IRCTC IPO – A Matter of Convenience – Pre Listing Note – Premium

  • Date: 11th Oct, 2019
  • Mid Cap – 5,120 cr. Mkt cap
  • Industry: Railway PSU
  • IPO Price – ₹320 /share

jainmatrix investments, IRCTC IPO

  • We had published an investment report  IRCTC IPO – A matter of convenience.
  • The response to the offer was excellent, with an 112 times subscription.
  • The IRCTC IPO lists on Mon 14th Oct.

Jainmatrix Investments has just published a Premium report – A Pre-Listing Note on IRCTC IPO that guides serious investors on this opportunity.

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DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or known financial interests in IRCTC or any group company. Punit Jain intends to apply for this IPO in line with the BUY recommendation. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

IRCTC IPO – A Matter of Convenience

  • Date 29th Sep 2019
  • IPO opens 30th Sep -3rd Oct at price range 315-320/share
  • Industry – Railways PSU
  • Mid Cap: 5,120 cr. Mkt cap
  • Valuations: P/E 18.8 times TTM
  • Advice: SUBSCRIBE with a 2 year perspective 

jainmatrix investments, IRCTC IPO

Summary

  • Overview: Railways are undergoing a dramatic transformation to improve service levels, technology, outsource and grow faster. Subsidiaries like IRCTC are executing on the new initiatives. IRCTC is an Indian Railways owned PSU. It is the only entity authorized to provide catering services to railways, online railway tickets and packaged drinking water at stations and trains. It is financially well-managed and the return ratios and operating cash flows are robust. There is ample scope for growth in almost all business segments. Profits are expected to improve in FY20 given earnings tailwinds including restoration of Convenience fees, lower corporate tax and lower bad debt provisions YoY.
  • Risks: 1) removal of exclusivity for its business divisions 2) reduction in price of services, higher haulage or a removal of convenience charge for tickets portal 3) In the water business, a ban on single use plastic 4) Any adverse news flow on catering services or Ticket booking scams 5) GoI may list RailTel and IRFC soon, both are PSU railway firms. This can impact valuations.
  • Opinion: At a P/E of 18.8 times, the valuation are attractive. Investors can SUBSCRIBE to this IPO with a 2 year perspective.
  • Download a PDF version of this report JainMatrix Investments_IRCTC IPO_Sep2019

Here is a note on Indian Railway Catering and Tourism Corporation (IRCTC) IPO.

IPO highlights

  • The IPO opens: 30th Sep -3rd Oct 2019 with the Price band: ₹315-320 per share.
  • Shares offered to public number 2.01 cr. The FV of each is ₹ 10 and market Lot is 40.
  • The IPO in total will collect ₹645 cr. while selling 12.6% of equity. The promoter group of Indian Railways (IR) owns 100% in IRCTC which will fall to 87.4% post-IPO.
  • The IPO is an Offer for Sale (OFS) by IR, and will raise ₹645 cr. at UMP. The IPO share quotas for QIB, NIB and retail are 50:15:35. Retail and employees will get a ₹ 10 discount to listing price.
  • The unofficial/ grey market premium for this IPO is ₹140-150/share. This is a positive.

Introduction

  • IRCTC was conferred the status of Mini – Ratna (Category-I PSE) by the GoI, on May 1, 2008.
  • IRCTC is a CPSE owned by the GoI under the Ministry of Railways. It is the only entity authorized by IR to provide 1) catering services to railways 2) online railway tickets and 3) packaged drinking water at railway stations and trains in India. IRCTC was incorporated with the objective to upgrade, modernize and professionalize catering and hospitality services, manage services at railway stations and on trains and to promote international and domestic tourism in India through PPP model.
  • Revenues, EBITDA and profit for FY19 were ₹1,957 cr., ₹461 cr. and ₹273 cr. resp. It has 1,384 employees (Aug 2019). IRCTC has been profitable and debt free since incorporation in 1999.
  • 55% of revenue was from catering services; internet ticketing was 13%, etc. See Fig 1(a)

jainmatrix investments, IRCTC IPOFig 1(a) – Revenue by Segments and Fig 1(b) Margins jainmatrix investments, IRCTC IPO

  • IRCTC operates in 4 business segments of Catering, Internet Ticketing, Tourism, State Teertha (travel packages) and packaged drinking water under the “Rail Neer” brand.
  • Internet Ticketing: IRCTC is the only entity authorized by IR to offer railway tickets online. As of Aug 2019, more than 14 lakh passengers travel on IR on a daily basis, of which 72.6% are booked online. As a result, there are more than 8.4L tickets booked through http://www.irctc.co.in and “Rail Connect” on a daily basis. IRCTC operates one of the most transacted websites, http://www.irctc.co.in, in the APAC region with volumes averaging 25-28 m. transactions/month.
  • Catering: IRCTC provides food catering services to IR passengers on trains (mobile catering) and and at stations (static catering). IRCTC provides catering services for 350 pre-paid and post-paid trains and 530 static units. They provide catering services through mobile catering units, base kitchens, cell kitchens, refreshment rooms, food plazas, food courts, train side vending, and Jan Ahaars over the IR network. All other catering units, such as refreshments rooms at stations categorized at B or below, AVMs, milk stalls, and trolleys are managed by zonal railways. IRCTC offers catering services to passengers through a mobile app “Food on Track” and a website, ecatering.irctc.co.in. They also operate executive lounges, budget hotels, and retiring rooms for railway passengers.
  • Packaged Drinking Water (Rail Neer): IRCTC is the only entity authorized by Ministry of Railways to make and distribute packaged drinking water at all railway stations and on trains. They have a packaged drinking water brand ‘Rail Neer’. Currently IRCTC operates ten Rail Neer plants located at Nangloi, Danapur, Palur, Ambernath, Amethi, Parassala, Bilaspur, Hapur, Ahmedabad and Bhopal, with an installed production capacity of 1.09 m. liters/day, which caters to 45% of demand for packaged drinking water at railway premises and in trains.
  • Travel and Tourism: IRCTC have been mandated by IR to provide tourism and travel related services. IRCTC has footprints in across all major tourism segments such as hotel bookings, rail, land, cruise and air tour packages and air ticket bookings. Additionally, it has a service the SBI IRCTC Credit Card.
  • Leadership is Mahendra Mall (CMD), Narendra (Dir. Finance), Rajni Hasija (Dir. Tourism & Marketing)

