Equitas Holdings Ltd – Initiating Coverage Research Report By Nirmal Bang

Best of both worlds: yield of NBFCs, cost of banks

Equitas offers a unique opportunity to participate in a business model that
offers nimbleness and pricing power of an NBFC on one hand and the deposit
generating ability of a bank on the other. Equitas has successfully diversified
across 9 products with its core focus on self-employed individuals and micro
and small enterprises (MSEs) that are underserved by formal financing
channels.

Why analysts prefer Equitas Holdings over peers.@dhanuka_saloni reports.

Read: https://t.co/UugW2Sua3V pic.twitter.com/Gey2zj3jgK

— BloombergQuint (@BloombergQuint) August 29, 2018

Fast paced transition towards high yield secured lending: Diversifying its
product portfolio over the years has been the key factor in Equitas’ strong
evolution and robust growth. Non-Microfinance mix in AUM has increased
from 46% in FY16 to 72% in FY18. We expect the company to maintain its
growth momentum and grow its AUM at 37% CAGR over FY18-21E.

Multiple levers to maintain NIMs: We expect Equitas to sustain NIMs in the
~7.0-7.5% range in the medium term. We believe a significant portion of the
long term strategy to scale down MF portfolio has been already executed with
the share of MF now at 27%. Equitas is on track to substantially reduce the
excessive investments it held historically which should aid in expansion of
NIMs. Cost of funds is expected to be under control on the back of increase in
deposits from 52% of total borrowings today to 68% by FY21E.

Scope for improvement in cost efficiency: Post FY16, Equitas’ conversion into a
SFB resulted in quantum jump in opex. Equitas converted 375 of its 500
branches into bank branches and also added ~3500 branch banking employees.
We believe the operating costs have peaked out and the benefit of operating
leverage shall kick-in with acceleration in loan/NII growth. We forecast Equitas’
opex to grow at 12% CAGR over FY18-21E as against NII growth of 26% CAGR
and thus deliver cost/income ratio of 54.8% in FY21E v/s 80.0% in FY18.

High capital adequacy to support high growth without dilution: With current
Tier 1 ratio of 22.3% and scope for raising Tier 2 capital (currently 1.6%), we do
not foresee Equitas raising Tier 1 capital over the next four years. We believe
Equitas can grow its AUM at 33%+ CAGR and reach top quartile profitability
levels (ROE of 17-18%) over the same period.

ROE to expand 760 bps over FY19-21E to 16.3% driven by operating leverage:
We expect a strong revival in loan growth on one hand and modest increase in
opex on the other; leading to robust operating leverage. Further, with an
improvement in capital gearing, we foresee ROE expanding to 16.3% by FY21E
from 8.7% in FY19E.

Valuation and Recommendation: With visible ROE expansion to ~17-18%
levels in the long term (by FY22E) on the back of strong AUM growth, lower
opex and lower credit costs, we believe Equitas’ valuations will gravitate
towards that of SFBs, banks and NBFCs demonstrating similar growth and
profitability. We value (Equitas SFB at 3.0x FY20E Adj. BV) Equitas Holdings at
a 20% discount to SFB, at 2.4x FY20E Adj. BV at Rs. 181, post factoring the
holdco discount. We initiate coverage with ‘BUY’ rating with a target price of
Rs. 181