Ujjivan IPO - a good buy?

Ujjivan is offering fresh Issue of Rs 358.16 crore of market value; and Offer for Sale of up to 2.49crore Equity Shares with the price band of Rs 207 – Rs 210. It expects to raise Rs 875.0 – Rs 882.49 crore from the issue. The minimum bid size is 70 shares. The offer opens from April 28th and ends on May 2nd. The offer will bring down the foreign shareholding in the micro-lender to around 45 per cent from the current 77 per cent, which is required as per RBI guidelines for setting up the Small Finance Bank.

Ujjivan which operates as a NBFC since 2005, providing a full range of financial services to the unorganised micro finance sector, is structurally suited to gain from the opportunity of transforming to a Small Finance Bank. This is the second IPO in the microfinance space after Equitas Holdings.

Strong market position and product portfolio: Company has approximately 11.15% market share by AUM (Rs.4589 crore as of Dec 2015) and has reach in 209 districts across India. The company has been growing its individual lending portfolio at the CAGR rate of approx. 173%. Currently, individual loan portfolio constitutes 12% of the assets under management (AUM) vs 4% in FY13; and the largest share of the pie comes from Group lending. As an SFB, the company would be required to continue to fish out opportunities in group lending that can be converted to Individual lending. The NPA’s for the company, with increase in portfolio size, have increased to the current peer level average of 0.15% from 0.08% in FY13. Also, we see that the exposure to Andhra Pradesh is minimum, the geography where the MFIs have always faced higher NPAs. Company has good penetration across India.

Within individual lending, we see lot of scope for company to expand in the housing finance section. The products like home improvement loan and secured home loan where the interest rates range between 15.75% to 19.75%, with ticket size of upto 10lac, offer ample opportunity to the company. Company has been seeing demand traction in this segment. Further, Mortgage finance is projected to be a Rs. 40 trillion market by 2022 and the penetration is expected to increase to 14% of GDP vs. 9%. Currently, for Ujjivan, 15% of Group Lending customers use Group Loans (ticket size up to Rs. 50,000) for housing or related activities.

As an SFB, the company can offer insurance services which company is already doing through its tie up with Birla Sun Life Insurance.

Technology driven: Ujjivan also has leveraged technology to help their field executives to access the credit history of the borrower. Through Trucell, the company facilitates the repayment transaction process and helps field executives to access customer information. This improves the operational performance and reduces overheads in rural areas. Company has partnered with IBM for the cloud networking services for improved connectivity and also has provided hand held devices at field level.

Solid organisational structure to reap benefits of growth: Going by organisational structure, the company is already operating in a hub and spoke manner by having two-tiered management hierarchy comprising of a National Leadership Team (“NLT”) providing overall direction to the business; and four Regional Leadership Teams (“RLT”) responsible for taking on-ground operational decisions. We believe having sound management practices will be crucial so that growth can be accommodated in a structured manner. The management has strong experience to ride on the growth and the risk management systems, which are well placed, will definitely help it to deliver better operational performance.

Financial performance: Going by financials, Ujjivan increased the total income at the CAGR of 40.6% to Rs 611.9 crore in FY15; while net profit has increased by CAGR of 59.5% to Rs 75.7 crore.  The net interest margin was 11.6% in FY15. The company due to the use of technology has been able to reduce the cost to income ratio to 61.79% in 9MFY16 from 78.15% in FY13. The P/B currently is 2.23x and post issue will be in the levels of 1.7x to 1.5x. We believe the company with its strong management will be able to increase revenues and hence pricing is in commensurate with the growth potential.

Industry potential: We believe industry has lot of potential for growth but it faces competition not only from other NBFCs but also local money lenders. As per CRISIL research, over 2014-15 to 2017-18, AUMs of non-Andhra Pradesh MFIs is expected to rise at a 30-34% CAGR, while total AUMs of all MFIs (including those in Andhra Pradesh) will rise at a lower range of 29-31%. With the market potential increasing, there is also rise in the micro-finance players entering newer markets to diversify their geographic risk.

Government Initiatives: For achieving the aim of financial inclusion, government is giving the required regulatory support to the MFIs. The RBI has approved two self-regulatory organisations (MFIN & Sa-Dhan) for microfinance sector to allow focused supervision and policy-support. Going back to the “last-mile” customer, small finance banks are a step in that direction and Ujjivan will benefit from the funding it receives from banks for the same. RBI grant to 10 entities in the SFB space itself shows the importance of it in the financial services industry.

Government launched the MUDRA Bank to accelerate the reach to micro-entrepreneurs and for taking tiny steps towards financial inclusion. MFIs will be pioneering this initiative to a large extent and SFB will get the required support from them. In order to succeed, it is important that the RBI’s regulations for MFIs and Priority Sector, work hand-in-hand with the MUDRA initiative.

Also for the success of Jan Dhan Yojana and the Jan Suraksha insurance programs the business will have to shift to the two new commercial banks and SFBs in the future.

Challenges for transformation to SFB structure: We believe Ujjivan is well structured to adopt the SFB structure. The biggest challenge will be converting the liability side of the balance sheet to confirm to that of a bank and comply with CRR and SLR requirements. Also, the portfolio needs to shift from group loan to individual loan as the industry is structurally changing in this direction. SFBs are required to maintain a minimum of 25% of their branches at all times in unbanked rural centres. The company already has 37% branches in the central, east and north east regions of India, where a majority of the under-banked districts are located. The IPO issue will also help Ujjivan to tame its negative cash flows and liabilities side of balance sheet.

Our view: We believe the company being a market leader has strong growth potential backed with the strong management. During the transition to SFB, it might see growth moderating and margin shrinking. However, we believe due to its strong reach, management capability and being technology savvy, it will quickly return to growth trajectory. We would recommend one to bid for the IPO not only for listing gains of approx 20% but also for long term returns.