News, Updates and Strategies

  • IRCTC will launch 2 new Tejas Express trains, where the train services will be managed by them rather than IR. It will offer upgraded services including food, have advertising rights to on these trains but will pay a lease to IR. The Delhi-Lucknow Tejas will begin services in Oct 2019 and the Mumbai-Ahmedabad train is expected to start in Dec 2019.
  • With effect from 1st Sept 2019, IRCTC will charge a convenience fee of ₹ 15 and ₹ 30 for booking railway tickets online for non-AC and AC classes, resp. This is expected to boost revenues; it had witnessed a revenue loss due to withdrawal of service charges after demonetisation, impacting top line over the past two years. The new fee is 25% lower than the earlier service charge, but it would help bump up revenues in the current fiscal itself. IRCTC earned ₹ 362 cr. service charges in FY17, prior to GoI withdrawing the same from Nov 23, 2016, in a bid to drive digital transactions. In place of this, the Ministry of Finance had reimbursed IRCTC ₹ 80 cr. and ₹ 88 cr. for FY18 and FY19 resp. for operational costs such as cost of server, IT staff and other IT costs. This may stop now.
  • IRCTC’s business strategy is – To diversify and offer new services to the passengers of IR, etc.
    • To develop their IRCTC iMudra wallet to promote digital payment options to customers/users. This is a prepaid card which allows users to book train tickets, shop online and transfer money.
    • To offer better services as a private train operator.
    • To continue to leverage the Government’s policy relating to their business; To strengthen products and services offering online and To strengthen operational efficiencies.

Railways Sector, Industry & Market Outlook in India

  • The GoI announced a planned outlay of ₹ 1.59 tn. for IR in the Interim Union Budget 2020, 14% higher than last year’s revised estimate of ₹ 1.39 tn., thus driving investment in the sector.
  • Total railway passenger traffic has remained nearly flat over the past four years, going from 8,397 mn. passengers in FY14 to 8,286 mn. passengers in FY18. Passenger traffic, after falling by 1-2% between fiscals 2014 to 2016, witnessed a revival in 2018, driven by non-suburban traffic.
  • As per a study conducted by Asian Institute of Transport Development (AITD) titled Environmental and Social Sustainability of Transport – Comparative Study of Rail and Road (2000), rail consumes 75% to 90% less energy for freight traffic; and 5% to 21% less energy for passenger traffic when compared to road. The social cost therefore, in terms of environmental damage or degradation is significantly lower in rail transportation.
  • IR is going through a massive revival and improvement program that includes additional lines, massive electrification, going green, technology improvement, outsourcing and efficiency.
  • A New Catering Policy 2017 will empower IRCTC and help improve coverage of catering services due to addition of base kitchens. Consequently, IRCTC’s catering revenues is expected to grow at 7.5-8.5% CAGR between fiscals 2019 and 2024 to reach ₹ 14.5-15.5 billion in fiscal 2024. IRCTC plans to expand its base kitchen network, with 15-20 greenfield base kitchens to be set up along with conversion of some Jan Ahar outlets on railway stations into base kitchens. IRCTC also plans to add pantry cars to some trains not having them.
  • IRCTC has less than 2% of the airline ticketing market share in India so there is big room to grow. The Indian Travel Agent / Booking industry was estimated at ₹1,370-1,390 bn. in FY14. On account of strong growth in domestic and inbound tourism, the industry grew at 11-12% CAGR to reach ₹2,335-2,355 bn. in FY19, including airline, hotels and railway bookings.
  • The organized packaged drinking water market has been estimated to have grown from ₹ 30-35 bn. (at retail price) in FY14 to ₹80-85 bn. in FY19 at 19.5% CAGR. Going forward, the market is expected to further grow by 16-17% CAGR and reach ₹ 180-185 bn. in FY24.

 Financials of IRCTC

  • IRCTC’s revenues, EBITDA and PAT over the years are in Fig 3. Revenues, EBITDA & PAT have grown at a CAGR of 10.4%, 10.1% and 9% resp. from FY17-19. The 3 year nos. may look average.
  • The PAT growth for FY19 was 23.5% from ₹221 cr. to ₹273 cr. IRCTC wrote off bad debts of ₹46.1 cr. in FY19. Adjusting for this the PAT growth would have been 37% for FY19.
  • IRCTC had a RoE of 26.1% and RoCE 38.8% for FY19, and 3 yr avg. RoE is 25%, this is  excellent.

jainmatrix investments, IRCTC IPOFig 2 – IRCTC Financials / Fig 3 – IRCTC Cash Flow jainmatrix investments, IRCTC IPO

jainmatrix Investments, IRCTC IPOFig 4 – IRCTC Corporate Income Tax Rate

  • IRCTC had an EBITDA margin of 23.5% and PAT margin of 13.9% for FY19. These are high margins and marginal sales growth can drive high profit growth.
  • IRCTC has strong operating cash flows and the firm is FCFE positive. See Fig 3.
  • IRCTC derives ~75% of its operating profits (EBIT) from its catering and internet ticketing business. Both the business segments have witnessed sharp rise in margins over the years. Tourism business margins have turned from loss making to high single digit margin. Rail Neer and State Teertha business segment margins have marginally declined. Overall the margin trajectory is robust.
  • Fig 4 we can see that IRCTC has paid an effective corporate IT rate of 36.6% for FY19. IT rates have been lowered from the current fiscal year to 25%. This will lead to higher earnings growth.
  • IRCTC FY20 PAT outlook is robust given (a) Tax Savings of 32% (b) Convenience fee restoration by Ministry of Railways which should double segment revenues (c) Low/No expected doubtful bad debts compared to FY19 (d) Organic growth across catering, water, ticketing and travel.

Benchmarking

jainmatrix investments, irctc ipoFig 5 – Benchmarking

We benchmark IRCTC against peers, See Fig 5. Note: For IRCTC, only 2 year CAGR sales and PAT growth have been presented, per RHP data.

