Bajaj Finance: Building scale with profitability

23 August 2013

Initiating Coverage |

Sector: Financial

Bajaj Finance

BSE SENSEX

S&P CNX

18,313

5,408

CMP: INR1,092

TP: INR1,520

Buy

Building scale with profitability

Above industry growth, superior return ratios to sustain



Bloomberg

Equity Shares (m)

M.Cap. (INR b)/(USD b)

52-Week Range

1,6,12 Rel.Perf.(%)

BAF IN

49.8

54.4/0.8

1,591/991

-10/-7/1



Financials & Valuation (INR b)

Y/E March

NII

PPP

PAT

EPS (INR)

EPS Gr. (%)

2013 2014E 2015E

17.2

10.5

5.9

119

22.5

13.8

7.5

150

800

3.7

20.3

15.0

7.3

1.4

28.0

17.4

9.0

181

949

3.5

20.7

15.0

6.0

1.1

2.5



Bajaj Finance (BAF) has transformed from a captive two-wheeler financier to a

diversified lender (Consumer, SME, Commercial), and is now building scale with

profitability.

Well-entrenched business model comprises businesses that are either profit

maximizers (generate RoA of over 5%) or scale builders (generate RoA of over 2.5%).

Diversification of product portfolio de-risks growth/earnings profile and mitigates

the risk arising from a particular segment or any adverse regulatory clampdown.

In the last three years, BAF has outpaced its peer group in growth and earnings; we

expect the strong business momentum to continue.

Improvement in risk management has led to historic low GNPA/NNPA at 1.1%/0.2%,

despite a challenging macro environment and operations in high-risk segments.

We initiate coverage with a Buy rating and target price of INR1,520 (1.6x FY15E BV of

INR949).

Well-entrenched business model

BAF has successfully transformed from a captive two-wheeler financer to a

diversified non-banking finance company (NBFC). It has fine-tuned its lending

model and redrawn its target segment, with a focus on affluent customers, high

value products and distribution network. Its business lines are complementary,

balancing risk. Its well-entrenched business model comprises businesses that

are either profit maximizers or scale builders. Profit maximizing businesses

include consumer durable loans, two-wheeler loans, personal/small business

loans and loans against shares, which generate RoA of over 5%. Scale building

loans include mortgage loans, loans against property, construction equipment

and infrastructure finance, which are of larger ticket size and generate RoA of 2-

2.5%.

BV/Share (INR) 676

RoA on AUM (%) 3.8

RoE (%)

Payout (%)

Valuations

P/E (x)

P/BV (x)

21.9

15.0

9.2

1.6

Div. Yield (%)

1.4

2.1

Price as on 22 August 2013

Share holding pattern (%)

As on

Jun-13 Mar-13 Jun-12

Promoter

62.1

62.3

Dom. Inst.

9.7

11.2

11.6

Foreign

8.7

6.9

6.7

Others

19.4

19.8

19.4

Diversification de-risks earnings and growth profile

With 10 business lines and rural lending foray underway, BAF is one of India's

most diversified NBFCs. Its diversified portfolio de-risks growth/earnings

profile, as weakness in a particular segment (ongoing slowdown in CVs/cars and

infrastructure segment) or impact of regulatory changes in a particular business

segment (tightening of regulatory norms for gold finance) can be absorbed by

other segments.

Stock performance (1 year)

Above industry growth rates, superior margins to sustain

BAF has been a key beneficiary of strong retail credit demand, which is reflected

in its business growth - loans grew ~3.5x in the last three years. Its loan book

posted 60% CAGR over FY09-13, significantly outpacing the peer group. We model

loan CAGR of ~28% over FY14-16. BAF has been able to maintain superior margins,

despite a rising interest rate environment and change in loan book in favor of

Bajaj Finance

lower yielding secured assets. Margins for FY13 were 11.7%, way above the peer

group. We estimate 100bp margin compression over the next three years due to a

change in loan mix in favor of secured loans. However, margins will still be healthy at

over 10.5%, higher than the peer group.

Diversification, better risk management reflected in asset quality

Strong asset quality performance (NPLs at historic lows - GNPA/NNPA at 1.14/0.25%

are among the least in the NBFC space) is a reflection of BAF's better risk management

practices and diversification strategy. Despite the challenging macroeconomic

environment and the company operating in high risk segments, its focus on affluent

segments, enhanced usage of credit bureau (CIBIL) and strong risk management

framework have ensured best-in-class asset quality, even in the riskier segments.

Impressive execution, superior return ratios; initiate coverage with Buy

Strong core operating performance and faster-than-expected turnaround in

operations demonstrate the management's superior execution skills. Superior

margins, focused fee income strategy and control over cost ratio will keep core

operating profitability strong. Strong loan growth momentum coupled with stable

asset quality and low credit costs would drive BAF's earnings at 21% CAGR over FY14-

16. We expect RoA/RoE to remain strong at over 3.4%/21% during FY14-16. We initiate

coverage with a

Buy

rating and target price of INR1,520 (1.6x FY15E BV of INR949).

Key operating matrix (%)

Yields on loans

Cost of funds

NIMs

Cost / Income

CAR

Tier 1

GNPA

RoE

RoA

EPS (INR)

EPS Growth

BVPS (INR)

FY10

25.3

8.3

18.8

44.7

28.0

26.0

7.60

8.0

2.5

24.4

163.6

314.9

FY11

22.7

7.5

15.0

44.5

20.0

16.8

4.30

19.7

3.8

67.4

176.0

370.8

FY12

20.4

8.8

12.2

46.9

17.5

15.0

1.2

24.0

3.8

98.4

45.9

487.0

FY13

20.2

10.2

11.7

44.7

22.0

18.7

1.1

21.9

3.8

118.8

20.8

676.4

FY14E

19.5

10.0

11.5

43.6

21.0

18.0

1.30

20.3

3.7

150.1

26.4

800.2

FY15E

19.0

9.3

11.1

42.4

20.0

17.0

1.60

20.7

3.5

181.1

20.6

949

23 August 2013

Bajaj Finance

Well-entrenched business model

Offers a bouquet of 10 products under three business segments



Focus on businesses that are either profit maximizers or scale builders.

