Spandana Spoorthy Limited

Industry

Peer comparision:
Market share based on AUM

Historical trend of Micro finance Industry:
For several decades, microfinance sector, in its various forms, has been in existence in India. The industry has grown manifold, driven by an inherent demand for credit at the bottom of the pyramid, which remained largely underserved. Number of negative events in the past have influenced growth as well as asset quality of the microfinance sector including – the AP crisis of October 2010, farm loan waivers by several states, as well as demonetisation in November 2016. Despite some setbacks, the industry has evolved over the cycles and demonstrated resilience by adapting to changing dynamics. The microfinance sector in India has grown at a CAGR of 23.1% over the past 10 years to reach ~| 263300 crore as of March 2019.

Overview of Indian Micro finance industry:
The share of portfolio in urban (and semi-urban) areas was at 39% (for MFIS+SFBs) as of December 31, 2018. Initially, MFIs exposure to urban areas was on the rise till March 2016 as lending in urban areas enables disbursement of higher ticket loans. However, post conversion of SFB licensees and their exclusion from NBFC-MFI category, share of rural clients has increased for NBFC-MFIs as they are more focused on serving rural clients. Over the years, average ticket size in the MFI business has been on the rise. While ~10% of borrowers had loans less than | 10,000 in March 2014, the share came down to slightly above 2% in September 2016 and remained broadly comparable as of December 2018. In contrast, loans with ticket size greater than | 25,000 have increased from 12% as on March 2014 to 47% of the portfolio as on September 30, 2016 and further to 83% as on December 2018.

Risks

Geographical concentration acts as risk:
As of March 31, 2019, the company has ~67.6% branch and ~72.94% of gross AUM originated in Karnataka, Madhya Pradesh, Odisha, Maharashtra and Chhattisgarh. While it has endeavoured to manage and monitor concentration risk at the district level, the company is susceptible to risks relating to concentration in these states. In the event of a regional slowdown in economic activity in one or more of these states, or any other developments including political unrest, disruption or sustained economic downturn, the company may experience an adverse impact on business, financial condition, results of operations and cash flows.

Potential conflicts of interest with one promoter and/ or directors:
Promoters may become involved in ventures that may potentially compete with the company, which may adversely impact business, financial condition and results of operations. For instance, individual promoter, Padmaja Gangireddy, owns 68.31% shareholding in Abhiram Marketing, one of the groups engaged in the business of consumer goods, whose retail products are sold at company’s branches. Further, Padmaja Gangireddy owns 69.18% shareholding in another group company - Criss Financial Holdings Ltd, which operates in the same line of business. The letter of intent to acquire Criss Financial Holdings has been submitted to RBI and approval is awaited. Also, some directors are associated with entities in similar business.

Regulatory, local disruption affect financial condition:
In October 2010, the AP government passed the AP Microfinance Ordinance to put in place extremely stringent operating guidelines in response to the allegedly coercive collection practices adopted by MFIs in the formerly unified Andhra Pradesh. Post this ordinance, loan collections and asset quality in the formerly unified AP was severely affected across the industry. As the company had large exposure in the formerly unified AP, the company had materially adverse effect on business. Thus, business operations may get affected by regulatory actions or any laws passed by state governments in which the company operates its business.

Company Description

Incorporated on March 10, 2003, Spandana Sphoorty Financial Limited ("Spandana") is a leading, Rural Focused NBFC-MFI with a geographically diversified presence in India offering income generation loans under the joint liability group model, predominantly to women from low-income households in Rural Areas. As of March 31, 2019, they were the 4th largest NBFC-MFI and the 6th largest amongst NBFC-MFIs and Small Finance Banks ("SFBs") in India, in terms of AUM.

Through their extensive corporate history, Spandana has developed an in-depth understanding of the borrowing requirements of the low-income client segment. Their business model involves regular client meeting processes through their employees, who maintain contact with the clients across the districts that they cover. As of June 30, 2019, Spandana had 7,062 employees (including 5,051 credit assistants) operating out of 929 branches in 269 districts across 16 states and 1 union territory in India. Through their loan products and client- centric approach, Spandana endeavor to strengthen the socio- economic well-being of low-income households by providing financing on a sustainable basis in order to improve livelihoods, establish identity and enhance self-esteem.