  • PE and PB of IRCTC is the highest in the peer group. However the valuations are attractive given the monopoly status, sector growth, B2C nature, high earnings, high return ratios and debt free status.
  • The sales and PAT growth look low. However the reasons for the same have been explained above. From FY20 the growth numbers should accelerate.
  • The EBITDA and PAT margins are in the high range amongst this group. RoE and RoCE are the highest. This is a positive. Dividend yield is average but high considering it is a state owned unit.

Positives for IRCTC and the IPO

  • Railways are much more environmentally friendly, consuming less fuel than road and air.
  • The GoI has planned a massive investment in IR to improve operations, and it has high potential to grow usage and volumes. IRCTC is dealing with essential and cutting edge initiatives, which can grow very rapidly. IRCTC enjoys a monopoly position in several niches with the IR – online ticketing, catering and branded water – which lower risks and ensure business stability and profits.
  • The restoration of Convenience Fee from Sept 2019 will allow IRCTC to sharply improve revenues from internet ticketing in FY20 itself. These had fallen in FY18 and FY19 post demon.
  • The Catering Policy 2017 envisages a bigger role for IRCTC and takeover of many catering activities.
  • The B2C nature of Business with large number of transactions is more stable and allows IRCTC to build a brand with consumers. IRCTC also has a vast amount of data on customers through online portal which can be used more effectively to upsell and cross sell other services.
  • With the IPO and listing, IRCTC is well organized and employees better incentivized to take advantage of the emerging opportunities in the defined and new sectors.
  • High cash and bank balances and debt free status are clear positives.
  • Valuation at PE 19 times is attractive given monopoly nature of its businesses and growth prospects.

Risks and Negatives for IRCTC and the IPO

  • If GoI were to allow competition in future in business areas of IRCTC, it will quickly affect valuations.
  • IRCTC might be unable to implement the directives of Catering Policy 2017 in a timely manner, which may result in penalties. Totally 159 observations were made by commercial inspectors during 2013-2016 relating to issues of hygiene, tariff, cooking, kitchen, food and service in IR.
  • Security, hacking and phishing are key concerns as IRCTC relies on tech to operate its ticketing and tourism business. Currently all servers, IT and storage systems are at a single location.
  • IRCTC has a JV, Royale Indian Rail Tours Ltd. (RIRTL) with Cox & Kings India which is under litigation. They have not been able to consolidate the financials of RIRTL since FY11.
  • IRCTC’s business can be negatively affected if they are unable to maintain quality standards. Any adverse claims, media speculation or bad publicity could quickly affect their reputation and image.
  • Ticket booking scams/frauds – many have been discovered on the IRCTC platform over the last few years. The fraud typically pertains to booking Tatkal (last minute travel) tickets. Action is usually taken quickly by authorities. In the high revenue area, good vigilance is needed to detect frauds.
  • Change in haulage by Ministry of Railways on the trains IRCTC operates could adversely affect business. Under haulage concept, IR takes fixed charges for hauling the rake of the train from one destination to another; charges are calculated and informed by IR to IRCTC.
  • While IRCTC has been asked to unbundle catering services by creating a distinction between food preparation and food distribution, the timelines are not clearly defined and are currently under discussions. Any failure on part of IRCTC to adhere to the mandate may result in penalties.
  • While IRCTC has several monopolies, it however does not have pricing controls over the services due to price regulation by IR; they do not hedge risks of market fluctuations in commodities market.
  • IRCTC uses PET bottles and other plastic items for their packaged drinking water, which is subject to various regulatory requirements and increasing public scrutiny.
  • There are whispers of overcharging in paid mobile catering and lack of transparency / bills.
  • In the past IRCTC was affected when Lalu Prasad Yadav (former Railway Minister) was accused of misusing his official position in 2004 and conniving with officials of IRCTC to grant sub-lease rights of 2 IRCTC owned hotels in Puri and Ranchi to a private party. Such scams can tarnish IRCTC’s image.
  • The GoI has pressured PSUs for dividends and is targeting massive revenue from disinvestment. In general this is an overhang and causes PSUs to lose valuation premiums.

Overall Opinion and Recommendation

  • The Indian Railways is undergoing a dramatic transformation to improve service levels, better technology, outsource and grow fast. Subsidiaries like IRCTC are executing on the new plans.
  • The Railway industrial complex is getting unbundled. 2 of 3 recently listed railway IPOs have performed well, RVNL (read IPO report) and RITES gained but IRCON lost value since listing.
  • IRCTC has performed well in the last 20 years, using its lean structure, good technology and conservative financials to record growth and profits and good return ratios and operating cash
  • There is ample scope for growth in all business segments. IRCTC enjoys several monopoly niches. Profits are expected to improve in FY20 given earnings tailwinds including restoration of Convenience fees, lower corporate tax and lower bad debt provisions YoY. Margins are flat or improving. This makes IRCTC attractive for investors. It looks poised for a good listing and future gains.
  • The key risks are 1) In the packaged drinking water business, a ban on single use plastic 2) removal of exclusivity for its business divisions 3) reduction in price of services, higher haulage or a removal of Convenience charge for tickets portal 4) Any adverse news flow on catering services 5) GoI may list RailTel and IRFC soon, both are PSU railway firms which can impact valuations.
  • At a P/E of ~19 times, the valuation are attractive.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Agree ? Disagree? Like the report? Any thoughts here? We welcome your comments below….

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or known financial interests in IRCTC or any group company. Punit Jain intends to apply for this IPO in line with the BUY recommendation. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Spandana Sphoorty Financial IPO – A Spunky Player

  • Date 06th Aug; IPO Opens 5-7th Aug at Rs. 853-856
  • Valuations: P/E 17.6 times TTM, P/B 2.4 times (Post IPO)
  • Mid Cap: Rs. 5,505 cr. Mkt cap
  • Industry – NBFC MFI
  • Advice: SUBSCRIBE
  • Overview: Spandana is a rural focused NBFC-MFI with a geographically diversified presence in India. It offers income generation loans under the joint liability group model, predominantly to women from low-income households in rural areas. They are the 4th largest NBFC-MFI and the 6th largest amongst NBFC-MFIs and SFBs in India, in terms of AUM. Revenues, NII and profit for FY19 were ₹1,049 cr., ₹640 cr. and ₹312 cr. resp. Capital adequacy is 39.6% which is very safe. Spandana exited from CDR in March 2017 and the operations are stable now. At a P/B of 2.4 times & PE of 17.6 times (post IPO), the valuation look attractive.
  • Risks: 1) Economically and politically sensitive sector 2) Significant exposure to unsecured loans.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Here is a note on Spandana Sphoorty Financial (Spandana) IPO.