Business segments — Consumer, SME and Commercial -- are designed to effectively

leverage BAF's large customer base to cross sell various products.

Business model marks competitive edge over other NBFCs on risk and growth profile.

Business model comprises of products that are either profit maximizers or scale

builders. Profit maximizing businesses are consumer durable loans, two-wheeler

loans, personal/small business loans and loan against shares, which generate superior

RoA of over 5%. For FY13, these segments constituted 57% of disbursements and 50%

of loan book. Scale building loans include mortgage loans, loan against property,

construction equipment and infrastructure finance, which are of larger ticket and

high duration products which generate RoAs of 2-2.5%. These loan segments formed

43% of disbursements and 50% of loan book. The unique combination of these

business lines led BAF to build a sustainable and scalable business model, with

superior return ratios.

Business mix generates superior returns or helps to build scale

Business model is

designed to ensure

healthy profitability

coupled with scale

Business Model

Large ticket

2-2.5% RoAs

High Churn

4-5% RoAs

loans

Profit Maxmisers

Scale Builders

Consumer

Durable

2 Wheeler

Loans

Mortgage

Loan

Against

Property

Loan against share

Construction equipment loan

Source: Company, MOSL

BAF offers a bouquet of 10 products under three business segments — Consumer,

SME and Commercial — and effectively leverages its large customer base to cross sell

various products and achieve higher growth by gaining market share in certain sectors.

Company is among the few organised lender in two-wheeler and consumer durable

financing segments and recently added lifestyle financing, which is also unique (BAF

being the sole lender) as it gives the edge to expand its bouquet of untapped consumer

business

23 August 2013

Bajaj Finance

BAF's unique business model marks a competitive edge over other NBFCs on two

counts - firstly the company focuses on three verticals with 10 business lines for

growth, compared to the single product focus in other NBFCs such as CV finance, gold

finance, car finance, home finance or infrastructure finance. Secondly, BAF has a

stronger customer focus on HNI and ultra HNI segments by offering innovative products

and superior customer experience.

Business lines cater to needs of varied clientele

High net worth Clients

BAF has a stronger

customer focus on HNI

and ultra HNI segments

by offering innovative

products and superior

customer experience

Affluent

Mass affluent

Mass clients

2wheeler & 3

wheeler finance

Consumer durables

salaried & cross

sell PL

SME

Commercial

Source: Company, MOSL

Products mix; Well tailored to tap the customer through life cycle

Consumer

Consumer durable financing

SME

Commercial

Construction Equipment

finance

Mortage - LAP and HL

Diversification reduces

risk viz-viz monoline

financiers

Lifestyle Financing

2 Wheeler & 3 wheeler

finance

Personal loan cross sell

Salaried loan

Small business loans

Secured auto

vendor finance

Loan against securities

Infrastructure finance

Cross sell - Life/General insurance, Extended warranty & credit card

Source: Company, MOSL

23 August 2013

Bajaj Finance

Diversification de-risks earnings and growth profile

Strategic presence in untapped segments or businesses where it has

regulatory/competitive advantage



BAF evolved from being a captive financier to one of the most diversified non banking

finance company, with 10 business lines.

Multiple business lines helps mitigate risk.

Business lines are designed to complement each other and tap the needs of customers.

BAF operates with 10

business lines: viz

consumer , SME &

commercial

BAF operates with 10 business lines and is in the process of foraying in rural lending.

With 11 business lines, it is one of the most diversified non banking finance company.

It has been taking consistent steps to evolve a lending model, whereby it aims to

build a loyal and captive customer base; catering and cross selling to a wide variety of

their needs. Business lines are designed to complement each other. Company is

strategically present in businesses where it has regulatory/competitive advantage or

in untapped/under-penetrated segments.

Strategic focus on segments where it has competitive/regulatory edge or untapped/under

penetrated segments

2wheeler & Consumer Business

(Captive financier for Bajaj

Auto, Only organised player in

INE 400b CD market & lifestyle

financing)

Loan against shares &

promoter funding (Banks

operate with restriction in

these segments)

Competitive Edge

Strategic

Presence

Regulatory Edge

Under penetrated

areas

Small business finance, LAP

(Underpenetrated markets

with significant potential)

Source: Company, MOSL

Multiple product

offerings mitigates risk as

well as open up cross

selling avenues

Diffrent product offerings enable to de-risk the portfolio and cross sell to prudent

customers. Diversification of product portfolio also de-risks growth/earnings profile

as weakness in a particular segment (ongoing slowdown in CV/cars and infrastructure

segment) or regulatory changes (tightening of regulatory norms for gold finance

NBFCs) can be absorbed by other faster growing segments.

23 August 2013

Bajaj Finance

Loan mix FY13; SME business forms ~50% of loan book

Source: Company, MOSL

BAF has developed

strong forte in consumer

electronic business.

Consumer line of businesses: Customer acquisition engine

BAF has been able to capture the untapped potential in consumer and small business

lending. Small businesses and consumer segments' access to finance was a constraint

for several years, as most players in the segment quit post FY08-10 shakeout. However,

BAF capatilised this opportunity as it reduced stiff competition in consumer financing

and imparted pricing power to incumbents like BAF.

