL built a liquidity buffer of 22% cash till Oct 2020. Business resumed normalcy Dec 2020 onwards. Total provisions expected to be 6,000 crores, 4.5% of o/s loan book.
source: management commentary over the years

As can be observed from above, BFL has escaped largely unscathed in the above downturns, and this gives us a conviction that the risk management practices of BFL are strong.

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BFL further perseveres in maintaining safety with an Asset Liability mismatch leading to an outflow only after 1 year (thus eliminating the need to rely on short term sources of finance) nor undergo a credit crunch. BFL further has a liquidity advantage due to a churn in its consumer durables loans which have a tenure of 3 months, due to which a natural liquidity of 5,500 crores – 7,000 crores is generated on a monthly basis.

On Flexi Loans – Post suspension of moratorium on repayment of EMIs in Sep 2020, BFL gave an option of converting fixed EMI loans to flexi loans, whereby payment of principal could be deferred as long as the interest on it was paid. Essentially, these loans work like a credit line. While the market participants viewed this as a restructuring of loans, the company maintained that flexi loans were almost 25% of the loan even before covid hit, and thus new loans given out under flexi are not new or significant. in fact, Personal loans to doctors are all flexi, 90% of of salaried PL is offered only in flexi. 100% of LAS portfolio is on flexi, 60% of LAP portfolio is on flexi, 65% of SME which is 11,000 odd Crores portfolio is on flexi. Thus as per me, the flexi conversion does not seem to be a reckless behaviour from BFL.

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Recovery Practices – With millions of loans sitting on its balance sheet, collections composes a major cost head for the company. of the 19,000 or so of its employees, almost 4,800 work in collections, where their role is simply to manage collection agencies, since BFL has outsourced all its collection operations and works with close to 16,000 agencies in 2,000 towns in India. A lot of these agencies work exclusively with BFL. In Jan 2021, RBI fined INR 2.5 crores to BFL on account of the strong arm and intimidation used by its agents in recoveries. While it is debatable on what % of blame lies with BFL, the reputational loss, both tangible and intangible, is a small risk to company’s operations.

The Dilution Flywheel

By regulation and prudence, lending companies cannot grow their loan books faster than the rate of earnings that they have retained, since its capital limits would be breached. Hence, both fast growing NBFCs and banks need regular access to the capital markets. Although never articulated well, analysts and investors have an obsessive compulsive fascination with growth in loan book, giving only a lip service to the return on Equity (RoEs) earned. While initially puzzling, I understand somewhat why this is true. The P/BV multiple at which a lending company dilutes its earnings has a significant impact on the incumbent shareholders since this multiple also determines their incremental RoE. Simply put, Incremental RoE = (P/BV multiple) x Business RoE. As an illustration –

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Particulars
Particulars 1x 3x 5x
Existing Shares 100 100 100
New shares 10 10 10
Capital Added 10 30 50
Business RoE 20% 20% 20%
Net Profit 2 6 10
Incremental RoE / share 20% 60% 100%
1x, 3x and 5x are P/BV dilution multiples

Funnily, analysts in J&K Bank Ltd.’s concall kept asking about loan book growth even when the bank was making losses (the J&K govt smothered these guys diluting at 0.3x P/BV). BFL, however, has diluted its shares at incredible valuations, not only spinning the growth wheel faster, but also making the incumbent shareholders wealthier, such that they have gained from the growth in business, as well as benefiting from the appreciating currency (Bajaj Finance’s own shares) –

Year Price PY BV P/BV Closing BV % diluted
2020 3900 341 11.4 539 4%
2018 1690 177 9.5 276 5%
2016 427.5 96 4.5 139 7%
2013 110 42 2.6 67.5 17%
source: annual reports

Taking the 2012 book value of Bajaj Finance as opening value, this is how Mar 20’s BV has been built over the years –

  INR As a % of BV
2012 BV 22.0 4%
Issue of Shares 268.3 50%
Profits 294.6 55%
Dividend -34.4 -6%
Other -32.4 -6%
2020 BV 533.6 100%

Almost half of all gains in book value till date, simply come from diluting its share capital, which I found incredibly interesting. I am still thinking about the repercussions on its valuation. This analysis is only 50% complete, since I have been unable to identify inherent risks in the business, nor have studied the competition. So I’ll take up Sundaram Finance Ltd. next, a lender with ratios as good as Bajaj Finance’, but has not diluted even once post its IPO. Honestly, figuring out Bajaj Finance Ltd. made me realise my own blind spots in being unable to identify or believe in the ability of some businesses to thrive so phenomenally. I doubt I would ever be able to pull the trigger here. This one defies gravity.

It would be incredible to know your view on this too! Do write in comments or on co ordinates in the About Page. Do spread the love.



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Umang Shah

Umang Shah

Through his writing, Umang shares his perspectives on how he thinks of investing, decision making, books and life in general.
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