IPO highlights

  • The IPO opens: 5-7th Aug 2019 with the Price band: Rs. 853-856 per share.
  • Shares offered to public number 1.40 cr. The FV of each is Rs. 10 and market Lot is 17.
  • The IPO in total will collect ₹1,200 cr. while selling 21.8% of equity. IPO is both an Offer for Sale by current shareholders (OFS) and a fresh issue of shares. The OFS proceeds would be ₹800 cr. at UMP and fresh issue size is ₹400 cr.
  • The Promoters are Padmaja Gangireddy, VSR Reddy Vendidandi and Kangchenjunga Ltd. that own 81.22% in Spandana which will fall to 62.58% post-IPO. The major selling shareholders are Kangchenjunga, VSR and Padmaja Gangireddy, see Exhibit 1(a). The IPO is being launched to provide partial exit to existing promoters as well as for Spandana to augment the capital base (Fresh Issue).

jainmatrix investments, spandana IPO

Exhibit 1(a) – IPO Selling Shareholders; Exhibit 1(b) – Shareholding pattern

  • The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
  • The promoter Kangchenjunga Ltd is a holding co. incorporated in Mauritius. It is a private company with limited liability, which holds a Category 1 Global Business License to carry out activities as an investment holding company and to acquire, invest in and hold securities of Spandana. The Class A shareholders of promoter Kangchenjunga are seen in Exhibit 1(b).

The unofficial/ grey market premium for this IPO is Rs. 18-20/share. This is small.

Introduction

  • Spandana is a rural focused NBFC-MFI with a geographically diversified presence in India. It offers income generation loans under the joint liability group model, predominantly to women from low-income households in rural Areas. As of FY19, they were the 4th largest NBFC-MFI and the 6th largest amongst NBFC-MFIs and SFBs in India, in terms of AUM. See Exhibit 2(a).
  • Revenues, NII and profit for FY19 were ₹1,049 cr., ₹640 cr. and ₹312 cr. resp. It has 7,062 employees (June 2019). 85% of their gross loans were Abhilasha loans, and 86% of the loan book is unsecured.

jainmatrix investments, spandana IPO

jainmatrix investments, spandana IPO

Fig 2a – Loan products (above) and Fig 2b AUM Spread

  • Spandana was incorporated as a public company in 2003 and registered as an NBFC with the RBI in 2004. Soon they registered as an NBFC-MFI in 2015. In October 2010, the MFI industry (including Spandana) was severely impacted as the govt. of AP promulgated the AP Microfinance Ordinance 2010, which enforced several restrictions on the operations of MFIs. This impacted Spandana collections, cash-flow, its ability to service debt, and so their growth and profitability.
  • Spandana’s lenders referred them to the corporate debt restructuring (CDR) mechanism of RBI to restructure borrowings and revive business. The CDR plan allowed them to get cash-flow relaxations to continue their portfolio diversification, process improvement and cost rationalization. Their operations turned profitable from FY14.
  • Spandana exited CDR in March 2017, which enabled it increase lender base, diversify its borrowings to new banks and NBFCs and also issue NCDs in the capital markets. As a result, during FY18, with increasing flow of capital, they expanded their operations and were able to utilize the existing branch network and employees (earlier underutilized due to lack of capital). Prior to their exit from CDR in 2017, they had limited access to capital, due to which they had to offer loans in lower ticket sizes than the demand from clients.
  • Distribution is strong as in 2019 they cover 16 states and 1 UT across India through 929 branches.
  • Leadership – Padmaja Gangireddy (MD), Sudhesh Chandrasekar (CFO), Abdul Khan (Strategy Officer).

News, Updates and Strategies of Bandhan

  • Prior to 2010 Andhra Pradesh MFI crisis, 51% of Spandana loan book was concentrated in AP. Post the debacle they have tightened internal controls to manage risk better by restricting (a) loan book exposure to a max of 22.5% for 1 state (b) loan book exposure to a max of 2.5% for each district (c) loan book exposure to a max of 0.3% for each branch.
  • Spandana’s business strategy is as follows:
  • To leverage their popular income generation loan products to derive organic business growth.
  • To leverage existing branch network by increasing loan portfolio and employee productivity.
  • To increase its presence in under-penetrated states and districts.
  • To further diversify their borrowing profile; and reduce their cost of borrowings.

Various shareholders invested in Spandana over the years. The average cost of acquisition per share for those shareholders is as follows:

jainmatrix investments, spandana IPO

Exhibit 3 – Cost of shares by investors

  • In Jun 2018 20.3L shares were allotted to Padmaja Gangireddy and 72K shares to Abdul Feroz Khan by private placement at Rs. 235.4/share. In IPO this has grown by 3.6 times in just over a year.
  • Spandana has raised Rs 360.28 cr. from 18 anchor investors by allotting 42,08,886 shares at a price of Rs 856, the upper band of its IPO. Among the 18 anchor investors, Wells Fargo Emerging Markets Equity Fund, Goldman Sachs India Ltd, ICICI Prudential Life Insurance Company and Bajaj Allianz Life Insurance Company have been allotted about 4.40 lakh shares each.
  • Spandana IPO was subscribed 6% on the first day of bidding on Monday (5th Aug).