BAF focused on consolidating the distribution franchise, rationalizing locations and

dealer network, changed the pattern of sourcing and collections and turned the risk-

reward in its favor by realigning and diversifying products and customer segments. It

also streamlined the processes and hiried/invested in key personnel.

Consumer electronic busines acts as a customer acquisition engine; BAF cross sells other products

to credit tested customers

Consumer durable business:

A customer acquisition engine

Acquire new customers(Aquired 2.8m new clients in FY13)

Credit test consumer

Cross sell products to credit tested customers

Source: Company, MOSL

23 August 2013

Bajaj Finance

Consumer electronic financing:

BAF is the largest consumer electronic lender in India.

It focuses on affluent customers and is among few organized player in consumer

financing industry, with ~14% market share (as on 1QFY14). Company has a unique

proposition in consumer durables. It finances only high value items such as LCD,

refrigerators and air-conditioners and effectively competes with credit cards. BAF

has invested considerable resources to reduce the turnaround time for loan

applications, from a few hours to 15 minutes, thus allowing it to compete with credit

cards in this segment. The turnaround time is maintained due large inhouse database

and better data availability with the Credit Information Bureau India Ltd (CIBIL).

Largest consumer electronics lender in India, with 14% market share; BAF aims to increase market share to over 25% in next five

years Increasing market share in consumer electronics market (%)

(%)

Source: Company, MOSL

Economics of consumer electronic financing

A customer availing a durable loan from BAF pays 0% interest, which has a duration of

eight months and is required to make 30% down payment for the product. In this BAF

earns 1-1.5% from processing fee and entire spread from the manufacturer (5-12% of

product value), who gives a subvention for the customer's purchase.

Consumer durable

business is a customer

acquisition engine and is

strategic for other lines of

business

Demand for consumer durables (26% of BAF's FY13 disbursements), mainly in the

premium product space (such as LED/LCD), continues to remain robust driven by the

mass affluent and affluent segment of customers. Manufacturers increasingly expect

to use the finance option to stimulate such sales as subvention plans have provided

better results, compared to advertisement spends and promotional activities done

by manufacturers.

Consumer durable business is a customer acquisition engine and is strategic for other

lines of business. BAF acquires customers and cross sell products to prudent and

credit tested customers, enabling it to reduce loan losses in other lines of business.

We expect consumer durable disbursements to post a 30% CAGR (FY14E-16E), with its

contribution to overall disbursements remaining stable at 23-24%.

23 August 2013

Bajaj Finance

Two-wheeler financing:

BAF is the largest two-wheeler lender in India and with

disbursements of INR3.4b in FY13 it has ~20% market share in the business. The business

is focused on semi-urban and rural markets and currently contributes 30% of Bajaj

Auto's domestic two-wheeler sales. BAF continues to leverage on Bajaj Auto's

distribution network to build its 2/3 wheeler loan book. Currently, company is present

in 571 dealerships and has access to over 1,700 sub-dealers across India. Two-wheeler

loans form ~21% of BAF's loan book and we expect this to decline to 18% by FY15E,

mainly due to a shift in favor of SME loans.

Number of loans disbursed( 2 Wheeler)

Largest two-wheeler financier with 20% market share (%)

Source: Company, MOSL

Cross sells products to credit tested customers:

BAF has an in-house customer database

of over 5m individuals and it processes close to 1m customers every year. Company

has devised a strategy to cross sell products to creditworthy and thrifty customers.

This strategy is handy for other lines of business as they get a conservative customer

base with adequate creditworthiness to sell products with low probability of

delinquency and losses. Around 47% are repeat customers. To enable faster loan

appraisal for repeat customers, company provides an EMI card to all its consumer

durable customers.

Number of loans disbursed (Sales finance)

Source: Company, MOSL

23 August 2013

Bajaj Finance

The cost of acquiring a customer is ~2% of the loan amount; however a repeat customer

can be sourced for as low as 0.1% of the loan amount. To reap the benefits, BAF has

made concerted efforts to use its database to identify cross selling options. The strategy

has started to reap benefits as 11,000 of its consumer durable customers have home

loans of over INR2m and can be customers for SME loans.

foray into lifestyle

financing reflects

continous innovation

products innovation in

consumer segment

Lifestyle financing

On the lines of consumer electronic financing, BAF has forayed into lifestyle financing.

The products financed will be home improvement and furniture, modular kitchens,

digital lifestyle products etc. Company is operating in 18 cities and has tie-ups with 19

lifestyle brands such as @Home, Duria, Evoke, Hypercity, Godrej Interio, Home Time

etc. The loan amount is in the range of INR30,000 to INR0.7m, tenure of 8-10 months

and is being offered at 0% interest to consumers; however, BAF gets a subvention

from manufacturers which works out at IIR of ~23%. Company has a loan book of

INR2.5b and aims to disburse INR5b in FY14.

SME lines of business

SME lines of business focus on high net worth SMEs for meeting the working and

growth capital requirements.

Catering to SMEs' requirements through varied products

Working capital

requirements

Small business loans

SME

Businesses

Growth capital

requirements

Loan against property

Collateral capital

requirement

Loan against shares

Source: Company, MOSL

Small business loans:

Small business loans (SBL) are primarily for working capital

requirements, and the amount ranges between INR1-3m, with a maturity of 12-36

months. BAF is an established player in this segment, with 7% market share. SBL were

6.4% of disbursements and 7.9% of the loan book as in FY13.

