Investment Rationale

Strong market presence in the Indian retail finance operations
Bajaj Finance has emerged as one of the largest retail asset financing NBFCs in India and continues with its two-pronged strategy of building scale and maximising profit. The company has demonstrated track record of profitable growth with segments such as mortgages, small business loans, and commercial lending which are focused on building scale, while consumer durable loans, personal loans, and 2- and 3-wheeler financing are focused on maximising profit.

The Company’s loan book continued to remain strong as a result of its deeply embedded risk culture and robust risk management practices. Over FY2015-20, the company posted an AUM CAGR of ~35% and this growth has been broad-based spread across various product segments. Further the company’s robust growth has been supported by large cross sell opportunity, product innovation, increasing geographical penetration (2,641 locations, distribution network consisting of 1,14,000+ points), customer acquisition and focus on existing customers. We believe the company ensures lower credit risk across portfolios by creating larger cross-sell opportunities and this strong cross-sell momentum is generated through a combination of a large franchise of mass affluent customers and multiple product offerings coupled with superior customer experience.

Exhibit 1: Personal Loan Cross sell AUM book

Consistent growth in Consumer finance business
The company is amongst the largest personal loan lenders in India and continued to be the dominant lender for consumer electronics, furniture and digital products. The company’s product offering consists of consumer durable loans, lifestyle product loans, digital product loans, EMI cards, personal loans, retail spend financing, e-commerce consumer finance and life care financing. Consumer financing business constitutes 36% of the loan book as on September 2020. The company’s growth has been sustained by an expanding distribution reach, innovative credit outreach and cross-selling opportunities. The company was also the largest financier of Bajaj Auto motorcycles and three-wheelers in FY20 (it financed purchase of 1.1 million motorcycles in FY20).

As part of its product expansion strategy, the company also extended its loan offerings in the healthcare segment & also introduced a ‘Healthcare EMI Card’ thus facilitating hassle-free processing of loans to customers. This initiative has resulted in health care offerings contributing over 19% of lifestyle finance business. Personal loans cross-sell (PLCS) (To cross-sell is to sell related or complementary products to an existing customer) and salaried personal loans AUM posted robust growth which was fuelled by growing customer franchise, investment in the effective use of advanced analytical capabilities, robust risk management and customer-centric loan processing capabilities. The company has been financing EMI card customers on e-commerce platforms for their various purchases and it has become a strategic business in the last 2-3 years. Further the company also expanded its online relationships from 19 to 33 partners in FY20.

Exhibit 2: AUM mix as on September 2020

SME financing & Partnerships business shall drive growth
SME financing and commercial lending now comprise 13% and 9% of consolidated AUM respectively as on September 2020. SME lending includes secured and unsecured loans to its customers. Unsecured lending is done through two product offerings: (i) business loans to small and medium enterprises and to self-employed persons, and (ii) professional loans. The company has launched two new products in the SME lending business in FY19, namely used car financing and secured enterprise loans. Commercial lending comprises of six products: loan against securities, loans to financial institution group lending (These clients are typically financial institutions which include banks, insurance companies, technology companies, specialty finance, and asset management firms), working and growth capital loans to auto component manufacturers, loans to light engineering industry and loans to speciality chemical industry verticals.

The company offers various products to its customers in partnership with various financial service providers such as life insurance, health insurance, extended warranty, comprehensive asset care, co-branded credit card, co-branded wallets and financial fitness reports. The company’s co-branded credit cards business in partnership with RBL Bank continued to grow in a robust manner and its co-branded credit cards stood at 18.7 lakhs cards-in-force (CIF) as on September 2020. The company’s co-branded wallet business in partnership with Mobikwik continued to grow by offering EMI cards in digital format and it had 16.8 million users as on September 2020. Both partnerships augur well to generate granular and sticky fee income.

Consistent high growth due to expansive distribution channel
The Company has not only diversified risk across millions of customers and product categories but has also diversified its risk and portfolio in about 2,641 urban and rural locations in India. We believe that the company’s geographically distributed portfolio aids in decreasing concentration risks to the minimal. Further we believe that one of the major reasons behind the consistent growth in AUM is continuous expansion in distribution channel, Consumer businesses are tough to grow and ordinarily have strong entry barriers as they require a significant support from a distribution standpoint. Competition has remained benign for the company despite the company consistently delivering highly profitable growth (which should ideally attract competition) mainly due to high upfront investments in distribution, technology and processes to compete in the relatively low-ticket size, high volume business.