Micro Finance and Banking Industry Outlook in India

  • Financing needs in India have risen along with economic growth over the past decade. By complementing banks and other financial institutions, NBFCs help meet this need.
  • MFI is a volatile sector that can be badly affected by economic and political events. Spandana’s operations were also affected post AP ordinance in 2010. It went into CDR however later came out of it in Mar 2017. In Nov 2016, the Indian government announced the demonetization of currency notes of ₹500 and ₹1,000 denominations. Though demonetisation affected the retail sector’s credit performance in FY17, which dropped 300 bps from FY16, growth remained higher than industrial and agricultural credit growth in FY17. The retail segment was negatively impacted by the demonetization driven slump in the real estate sector. Retail credit grew 16% YoY, while industrial credit contracted YoY by 2%. Such events have affected collection efficiencies which could happen in the future as well.
  • Spandana has a 2.6% market share basis its GLP. See Exhibit 4

jainmatrix investments, spandana IPO

Exhibit 4 – Market share and AUM growth for MFI players over the years

  • The share of adults with a bank account in India has more than doubled to approximately 80% since 2011, largely supported by the Pradhan Mantri Jan Dhan Yojana (PMJDY) a scheme of the GOI, which led to account growth and traction in savings. However, while significant traction is present on the deposit side, India is still among the Top 3 nations with unbanked people in the world, reflecting the strong need for an enhancement of the financial inclusion agenda.
  • The microfinance sector in India has grown at a CAGR of 23.1% over the past 10 years to reach ₹2,633 bn. as of FY19, despite some setbacks that have impacted the industry’s growth. The industry has evolved over time, starting with the Self-Help Group (SHG) Bank Linkage program and not-for-profit organisations (NGOs) being the key participants in the sector, to the scaling of NBFCs, the conversion of Bandhan Financial Services into a universal commercial bank and the launch of the Small Finance Banks. Presently, the demand for micro credit is primarily being serviced by industry participants such as MFIs, NBFC-MFIs, SHG, Banks, SFBs, NGOs, and other informal lenders.
  • The MFI sector has potential to grow the client base as well as ticket size per borrower. The micro-credit opportunity is about ₹5-6 tn. supported, considering the addressable market of low-income households in India. The traction in disbursements is expected to sustain and the industry is projected to witness a portfolio growth in the range of 20-24% p.a. over the medium term. Within this, the pace of growth of the non-SHG portfolio is expected to be higher at 25-30% p.a. Further, the ticket sizes are likely to go up in the states where the penetration levels are high. Overall client growth may be 8-10% and loan outstanding per borrower may increase by 12-15%.
  • Current challenges in the Indian BFSI sector include the collapse of IL&FS, a liquidity shortage in the BFSI sector, an NPA crisis in PSBs, real estate loans troubles and weakness in DHFL and Yes Bank.
  • Per management, MFI customers are unaffected by these industry events and are doing better.

Financials of Spandana

jainmatrix investments, spandana IPO

Fig 5 – Spandana Financials

Note: 1) Data for FY15-FY16 are per Indian GAAP, FY17-FY19 is basis IND AS with FY18-FY19 are consolidated 2) NIM or Net Interest Margin = Net Interest Income / Annual Average Gross AUM (%)* 3) NIM-R is net interest margin computed as Average Interest Charged less Average Cost of Borrowing. 4) Diluted EPS has been calculated after considering fresh shares to issued post IPO.

  • Spandana’s revenues, NII and PAT over the years are in Fig 5. Revenues, NII & PAT have grown at 33.9%, 34.5% and 31.2% resp. from FY15-FY19. These are good growth numbers.
  • Spandana had a RoE of 16.51% and RoA of 8.2% in FY19. This is moderate and sustainable as the business operations have stabilized now. NIM and NIM-R have stabilized for Spandana over the last 3 years. NIM at 16.39% for FY19 is the highest in the industry.
  • The PAT for FY17 surged 82.3% as it took a deferred tax credit of ₹421 cr. PBT for FY17 was ₹35 cr.
  • Spandana has the best asset quality in the industry. The NNPA as of FY19 stood at 0.02%. The NPA’s have largely come from unsecured personal loans, agri loans as well as MSME loans.
  • NBFCs are required to maintain a CRAR consisting of Tier I and Tier II capital which should not be less than 15% of its aggregate risk weighted assets on-balance sheet and of risk adjusted value of off-balance sheet items. The Tier-I capital was required to not be less than 8.5% by FY16 and 10% by FY17. Spandana has an aggregate CRAR of 48.96% and Tier 1 capital to the extent of 48.52%. This is much higher than what RBI has prescribed which is a positive.

Benchmarking

We benchmark Spandana against peers, See Fig 6.

jainmatrix investments, spandana IPo

Fig 6 – Benchmarking

  • PE of Spandana is the lowest in the peer group. This makes the offering attractive on relative basis.
  • In terms of PB, the valuations are average. This is on an adjusted basis post dilution.
  • The 3 year sales and PAT growth is robust. However Bandhan continues to be the sector leader. The Cost/Income ratio too is low. The PAT margin (PAT/Income) as well as the NIM is highest amongst the peer group. This is a positive. The RoE is average among peer group.
  • GNPA is very high while NNPA is fine. The reason for this is loans outstanding from the AP crisis of 2010. However these are provided for by Spandana.
  • Overall we see Spandana as a MFI rapidly emerging from CDR and stabilizing operations well.

Positives for Spandana and the IPO

  • Spandana has suffered heavily and learnt its lessons in the 2010 AP MFI debacle. It emerged from CDR in 2017 after repairing its books. It now has geographically diversified operations which help in risk containment and business resilience. It also will target 25% CAR to ensure safety of operations.
  • They have a good branch network, with a current AUM of Rs 5 cr. /branch. Per management the focus now will on assets growth to Rs 10 cr. / branch.
  • Spandana’s growth has been achieved despite difficult conditions in MFI industry. After the AP crisis in 2010, there was demonetisation in 2016 and many farm loan waivers. But Spandana did well.
  • The asset quality of Spandana is robust with NNPA at 0.02% for FY19. Financially the firm is well managed with moderate return ratios, superior margins and has high growth rates. The IPO valuations at PE of 17.6 times and PB 2.4 times are also attractive.
  • Spandana has an experienced management team. Ms. Padmaja Gangireddy has 24 years of experience in Indian MFI.