Loan against property:

LAP has been one of the key growth drivers for BAF and with an

outstanding portfolio of INR58b, it formed 34.6% of the loan book in FY13. With

disbursements of INR44.3b in FY13, company is one of the top four loan originators

for LAP. BAF benefited from the prevailing high interest rate regime, which forced

small business borrowers to shift working/growth capital loans from banks (banks

23 August 2013

Bajaj Finance

offering loans upward of 16% for LAP product) whereas BAF offered loans at much

lower rates ~13% due to their secured nature. The ever increasing real estate prices

also supported to make LAP product an attractive proposition for both borrowers &

lender.

BAF took a new initiative for its mortgage customers by providing property search

services in its tie-up with Jones Lang Lasalle (JLL). This would facilitate company's

affluent customers locate and acquire suitable property, thereby giving end-to-end

solution and increasing loyalty.

BAF has also entered into an alliance with Central Bank of India (CBI) to co-finance

retail and SME loans, whereby the loans would be partially assigned to CBI on a periodic

basis. However, administration and servicing of loans will be managed by BAF. Company

intends to assign INR10b of co-financing loans over FY14 and will also earn upfront

fees (0.50-1.25%) and service charges (0.75-1%).

Rural foray will help to

generate PSL assets;

which will play a crucial

roal if it obtains new

banking licence.

Foray into rural market on pilot basis

BAF is planning to enter rural markets with the objective to give loans against free

assets like tractor, gold, commercial vehicles and insurance policies. Initial plan is to

start operations from 8-10 centres. However, management indicated it will be selective

and watchful of the portfolio behavior. The foray will also help it meet rural lending

criteria if it obtains a new banking licence.

Banking licence

Bajaj Finserv (parent of BAF) has applied for a banking licence and is a key and eligible contender in the race.

Management has stated that it will convert BAF into a bank on obtaining a licence. BAF has started preparations

for the same — launched the rural financing segment in June 2013 and brought a new CFO from HDFC Bank to

align the best practices with those of commercial banks. Currently, ~8% of loans comprise those to the priority

sector v/s 40% required for banks. We believe that BAF is a strong contender for banking licence; we analyze key

strengths and weakness of the group:

Advantages



Strong brand name and track record:

Bajaj Group has a robust brand name and is among the oldest business

houses. Through various companies, the group has a presence across several industries. Financial services

business has been in existence since 1987 through BAF and also has a strong presence in life and non-life

insurance business in India.



Diversified player:

Bajaj Finserv has a well diversified range of financial services: products lending, insurance

and wealth management. Lending business (through BAF) has a healthy mix of consumers, SME and

commercial finance segments.



Large footprint:

Bajaj Finserv at the group level has an existing customer base of 15m+ & presence at 1,000+

locations through its subsidiaries and also access to 550+ Bajaj Auto dealerships and 1,700+ sub-dealers.

Hurdles



Financial inclusion:

Bajaj Finserv has been focusing on the affluent segment of customers and thus does not

score very high in the objectives of financial inclusion.



Concentrated shareholding:

It has a concentrated shareholding structure, with 59% promoter holding-

company shareholding in Bajaj Finserv, with 40%+ promoter shareholding in promoter holding company.



Lending to group vendors and customers:

Bajaj Finserv has almost 21% of its book focused on financing

purchase of products of group companies. Hence, it does not bode well as RBI is not comfortable with

connected lending.

23 August 2013

Bajaj Finance

Products offering

Consumer Finance

Product offering

Product profile

2 Wheeler

financing

2-3 Wheelers

Consumer durable Lifestyle Finance

financning

White goods- TV, lifestyle

products - Home

AC, LEDs ect

improvements

and furniture

Personal Loans

Cross Sell

Offer existing

customers with

good repayment

history various

pre-approved

personal loan

offers

Salaried Personal

Loans

affluent salaried

employees

above a

threshold salary

range employed

with leading

companies

SME Finance

Mortgage & LAP

Affluent and

high net worth

small business

and self-

employed

customers,

offering loans

against the

mortgage of

retail,

residential and

commercial

premises

40 Cities

Business Loan

Commercial Lending

Vendor

Financing

This business

focuses on

Project Finance,

Corporate

Finance and

Mezzanine Debt

to infrastructure

companies/

projects

Construction

equipment

Construction

SME customers

unsecured loans Equipment

Finance

for their varied

business needs.

Distribution

Network

~571 dealers of

Bajaj Auto &

1,700 Sub

dealers

2,500 point of

sales in top 79

cities

Loan size range

Yield (%)

Duration (in

months)

% of Loan book

(FY13)

Key Competitors

30K

Unorganized

Players

50k

Credit

Cards

Partner chains

like @home,

EVOK, Hypercity,

Durian, Timbor,

Reliance Living

and Fitness One

IN top 19 cities

15K-3Lac

None

40 Cities

31 Cities

0.1.-25m

Banks

0.1-2.5m

3.5

Banks

1-15m

60-84

34.6

Indiabulls

HDFC Bank

SREI, Magma,

Shriram

4.5

Banks & IFCs

23 August 2013

Bajaj Finance

Above industry growth rates, superior margins to sustain

To attain balance sheet scale via secured segments



BAF has delivered above industry growth and maintained high margins; we expect the

trend to continue.

Loan growth to outpace peer groups and NIMs to stay above 10.5% despite compression.

Operational efficiencies, restructuring of distribution network and increasing ticket size

will lead to improvement in cost ratios.

Earnings to post a CAGR of over 21% over FY14-16E.

BAF has developed a forte in consumer business by gaining the top slot in consumer

durables and two-wheeler financing. Despite being a late entrant in the LAP market,

company has done well in the segment and is among the top four originators. BAF has

delivered an above industry growth, while keeping high margins. It has been one of

the key beneficiary of strong retail credit demand, which is reflected from business

growth — AUMs have jumped 3.5x during the last three years. The loan book clocked

60% CAGR over FY09-13, significantly outpacing the peer group. We model the loan

book to post a CAGR of ~28% over FY14E-16E. BAF has been able to maintain superior

margins despite a rising interest rate environment and change in loan book in favor of

lower yielding secured assets.