In October 2010, the MFI industry (including Spandana) was severely impacted due to external regulatory action, as the government of the formerly unified Andhra Pradesh promulgated the AP Microfinance Ordinance 2010, which enforced several restrictions on the operations of MFIs. This severely impacted Spandana's collections and the consequent cash-flow shortage impacted their ability to service their debt, which in turn impaired their growth and profitability. Their lenders referred Spandana to the Corporate Debt Restructuring ("CDR") mechanism of the RBI to develop a plan to restructure the borrowings and revive the business. Spandana agreed on a CDR plan with their lenders, which allowed them to get cash-flow relaxations to enable them to continue their efforts towards portfolio diversification, process improvement and cost rationalization. These measures helped them turn their operations profitable from the year ended March 31, 2014.

Further during the time that Spandana were under CDR, they deployed efforts to recover dues in AP, such as continuing to keep their branches open and continuing to engage with borrowers. Their operations turned profitable in the year ended March 31, 2014 and they went on to make profits for 4 consecutive years while operating under the CDR mechanism. The restated consolidated profit for the period (under Ind AS) for Fiscals 2018 and 2019 was Rs.187.95 crore and Rs.311.90 crore. As a result of their collections from the old AP portfolio and the profits generated from the operations in other states, Spandana was able to restructure their outstanding debt as well as raise refinancing debt from the existing CDR lenders. Spandana also received capital infusion from Kangchenjunga, their Corporate Promoter, and Kedaara AIF - 1, which enabled them to exit from CDR mechanism successfully in March 2017 with approvals from the RBI and their lenders. ICRA Research notes that they were one of only 2 major companies that were able to successfully exit from CDR.

Post their exit from CDR in March 2017, Spandana has increased their lender base, diversified their borrowings to new banks and NBFCs and also issued NCDs in the capital markets (leading to a reduction in Average Effective Cost of Borrowing to 16.31% for Fiscal 2017 from 14.74% for Fiscal 2018 and further to 12.84% for Fiscal 2019). As a result, during Fiscal 2018, with increasing flow of capital, Spandana expanded their operations and were able to effectively utilize the existing branch network and employees.

Prior to their exit from CDR in 2017, Spandana had limited access to capital, due to which they were able to offer loans in lower ticket sizes than the demand from the clients. According to ICRA Research, Spandana had the lowest portfolio per branch amongst peer comparison of major NBFC-MFIs and SFBs, as of March 31, 2017. Post exit from CDR, they were able to optimize the ticket sizes and also acquire new clients at existing and new branches. This helped them grow their AUM in Fiscal 2018 at one of the highest rates (143.8%) among large NBFC-MFIs in India (Source: ICRA Research). Over Fiscals 2018 and 2019, their Disbursements increased by 87.34% and 28.82% (from Rs.2,059.17 crore as of March 31, 2017 to Rs.3,857.65 crore as of March 31, 2018 and to Rs.4,969.28 crore as of March 31, 2019) and the Consolidated Gross AUM grew from Rs.3,166.79 crore as of March 31, 2018 and to Rs.4,437.28 crore as of March 31, 2019.

Valuation

Spandana Sphoorty is a rural focused MFI with a diversified geographical presence in India. As on FY19, it makes an ROA of ~13% largely due to lower leverage of ~2.3x, reversal of tax (benefit to be received till FY20) and comparatively lower cost structure as compared to the peers (C/I ratio ~21% as against ~35% industry average). We believe higher yields are not sustainable as RBI does not permit lending rate to exceed more than 10% above the cost of funds on the balance sheet. However, we believe strong AUM growth of ~35% (~52% CAGR for last 3 years) and increasing leverage to keep ROA /ROEs ~6.5% / 24% in the medium term. At the upper price band of INR 856, the stock is valued at 2.4x P/BV as on FY19 and 11.6x FY19 P/E post dilution basis. We believe the risk/reward ratio is encouraging and recommend SUBSCRIBE to the issue with a long-term perspective.

Key Information:

Use of Proceeds:
Offer For Sale (OFS) (INR Mn) 8,009
Fresh Issue (INR Mn) 4,000

The Net Proceeds of the Fresh Issue are proposed to be utilised for augmenting theircapital base and general corporate purposes.

Book running lead managers:
Management:
The promoter & management team have long standing experience of MFI lending, which gives it a competitive edge over its competitors & aids to perform better through various business cycle keeping growth healthy.