As of Q2FY21, the overall distribution network stood at 114,400+ touch points, almost 3x over the last three years. Over FY13-FY19, the company expanded its distribution network at 34-63% annually. However, it slowed down to 25% in FY20.

The rural-lending vertical was launched in 2014 with 7 branches to start with in Maharashtra. Incrementally, the company has equally focused on scaling up the rural presence, whereby the current rural presence is 43% of the total branch mix.

Exhibit 3: Branch mix (%)

Major focus on fee income generation
The company has been pioneer in delivering industry-leading NIMs on a sustainable basis. Moreover, the company has equivalent focus on augmenting profitability through fee income generation. The company’s major part of the fee income is earned through distribution income and other activities which are not in co-relation to the asset growth. Generally, we believe a fee income growth which is not co-related with the balance sheet growth is more sustainable in nature and can camouflage for weak asset growth during tough times. The company has a superior fee income generation capability in comparison to its peers.

Distribution of insurance and other financial products, EMI cards have also aided in strengthening the fee income stream. As of Q2FY21, the EMI franchise stood at 20.6 million cards while Bajaj Finserv Mobikwik app has 16.8 million users who have linked their EMI card to wallet.

Exhibit 4: Fee Income Trends

Focus on Analytics & technology modernisation
Productivity has increased due to the effective use of technology and analytics. The company has invested deeply in data analytics, machine learning models and artificial intelligence (AI) to better service customers and drive the business. Facial recognition technology, natural language processing (NLP) and optical character recognition (OCR) have been deployed in offices and some branches, with the aim of providing a differentiated and frictionless customer service experience. The company is planning to launch a financial service core proprietary ecosystem by Q2FY22 with an aim to provide an insurance mall (compare, review and buy across 800 insurance products), broking account, mutual fund and health & wellness products – all combined in one.

The company has been investing in an e-store which should be live soon and should enable customer origination, considering the customer trend of increasing online and digital purchases, over the past 3-4 years. Moreover, the company is looking to harmonize the offline ecosystem and help merchants with SIS (store-in-store) with a table to enable it for all of its merchant partners over a three-year horizon. Further the company has deeply invested in Application Programme Interface (API) to integrate specialised applications with customer facing interfaces like web portals, app infrastructure and BOTS on to a micro services architecture supported by platform as a service (PaaS) infrastructure.

Prudent Asset Liability management
The company’s strategy is to create a balanced mix of wholesale and retail borrowings. It continued to prudently manage its asset liability with a strategy of raising long-term debt and maintaining a judicious mix of borrowings between banks, money markets, external commercial borrowings and deposits thus enabling the company to effectively manage their NIM.

The Liquidity Coverage Ratio requirement mandates NBFCs to maintain a minimum level of high-quality liquid assets to cover expected net cash outflows in a stressed scenario. The company’s liquidity buffer management framework exceeds these requirements and demonstrates its strong orientation towards liquidity management. As on 31 March 2020, the Company had a consolidated liquidity buffer of Rs 15,725 crore which will enable to prudently manage liquidity risk.

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Exhibit 5: Cumulative Mismatch as on September 2020

Financials

Net Interest Income expected to grow @~ 17% CAGR over FY20-FY23E
We expect Net interest income to grow @ 17% CAGR over FY20-23E supported by i) cross sell franchise ii) better customer experience model by June 2021 which will further strengthen its technology, data science, app design, etc. iii) acceleration in partnerships and Card business. We have a positive outlook on the company led by credit growth and business normalcy.

Exhibit 6: NII trends

Net profit expected to grow @~26% CAGR over FY20-FY23E
We expect Net profit to grow @ 26% CAGR over FY20-23E supported by i) focus on cost rationalisation ii) strong AUM growth and iii) comparatively lower provisions. The business volumes are returning to normal and we believe the company intends to be aggressive on pricing which will enable strong growth going forward.

Exhibit 7: Net profit Trends

Diversified Liability Profile
We believe the company has steadily increased its borrowings from deposits. Deposits have increased from 8% in March 2017 to 22% in September 2020. Currently with excess liquidity buffer, the company is able to borrow at lower interest rate, which will lead to improvement in spreads.