Loan book to post 28% CAGR over FY14-16E; led by secured loans

BAF is focused on building a diversified consumer franchise and plans to attain balance

sheet scale via secured segments. Scaling up in secured product segments led to a

loan book CAGR of over 60% during FY10-13. Secured products are expected to drive

28% loans CAGR over FY14E-16E. These segments would form ~65% of the loan book

by FY16E, from ~50% currently.

Loan growth has outpaced peer group

INR (b)

Loan mix; shifting in favour of SME (%)

Source: Company, MOSL

23 August 2013

Bajaj Finance

Loan mix FY10; Consumer segment formed ~54% of loan book

Loan mix FY13; SME segment froms ~50% of loan book

Source: Company, MOSL

NIMs to moderate ~100bp over next two years, yet to remain over 10.5%

NII clocked a CAGR of 37% over FY11-13 led by healthy loan growth of over 50% in the

same period. NIMs for FY13 stood at 11.7%, much higher than the peer group. However

Incremental loan growth will be driven by secured but lower yielding lending such as

loan against property as the shift will be in favor of low yielding assets, we assume

the yield on advances to moderate.

We factor a margin decline of ~100bp over FY14E-16E on a moderation in margins

arising from the change in loan mix for lower yielding but secured lending towards

LAP and mortgages. However, despite some some pressure; margins to remain healthy

at 10.5%, which is superior to peer group.

NII grew at a strong pace despite margin compression; NII growth to remain strong

Source: Company, MOSL

23 August 2013

Bajaj Finance

Diversified source of funds; lowest funding cost among peers

Company has a diversified borrowing profile, with the source of funds comprising of

term loans from banks (constituted 57% of FY13 borrowings), NCDs and CPs (43%).

With a cost of borrowing at 10.2% in FY13, BAF has one of the lowest borrowings cost

among peers, highlighting its ability to raise funds at competitive rates from financial

institutions. BAF enjoys strong credit ratings of AA+ from Crisil and LAA+ from ICRA

due to strong parentage (Bajaj Finserv rated AAA). Improved financials, better and

stringent risk assessment process, regular capitalization enabled BAF to raise funds

at competitive rates.

BAF's incremental borrowing cost as in 1QFY14 was ~10%. However post RBI's recent

action the short term rates have spiked by 100--150bp, (with 9% share of short term

borrowing; overall cost of funds can increase by 15-20bp). However banks constitute

57% of total borrowings; in event of reduction in base rate (in 2H) could reduce BAF's

cost of funds. If the spike in short term rates is temporary and banks reduce base rates

in 2H; provides an upside risk to our margin estimates.

Funding Mix FY13: Diversified source of funds: (%)

Borrowing cost lower compared to peer group

Source: Company, MOSL

Earnings to clock 21% CAGR over FY14-16E

We estimate net profit to witness 21% CAGR over FY14E-16E driven by strong loan

growth (28% CAGR over FY14E-16E), stable credit costs (FY13 credit costs of 125bp)

and improvement in operating efficiency (cost to assets to improve by 100bp to 4.8%

over FY14E-16E). However, we have factored a margin decline of 100bp over FY14E-

16E, led by change in loan mix and increase in borrowing costs. Hence, we expect BAF

to report healthy return ratios, with RoA and RoE of 3.4% and 21% respectively over

the next three years.

23 August 2013

Bajaj Finance

Strong PAT growth from FY09-FY13 (INR m)

Source: Company, MOSL

Operational efficiencies, restructuring of distribution network and increasing

loan ticket size will lead to better cost ratios

BAF has aggressively been investing to build its presence across consumer retailing

chains for consumer durables financing and small business lending. It made huge

investments in technology upgradation and implemented a fully integrated lending

platform to streamline processing. These one-time investments resulted in higher

operating costs; since the investment phase is over; operating efficiencies will kick

in. Moreover, restructuring of distribution network and higher ticket loans will help

contain costs. We expect the cost to income ratio to decline to ~42% by FY16E, from

45% in FY13, and cost to assets to fall by 100bp over the next two years to 4.8%, from

existing 5.8%.

Cost to income ratio to decline over 205bp by FY16E (%)

Cost to average asset to improve by 100bp by FY16E (%)

Source: Company, MOSL

23 August 2013

Bajaj Finance

Diversification, better risk management reflected in

asset quality

Operating in riskier segments with safeguards



Focus on affluent segments, enhanced usage of credit bureau, product rationalization

and strong risk management framework have ensured best-in-class asset quality.

NPLs running at historic lows despite challanging macro environment and operations in

riskier segments.

Use of technology to keep a check on asset quality.

Focus on affluent

segments, enhanced

usage of credit bureau,

product rationalization

and strong risk

management framework

backed by technology has

ensured best-in-class

asset quality, even in the

high risk segments

Focus on affluent segments, enhanced usage of credit bureau, product rationalization

and strong risk management framework have ensured best-in-class asset quality,

even in the riskier segments. BAF's proposition of aggressive loan growth without

compromising the risk profile is clearly visible with NNPAs of 0.25%. BAF has seen a

marked improvement in the asset quality over the years, which is largely attributable

to the loan book mix and risk adjusted pricing approach. GNPAs and NNPAs stand at

1.14% and 0.25% respectively, while the coverage gets stronger at 78% as on 1QFY14.

BAF's strong credit origination practice has added to the strength, with credit cost

falling from 8% in FY10 to 1.25% in FY13. NPLs are running at historic lows and are one

of the best among the NBFC space. We believe the performance in containing the

asset quality is commendable despite the challanging macro environment and

operating in high risk segments.