Risks and Negatives for Spandana and the IPO

  • Spandana’s MFI loan portfolio is unsecured, and in the event of non-payment by a borrower, they may be unable to collect the unpaid balance.
  • The operations are still concentrated in the states of Karnataka, MP, Orissa, Maharashtra and Chhattisgarh. Any adverse developments in these states could affect business.
  • The promoters and certain directors have entered into ventures that may lead to potential conflicts of interest with their business. For instance, their Individual Promoter, Padmaja Gangireddy, owns 68.3% shareholding in Abhiram Marketing, a group company engaged in consumer goods, whose retail products are sold at their branches (and from whom they receive a sales commission). There is no assurance that the interests of Abhiram Marketing will align with Spandana’s business interests.
  • Any downgrade of Spandana’s credit ratings may increase their borrowing costs and constrain their access to capital and debt markets and, as a result, may adversely affect their results of operations.
  • MFI industry has enjoyed high growth and margins for the last few years. However the market may be getting crowded with several Private Banks acquiring or setting up MFI subsidiaries, Bandhan Bank getting a universal license and many MFIs getting SFB license.

Overall Opinion and Recommendation

  • The microfinance sector promises to extend credit to the underbanked and informal sector people for financial services penetration into rural India. The potential is immense and is barely tapped.
  • Spandana has a decent size, strong financial performance, recent recovery, good asset quality and an experienced management.
  • It is now the 4th largest NBFC-MFI with AUM, and post CDR has grown rapidly. It has a different DNA and may remain sharply focused on a national presence in only MFI loans for the next few years.
  • The management appears conservative and should able to target growth with lower risk taking.
  • At a P/B of 2.4 times & PE of 17.6 times (post IPO), the valuation look attractive.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Download Report:

The entire report can be downloaded, Click JainMatrix Investments_Spandana IPO_Aug2019

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or known financial interests in Spandana or any group company. Punit Jain intends to apply for this IPO in the Retail category. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

RVNL IPO – Railways’ Growth Engine

  • Industry – Railway Transportation PSU in PMC space
  • Mid Cap of Rs. 4,000 crore
  • IPO Opens 29th Mar – 03rd Apr 2019; Price range Rs. 17-19/share
  • Valuations: P/E 6.9 times TTM; with a discount for Retail investors
  • Advice: SUBSCRIBE for listing gains

Summary

  • Transportation Infrastructure is a crying need in India. With Airlines, Roads and Ports sectors making good progress, the final frontier is the Indian Railways. The sleeping giant of IR appears to be getting up in the last few years.
  • IPO Overview: RVNL is a Delhi based PSU into PMC of Railway projects like track laying, electrification, bridges etc. Its FY18 revenue, EBITDA and PAT were Rs. 7,822 cr., Rs. 614 cr. and Rs. 570 cr. resp. Revenue has grown at an impressive 33.7% and PAT at 19.2% over the last 3 years. Valuations are attractively low with a FY18 PE of 6.9x for the IPO. It has an asset light model. A good kicker should come from Q4FY19 results and listing gains in a positive market. Governance appears good and transparent within the PSU limitations.
  • Key Risks: 1) Change in Central Govt. 2) De-emphasis on infra and railways by govt. 3) Issue of a contingent liability 4) Weak infra funding environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a listing gains and a 2 year perspective.

Here is a note on RVNL IPO.

IPO highlights

  • The IPO opens: 29th Mar-03rd Apr 2019 with the Price band: Rs. 17-19 per share. A discount of ₹0.50 per share on the offer price has been offered to retail and employee bidders.
  • Shares offered to public number 25.34 crore of FV Rs. 10 and each market lot is 780 shares.
  • The IPO will raise Rs. 482 cr. for 12% equity by current promoter i.e. Govt. of India with no dilution. The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 1-1.5/share. This is a positive.

Introduction

  • RVNL – Rail Vikas Nigam Ltd – is a Delhi based PSU into PMC of Railway projects like track laying, electrification, bridges etc.
  • Its FY18 revenue, EBITDA and PAT were Rs. 7,822 cr., Rs. 614 cr. and Rs. 570 cr. resp. Revenue has grown at an impressive 33.7% and PAT at 19.2% over the last 3 years.
  • RVNL is a Miniratna (Category – I) firm incorporated by the Ministry of Railways (MoR) in 2003, as a project executing agency for MoR to undertake rail project development, mobilization of financial resources and implementation of rail projects for golden quadrilateral, port connectivity and project execution. RVNL mobilizes finances and forms project specific SPVs with private participation.
  • The railway projects include new lines, doubling, gauge conversion, railway electrification, metro projects, workshops, major bridges, cable stayed bridges, institution buildings etc.
  • Since 2003, RVNL has got 179 projects of which 174 are sanctioned for execution. Out of these, 72 have been fully completed for ₹20,567 cr. outlay and the balance are ongoing. They have an order book of ₹77,504 cr. as on Dec 2018 for 102 ongoing projects.
  • During FY18, they completed 885 RKm (Route kilometre) of project length which included 315 RKm of track doubling and 425 RKm of rail electrification.
  • RVNL earnings are from a management fee on the annual expenditure incurred for the execution of projects, of 9.25% for metro projects, 8.5% for other plan heads and 10% for national projects.
  • Their activities under the various plan heads can be classified as under:
    1. New lines: is augmenting the rail network by laying new lines to achieving seamless multi-modal transportation network across the country and connecting remote areas.
    2. Doubling: Doubling involves the provision of additional lines by way of doubling the existing routes to enable the Indian Railways to ease out traffic constraints of single line or construction of 3rd/4th line to increase the capacity. RVNL is a significant contributor to the doubling projects and has been contributing to a third of the total doubling being completed / commissioned on Indian Railways for the last three years. (Source: CARE)
    3. Gauge conversion: includes conversion of meter gauge lines to broad gauge railway lines.
    4. Railway electrification: This includes electrification of current un-electrified rail network and electrification on the new rail network, generally from diesel run trains.
    5. Metro projects: This includes setting up of metro lines and suburban network in larger cities.
    6. Workshops: This includes mfg. facilities, and workshops for repairing and mfg. rolling stock.
    7. Others: This includes but is not limited to construction of traffic facilities, railway safety works (building of sub-ways in lieu of crossings), other electrification works, training works, surveys, construction of bridges including rail over bridges, etc.
  • As a PMC (Project Management Consultant) firm, its services comprise of: (i) project development and execution of works related to creation of rail infrastructure; (ii) creating project-specific SPVs for encouraging private participation in the funding of railway projects; (iii) undertaking execution of railway projects under specific financial arrangement for the MoR and other Govt. departments; (iv) and other ancillary services like bankability studies for projects and preparation of detailed project reports.
  • It has an asset light model where the contractor identified for project execution brings in all the people resources and machinery required.
  • RVNL has a lean organization with only 541 employees of which 150 are regular and 391 are on deputation and may return to their home employer over time.
  • Leadership in RVNL is Pradeep Gaur (53) is CMD, Ajay Kumar (56) is Director (Personnel), Vijay Anand (59) is Director (Projects) and Arun Kumar (59) is Director (Operations). They are all professionals with experience in Indian Railways and Metro corporations.