Exhibit 8: Borrowing Mix as on 30 September 2020

Asset quality
We believe that the management has been quite proactive in perceiving stress and providing for it upfront. The company’s provisioning norms have always been more stringent than regulatory requirements and have been expedited during early stage of delinquencies. Further we believe that company’s strategy towards risk is a highly comprehensive one, which takes priority over growth. Additionally, the company’s capability on risk analytics and scorecards have aided in following the expected credit

loss (ECL) based provisioning requirement. As on 30 September 2020, the company has taken a loan loss provision of Rs 3386 crores against its credit cost estimate of Rs 6000 crore for FY21, which will enable them to provide for additional losses that may otherwise occur in FY22. Adjusted GNPA and NNPA stood at 1.34% and 0.56% respectively

Industry

The NBFC sector continued to grow its share in the financial services industry. Credit growth of scheduled commercial banks (SCBs) continued to moderate throughout FY20. On 31 March 2019, growth in advances of SCBs was 13.2%. By 30 September 2019, this had reduced to 8.7% and on 27 March 2020, it was further down to 6.1%. SCBs also continued to face asset quality challenges in FY20. Data published by the RBI in its Financial Stability Report dated 27 December 2019 show that NBFCs have outperformed SCBs on asset quality.

NBFCs play a crucial role in financial inclusion by providing last mile access to meet the diversified financial needs of less-banked customers. The sector also plays a vital role by meeting the credit needs of retail and MSME segment. Over the years, the sector has rapidly grown with a few large players becoming comparable in size to some of the private sector banks and has also witnessed advent of many non-traditional players leveraging technology to adopt tech-based innovative business models.

The primary activities of NBFCs are providing consumer credit, including consumer durable products finance, automobile finance, home finance and wholesale finance products such as bills discounting for small and medium companies and infrastructure finance, and fee-based services such as investment banking and underwriting. NBFCs mobilise resources largely from debentures and bank borrowings. The default by one large NBFC a couple of years ago has shaken the market confidence and created ripple effect over the entire sector which had resulted in drying-up bank lending, thereby forcing NBFCs to scout for alternate sources of funding. However, in 2020-21, up to September, market confidence revived and NBFCs’ borrowings from banks and FIs accelerated, buoyed by various policy measures taken by the RBI and the government to combat the impact of covid-19 pandemic.

Various segments for financing include:
Consumer Lending
This segment comprises of consumer durables, furniture and digital products in India. Personal loans cross-sell (PLCS) (To cross-sell is to sell related or complementary products to an existing customer). and salaried personal loans is gaining a lot of traction and this growth was fuelled by growing customer franchise, investment in the effective use of advanced analytical capabilities, robust risk management and customer-centric loan processing capabilities.

SME Lending
SME lending includes secured and unsecured loans to its customers. Unsecured lending is done through two product offerings: (i) business loans to small and medium enterprises and to self-employed persons, and (ii) professional loans. New products in the SME lending business consists of used car financing and secured enterprise loans.

Rural Lending
This segment caters to financial services needs of rural consumers. Rural lending is gaining lot of traction and many companies are setting up branches in new states and penetrating deeper in the existing states. Rural lending business also offers fixed deposit schemes which will further widen product offerings to rural customers and expand its retail liabilities business.

Commercial Lending
It comprises of six products: loan against securities, loans to financial institution group lending (These clients are typically financial institutions which include banks, insurance companies, technology companies, specialty finance, and asset management firms), warehouse receipt financing ( finance owners of goods for own processing against Warehouse Receipts), working and growth capital loans to auto component manufacturers, loans to light engineering industry and loans to speciality chemical industry verticals.

Partnerships and Services
In partnership with various financial service providers comprises the following products to its customers: life insurance, health insurance, extended warranty, comprehensive asset care, co-branded credit card, co-branded wallets and financial fitness reports.

Risks & Concerns

1. Deterioration in macros and company financials would enable in higher cost of funds, impacting margin/profit estimates.
2. Higher slippages (than expected) and Lower growth, would impact profit and book value estimates.

Outlook & valuation

We expect the company to capitalize on growth opportunities supported by healthy capitalization, surplus liquidity on its balance sheet and resilient asset quality. Further we expect the company to invest in distribution & expand its geographic footprint and it has multiple levers to reduce cost, given its multiple product lines. Further disbursements have been picking up gradually month on month which will enable stable earnings growth going forward. Thus, we initiate our coverage on Bajaj Finance with a Buy Rating.