Company's foray into commercial space through construction equipment (4.2% of

loan book) and infrastructure financing (2.6% of loan book) raised concerns, given its

lack of expertise and potentially lumpy NPL accretions, (In wake of fragile macro

environment). However, concerns on commercial segment receded, and the

construction equipment segment, which has been witnessing stress since June-2012,

saw an improvement during 4QFY13. Management believes the worst is over and will

continue to see an improvement, going forward. However, we estimate some uptick

in NPAs and credit cost; GNPAs to increase to 1.6% by FY15E, from existing 1.14%, and

credit cost to increase to 1.55% from 1.25% currently.

NPLs at historic lows

Credit cost to remain low

Source: Company, MOSL

23 August 2013

Bajaj Finance

How BAF has been able to maintain good asset quality

CIBIL checks maintain good asset quality in riskier consumer loans

Due to operations in riskier segments, BAF ensures that the asset quality is healthy. It

implemented the usage of credit bureau, CIBIL, from FY09. BAF also has an inhouse

database with credit history of over 5m of its customers (especially for consumer

durables and two-wheelers). The effective usage of this database along with CIBIL

scores has helped maintain good asset quality. Once the credit record is approved, a

loan is disbursed instantly — a three-minute turnaround time in FY13, compared to

three days in FY07-08.

Strong risk management framework

BAF has strong risk management practises whereby it keeps a tigh vigil on all the

portfolio; in event of any adverse behaviour in any segment the management is prompt

to take corrective measures. BAF also involves dealers in the credit disbursement

process by a unique arrangement. If credit losses on loans disbursed through a specific

dealer are below the initial estimation, company pays an incentive to the dealer. This

enables the dealer to ensure timely collection on goods sold. Thus, it ensures lower

credit losses and higher penetration for BAF.

Use of technology to keep tabs on asset quality

BAF extensively uses technology to map customer credit history and track its portfolio

risk. It identifies trends in delinquent loans across time lines or geographies and then

changes the loan appraisal policy to reduce credit losses in the future and also monitor

the collections across business lines. Company has an in-house database of over 5m

individuals and it also makes extensive use of CIBIL's database (the largest user of

CIBIL) to prepare an application and fraud scorecard before disbursing a loan.

23 August 2013

Bajaj Finance

Capital raising to suffice 3-year growth requirements

Headroom remain for increasing leverage by raising tier 2 capital



In Jan 2013, BAF raised INR 7.5b through rights issue

Post capital infusion CAR stands at 21.5% of which 18.1% is tier1

Capital infusion to take care of growth requirements for next 2-3 years.

In Janurary 2013 BAF raised INR7.5b through a rights issue to shore up the capital base

to 22% and ensure growth requirements for two to three years. Capital adequacy

stands at 22%, of which 18.7% is Tier 1. As the company has not yet used Tier 2 capital,

going forward it can raise Tier 2 to leverage efficiently.

Healthy capital adequacy ratio (%)

Shareholding, post capital raising

Source: Company, MOSL

Earlier capital raisings

Date

Janurary-2006

Feburary-2007

Mar-07

Jul-07

Mar-12

Janurary-2013

Mode

Preferential Allotment

Rights Issue of 6:10

Conversion of Preferential Warrants

Rights Issue of 3:19

No of shares (m)

1.0

3.5

12.6

1.8

1.2

6.0

6.8

Price per share

410

450

325

410

651

1,100

Amount Raised (m)

411

1,575

4,094

721

512

3,906

7,425

Source: Company, MOSL

23 August 2013

Bajaj Finance

Impressive execution, superior return ratios

Estimate RoA/ RoE of 3.4/21% over the next three years



BAF has delivered strong business and earnings growth, driven by expanding product

portfolio and gaining market in key business segments.

Return on assets has improved significantly from 2.3% in FY10 to 3.8% in FY13 and RoE

improved from 8% in FY10 to 22% in FY13. We estimate a steady state RoA/ RoE of 3.4/

21% over the next three years.

At CMP INR1,092, the stock trades at 1.1x FY15E price to book and 6x FY15E earnings,

with further scope to re-rate on strong earnings visibility and sustainable return ratio.

BAF has delivered strong business and earnings growth driven by expanding product

portfolio and gaining market in key business segments. Return on assets improved

significantly from 2.3% in FY10 to 3.8% in FY13, primarily attributable to the operating

leverage and sharp fall in credit costs due to better-than-expected portfolio behavior

and shift in loan book mix. The stock has given healthy return during past 2 years ,

reflecting sustained improvement in company's fundamentals.

We believe the unique business model, strategic focus on high growth segments,

continuous product development and innovative customer service, sustaining superior

return ratios and risk adjusted approach for product pricing are key value drivers for

the stock.

We expect BAF to continue outpace the sector growth and sustain superior return

ratios for the next three years. We estimate the company to deliver 21% CAGR in net

earnings over FY14E-16E, driven by 28% CAGR in loan book, and 3.4% plus RoA and

21% plus on a sustainable basis in the medium term.

At CMP INR1,092, the stock trades at 1.4x/1.1x FY14/15E price to book and 7.3/6x FY14/

15E earnings, with further scope to re-rate on strong earnings visibility and sustainable

return ratios. Going forward, we believe BAF is well positioned to deliver sustainable

and profitable growth, which is scalable with lower risk as it intends to focus on

secured business lines, which should lead to significant re-rating of the stock. We

initiate coverage with a

Buy

rating and target price of INR1,520 (1.6x FY15E BV of

INR949), with an 12-month investment objective.