Financials and Segments

  • We can see a solid growth of financials. FY19 so far does not look good, but we typically see H2 and Q4 as better than H1. See 4 year financials of RVNL in Fig 1.
  • The emphasis in RVNL is on new lines, lines doubling and Metro projects. See business segments as reflected by the Order Book as on 31st Dec 2018 in Fig 2.

jainmatrix investments, RVNL IPO

Fig 1- RVNL FY18 Financials
jainmatrix investments, RVNL IPO
Fig 2 – RVNL Order Book Segments

Industry thoughts:

  • Over the last few decades, the Indian Railways (IR) has not developed as fast as Roads, Ports and Airline sectors. It has struggled with its public service role as the dominant transporter of passengers. Most of the passenger services are priced at a discount and profits are from the goods services.
  • However capacity constraints like tracks have forced IR to de-emphasize goods services.
  • Productivity improvements have suffered in IR due to large and ageing workforce, legacy organization issues, weak governance in the past and slow decision making. Corruption has been an issue in IR in recruitment, private contracts and public services.
  • Computerization has helped improve the Reservation system in IR. However there is still a long way to go in passenger capacity utilization, flexible pricing and ease of access.
  • In recent times we have seen a dramatic improvement on many of these parameters in IR.
  • In 2016, IR announced a capex plan of Rs 8,60,000 cr. over 5 years i.e. 2016-20. The capex plan is 90% more than the capital outlay in the previous 15 years.
  • IR may be a critical element of India’s future growth story if it improves productivity, technology upgrades, goods transportation focus, financial sensitivity and improves services.
  • RVNL is a key growth arm of IR and may have a good role to play in the transformation of IR in terms of capacity increase, new tech initiatives, metro projects, high speed train lines, etc.
  • RVNL is also one of the second generation PSU firms that are lean in terms of employees, have a sharp business focus and outsource routine tasks to firms and have high productivity.
  • MoR has under it group firms Indian Railways, Concor, RITES Ltd., IRCON, IRFC and RVNL.
    • IR is the monopoly operator of rail based passenger and goods transportation services.
    • Concor is a listed container focused transport firm running multi modal services.
    • IRCON is a multi national consultancy firm active in transportation and infra, listed recently.
    • RITES is a turnkey construction firm active in Rail and non-rail infra areas, listed recently.
    • Indian Railway Finance Corporation (IRFC) is the dedicated financing arm of the Indian Railways for mobilizing funds from domestic as well as overseas Capital Markets.
    • In this comparison it is clear that RVNL has a focus on India based Railways related work as a PMC consultant. There is little overlap with group firms.

Benchmarking

We benchmark RVNL against other comparable Indian Railway firms, and also KEC which is a private sector infra EPC firm. See Exhibit 3.

jainmatrix investments, RVNL IPO

Exhibit 3 – Benchmarking

  • The PE post IPO is low. This provides a safety net for IPO investors.
  • Return ratios are good among the PSU pack.
  • Debt is high but this is expected from an infra projects firm. Also it is a pass through debt, with IR making the payments as per schedule.
  • 3 year growth of revenues and PAT is excellent.

Positives for RVNL and the IPO

  • We have seen a flurry of new initiatives in IR and a slew of new projects and technology initiatives. The GoI is serious about change. So RVNL may see acceleration in business.
  • Many private sector suppliers to IR have reported good growth in orders booked and revenues, across parts supply, and projects related to track laying and electrification. Many of these initiatives may be run by RVNL. Also it is notable that GoI is procuring from reputed private sector firms and taking their help to ramp up its operations.
  • RVNL is a lean and productive firm, and with this listing, may be allowed to chart an Indian Railways independent part to growth and impact. Infra development is a high potential sector.
  • It has attractive valuations with low PE and PB, moderate return ratios and a high 3 year revenue and PAT growth. The over 4%+ dividend yield is good.
  • An order book of Rs. 77,500 cr. gives business visibility of 10 years.
  • BV of Rs. 4,062 cr., and BVPS of Rs. 19.4/share is close to IPO price.

Risks and Negatives for RVNL and the IPO

  • Typically infra projects have issues like land acquisition and govt. clearances which delay execution. This is true for railway projects too with suburban and metro projects.
  • Funding of infra projects is underdeveloped in India. Long term funds from insurance and pension firms do not flow smoothly to infra, so projects become riskier with shorter term and more expensive funding. It is also exposed to financial variations like the current NBFC liquidity issue.
  • On many parameters IR is weak when compared internationally, such as speed of trains, passenger services in trains and at stations, etc. Conversely many improvements are possible.
  • The MoR and IR have been slow to grow in the Metro segment in India. As a specialized suburban train, the Metro is seen as an essential urban solution in Tier 1, 2 and 3 towns.
  • As a MoR firm, with IR as the key group firm, RVNL may be constrained by their slow approvals and permissions. There are worries around political compulsions in MoR.
  • Also RVNL has got projects by default from IR in the past due to relationship and structure. However in future and after RVNL listing, the flow of new projects is not assured.
  • There is a contingent liability of Rs. 3774 cr. This is due to a demand from a contractor. However RVNL feels that the demand is not as per agreement, also if the charge is enforced, it will add to the project cost and be reimbursed by respective clients.
  • H1 FY19 performance indicates no growth over FY18, however financials for PSU could be skewed towards H2 and Q4 which is usually the best quarter for infra/ GoI firms.
  • Of the 10 IPOs made by PSUs in the last 2 years, only 2 have generated positive returns. Balance 8 are down 30% on average. IRCON is down 16% since listing.
  • Political risk: With elections due in 1-2 months, we note that RVNL has accelerated performance in the current term of GoI. A change in leadership or party in power at MoR may affect future growth.