One-year forward P/E

One-year forward P/B

Source: Company, MOSL

23 August 2013

Bajaj Finance

Comparative valuation

EPS (INR)

FY14E FY15E

150.1

181.1

65.2

75.2

17.9

22.2

88.0

114.0

4.4

5.7

P/E (x)

FY14E FY15E

7.3

6.0

8.5

7.4

12.2

9.8

6.8

5.2

12.7

9.8

BV (INR)

FY14E FY15E

800.2

949.4

386.2

459.1

92.3

108.8

488.0

589.0

36.0

42.0

P/BV (x)

FY14E FY15E

1.4

1.1

1.4

1.2

2.4

2.0

1.2

1.0

1.6

1.3

RoA (%)

FY14E FY15E

3.7

3.5

2.4

3.4

3.3

2.9

1.8

2.0

RoE (%)

FY14E FY15E

20.3

20.7

18.9

18.5

20.9

22.1

19.9

21.1

12.5

14.0

Source: MOSL

Bajaj Finance

Shriram Transport

Mahindra finance

Shriram city union finance

L&T Finance

Key risks

Prolonged economic slowdown:

A prolonged economic slowdown is a key risk and

could lead to slower growth and impact BAF's earnings adversely. Further, it may

result in deterioration of asset quality and could adversely affect its profitability.

Sharp surge in credit losses:

Although we have been conservative in our credit cost

assumptions, higher-than-expected delinquencies due to unseasoned loan book

(construction equipment, LAP and infrastructure finance) remain a risk to our

estimates.

Competitive intensity:

A key reason for the failure of consumer business during the

last cycle was intense competition among lenders, which led to a compromise in

business practices. Any significant increase in competition, mainly in consumer

durables and two/three-wheeler space, could impact adversely.

23 August 2013

Bajaj Finance

Company background

Bajaj Finance Ltd (BAF), a Bajaj group company, was incorporated in 1987 and

commenced operations as a captive financer for Bajaj Auto vehicles. Over the past

few years, its business model has been broadened and reliance on Bajaj Auto has

reduced, enabling it to emerge as a diversified consumer finance NBFC. BAF has a

presence in 10 business lines: two-wheeler, consumer durables, small business, loan

against property, loan against shares and construction equipment.

BAF forayed into the consumer finance business in late 2007, which coincided with

the downtrend in overall economic environment. Thus, its addressable consumer

segments faced difficulties in servicing existing obligations, leading to higher

delinquencies for banks/finance companies, and BAF was not insulated from it. This

also led to a demand slowdown and liquidity constraints, impacting the business

operations and asset-liability positions of banks/finance companies severely.

However, being a late entrant to the consumer business enabled BAF to survive the

cyclical stress as many players exited the sector/segment. Company, in trying times,

cleaned up its books, set up strong risk assessment and lending process and undertook

a phase of consolidation. It also implemented a series of measures to proactively

manage the economic slowdown and minimize the potential losses arising from

delinquencies, while laying the groundwork for broadening its franchise.

BAF implemented several initiatives to restructure the cost base, tighten risk policies,

increase usage of credit bureau and undertake branch rationalization. Company is

the survivor in some of its business segments, as cyclical stress forced other players

to exit. Now, it is witnessing a sharp turnaround in business on the back of favorable

environment and benign competition, which translates into stronger pricing power.

BAF is well positioned to capture opportunities arising from the consumer finance.

Strong and focused management team

BAF has a highly experienced management team, with almost the entire team having

worked with reputed multinationals and private banks. It is led by Mr Rajeev Jain,

who has ~20 years of experience in auto loans, durable loans, personal loans and

credit cards. Mr Jain's past experience includes four years with GE and eight years

with American Express respectively. He has been instrumental in restructuring BAF

and transforming it from a consumer finance business to one of the most diversified

NBFCs. Mr Jain is supported by experienced professionals, with all business heads

having an experience of over 10 years and niche in their respective fields.

To retain talent and encourage loyalty, BAF introduced performance linked pay and

an employee stock option scheme to lower the turnover rate. This worked well as the

senior management on an average has a tenure of around five years and almost all

the top management team that was inducted post FY08 are at the helm of affairs.

Current management team has successfully restructured the businesses and

transformed BAF from a captive two-wheeler lender to a successful diversified retail

lender. In the next phase, management will be responsible for building scale with

profitability. We believe that with a strong and experienced team at the helm of

affairs, BAF is well positioned to deliver sustainable and profitable growth.

23 August 2013

Bajaj Finance

Management profile

Name

Mr. Rajeev Jain

Designation

CEO

Profile

1) 20 years of experience in auto loans, durable loans, personal loans and

credit cards 2) – Past experience includes 4 years with GE & eight years with

American Express respectively; Post that he joined AIG, and was the Deputy

CEO of the consumer finance business 3) – Mr. Jain has been instrumental

in reastructuring og BFL and subsequent a sucessful transforming BAF from

a consumer finance business to one of the most diversified NBFCs

1) 30 years of experience in financing, financial accounting, cost accounting,

tax, and systems 2) – His previous assignments were with Bajaj Auto

Limited, Eicher and Mico

1) Responsible for the overall risk policy, portfolio management, risk analytics

and fraud management for the firm 2) Erlier worked with HSBC where he

was leading the portfolio risk management unit for HSBC’s Consumer Credit

Risk function

1) Worked with GE Money, AIG and E&Y on various assignments in Six Sigma,

Sales Finance, Cross-Sell, and Personal Loans 2) – Instrumental in building

the sales finance business & leading substantial market share gains

1) 15 years of experience, manages the Loan Against Property business which

is a high growth business for the company 2) Joined from GE Money, where

he held the position of National Sales“Manager - Mortgages"

1) Over 18 years of experience prior experience includes ABN Amro Bank

wherein he was heading Asset Backed Finance (ABF) business in the

Infrastructure and Healthcare segment.

1) Over 10 years of experience; he is responsible for overall risk policy

portfolio management risk analysis and fraud management. Prior

experience includes with HSBC & GE.

1) Over 10 years of experience and in retail banking has worked with Citi,

Barclays and standard charterd bank. His last assignment was with

Barclays bank as the Head of Acquisition and Portfolio Actions

1) Has extensive work experience in the services industry spread across

printing solutions, reprographics, rating firms, supply chain management

and lending. He joined us from Yes bank where he was the Zonal head for

the unsecured business. Prior to which he has worked with HDFC bank,

ONICRA, Mahindra & Mahindra and Modi Xerox.

Mr. Pankaj Thadani

CFO

Mr. Rakesh Bhatt

COO

Mr. Devang Mody

Predident- Consumer

Finance

Business Head-

Mortgage

Business Head-

Construction

equipment financing

Chief Risk Officer

Mr. Amit Gainda

Mr. Sanjeev Vij

Mr. Rajesh K

Mr. Ashish Panchal

Mr. Deepak Bagati

Business Head-

Credit cards &

salaried loans

Business Head-

Business laon

23 August 2013

Bajaj Finance

Financials and Valuation

Income Statement

Y/E March

Interest Income

Interest Expended

Net Interest Income

Change (%)

Other Operating Income

Other Income

Net Income

Change (%)

Operating Expenses

Operating Income

Change (%)

Provisions and W/Offs

PBT

Tax

Tax Rate (%)

PAT

Change (%)

Proposed Dividend

2011

12,838

3,710

9,128

50.1

1,085

138

10,351

44.9

4,606

5,745

45.5

2,046

3,699

1,229

33.2

2,470

176.2

366

2012

19,963

7,462

12,501

36.9

1,668

14,257

37.7

6,691

7,566

31.7

1,544

6,022

1,958

32.5

4,064

64.6

496

2013

29,248

12,057

17,191

37.5

1,689

177

19,057

33.7

8,523

10,534

39.2

1,818

8,716

2,803

32.2

5,913

45.5

747

2014E

36,932

14,458

22,474

30.7

1,864

101

24,439

28.2

10,645

13,794

30.9

2,725

11,069

3,597

32.5

7,471

26.4

1,121

(INR Million)

2015E

46,197

18,243

27,954

24.4

2,050

121

30,126

23.3

12,774

17,352

25.8

3,999

13,353

4,340

32.5

9,013

20.6

1,352

Balance Sheet

Y/E March

Capital

Reserves & Surplus

Net Worth

Borrowings

Change (%)

Other liabilities & provisions

Total Liabilities

Investments

Change (%)

Advances

Change (%)

Net Fixed Assets

Other assets

Total Assets

Assumptions (%)

Deposit Growth

Advances Growth

Investments Growth

E: MOSL Estimates

2011

366

13,215

13,581

67,086

107.9

4,552

85,219

-98.1

72,718

80.4

1,026

11,419

85,219

2012

413

19,923

20,336

102,264

52.4

6,667

129,267

-2.3

122,831

68.9

1,388

4,993

129,267

2013

498

33,173

33,670

133,490

30.5

11,051

178,211

-4.0

167,440

36.3

1,762

8,957

178,211

2014E

498

39,333

39,830

174,138

30.4

12,156

226,124

10.0

217,672

30.0

1,772

6,622

226,124

(INR Million)

2015E

498

46,764

47,262

231,255

32.8

13,372

291,888

10.0

278,620

28.0

1,782

11,422

291,888

107.9

80.4

-98.1

52.4

68.9

-2.3

30.5

36.3

-4.0

30.4

30.0

10.0

32.8

28.0

10.0

23 August 2013

Bajaj Finance

Financials and Valuation

Ratios

Y/E March

Spreads Analysis (%)

Yield on Advances

Cost of borrowings

Interest Spread

Net Interest Margin

Profitability Ratios (%)

RoE

RoA

Int. Expended/Int.Earned

Secur. Inc./Net Income

Efficiency Ratios (%)

Op. Exps./Net Income

Empl. Cost/Op. Exps.

Asset-Liability Profile (%)

Loans/Borrowings Ratio

CAR

Tier 1

Valuation

Book Value (INR)

Price-BV (x)

EPS (INR)

EPS Growth (%)

Price-Earnings (x)

Dividend per Share (INR)

Dividend Yield (%)

E: MOSL Estimates

2011

22.7

7.5

15.2

15.0

2012

20.4

8.8

11.6

12.2

2013

20.2

10.2

9.9

11.7

2014E

19.5

10.0

9.5

11.5

2015E

19.0

9.3

9.8

11.1

19.7

3.8

28.9

10.5

24.0

3.8

37.4

11.7

21.9

3.8

41.2

8.9

20.3

3.7

39.1

7.6

20.7

3.5

39.5

6.8

44.5

31.4

46.9

28.4

44.7

28.8

43.6

27.6

42.4

27.6

108.4

20.0

16.8

120.1

17.5

15.0

125.4

22.0

18.7

125.0

21.0

18.0

120.5

20.0

17.0

371

2.9

67.4

176.0

16.2

10.0

0.9

487

2.2

98.4

45.9

11.1

12.0

1.1

676

1.6

118.8

20.8

9.2

15.0

1.4

800

1.4

150.1

26.4

7.3

22.5

2.1

949

1.1

181.1

20.6

6.0

27.2

2.5

23 August 2013

Bajaj Finance

N O T E S

23 August 2013

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Bajaj Finance

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