Overall Opinion and Recommendation

  • Infrastructure is a crying need in India. With Airlines, Roads and Ports sectors making good progress, the final frontier is the Indian Railways. The sleeping giant of IR appears to be getting up in the last few years.
  • RVNL represents the new initiatives, new technologies and expansion projects for IR. The current path is of acceleration, ambitious growth and standardization across India. The challenge is to get IR to grow in double digits, improve productivity, cover the country better and lower costs.
  • Valuations are attractively low with a FY18 PE of 6.9x for the IPO. A good kicker should come from Q4FY19 results and listing gains in a positive market.
  • Governance appears good and transparent within the PSU limitations.
  • Key risks are 1) Change in Central Govt. 2) De-emphasis on infra and railways by govt. 3) Issue of contingent liability 4) Weak infra funding environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a listing gains and 2 year perspective.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake, ownership or known financial interests in RVNL or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

HDFC AMC IPO – A Quality Asset

  • Date 24th July; IPO Opens 25-27th July at Rs. 1095-1100
  • Valuations: P/E 32.3 times TTM, P/B 10.7 times (Post IPO)
  • Mid Cap: Rs. 23,300 cr. Mkt cap
  • Industry – Asset Management
  • SUBSCRIBE for the IPO

Summary

  • Overview: HDFC AMC is the #2 player among AMCs by AUM and #1 by profits. HDFC operates as a JV between HDFC and Standard Life Investments. HDFC is one of India’s leading finance companies. Revenues and profit for FY18 were Rs. 1,867 cr. and Rs. 722 cr. HDFC revenues, EBITDA and PAT grew at 19.9%, 19.2% and 19.1% CAGR in 5 years. The Indian mutual fund industry is expected to grow at a CAGR of 20% between FY18 and FY22, due to buoyant capital markets, and a shift from physical to financial assets. Valuations in terms of P/E are 32.3 times, P/B at 10.7 times and market cap/AUM at 8% are high. However we have seen that in emerging sectors/ industries the excelling high quality players can command very high valuations. So a good track record, robust financial performance, sectoral tailwinds, reputed management team and good promoter identity makes this IPO attractive.
  • Risks: 1) High Valuations 2) Regulatory risks 3) Competition can impact margins 4) Macro concerns
  • Opinion: Investors can SUBSCRIBE to this IPO with a 3 year perspective.

Here is a note on HDFC Asset Management Company (HDFC) IPO.

IPO highlights

  • The IPO opens: 25-27th July 2018 with the Price band: Rs. 1095-1100 per share.
  • Shares offered to public number 2.54 crore. The FV of each is Rs. 5 and market Lot is 13.
  • The IPO is of Rs. 2,800 cr. for 12% equity by current promoters HDFC Ltd. and Standard Life Investments UK, with no dilution. HDFC Ltd. and Standard Life are selling 4.05% and 7.96% of shares.
  • The Promoter group (HDFC and Standard Life) own 95% in HDFC which will fall to 83% post-IPO, ie. 53% and 30% in resp. HDFC is a well-known Indian NBFC and is the holding company into financing the purchase or construction of houses, commercial real estate, etc. in India.
  • The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 370-380/share. This is a positive.

Introduction to HDFC AMC

  • HDFC AMC is a leading Indian asset management firm into Mutual Funds and PMS Advisory. It is a JV between HDFC Ltd and Standard Life Investments. HDFC Ltd. is a leading Indian housing finance firm.
  • Revenues and profit were Rs. 1,867 cr. and Rs. 722 cr. for FY18. It has 1,010 employees out of which 58% are in sales and 29% are in client services. It had an AUM of Rs. 2,92,000 cr. in FY18. It is the most profitable AMC in India. It is the largest AMC in India in terms of equity-oriented assets and has consistently been among the top 2 AMCs in India in terms of total average AUM since Aug 2008.
  • The equity-oriented and non-equity-oriented assets are Rs. 1,50,000 cr. and Rs. 1,42,273 cr. resp. of total AUM. HDFC AUM has grown at 25.5% CAGR over FY13-18. Their proportion of equity-oriented AUM to total AUM is 51.3%, higher than the industry average of 43.2%. As equity schemes have a higher fee structure compared to non-equity schemes, the product mix helps achieve higher profits.
  • The market share of AUM is 13.7% and of active equity AUM is16.8% among AMCs see Fig 1c.
  • HDFC offers a large suite of savings and investment products across asset classes, which provide income and wealth creation opportunities to customers. In FY18, they offered 133 schemes classified as 27 equity-oriented schemes, 98 debt schemes (including 72 fixed maturity plans FMP), three liquid schemes, and 5 other schemes (including ETF schemes and funds of fund schemes).
  • This diversified product mix provides them with the flexibility to operate successfully across various market cycles, cater to a wide range of customers from individuals to institutions, address market fluctuations, reduce concentration risk in a particular asset class and work with diverse sets of distribution partners which helps them expand their reach.

jainmatrix investments, hdfc amc ipojainmatrix investments, hdfc amc ipoFig 1(a) – HDFC AUM split -June 2018 (b) HDFC Segment revenues c) Market share /Note – QAAUM is Quarterly Average AUM /Click to enlarge image view. 

  • HDFC also provides portfolio management and segregated account services, including discretionary, non-discretionary and advisory services, to high networth individuals (HNIs), family offices, domestic corporates, trusts, provident funds and domestic and global institutions. As of FY18, they managed AUM of Rs. 6,474 cr. as part of their PMS and segregated accounts services’ business.
  • HDFC had a total of Live Accounts of 81 lakh as of FY18, and their Monthly Average AUM from individuals was 62.2% of their total MAAUM, compared to the industry average of 51.4%.
  • A key element of their strategy is to promote a customer-centric culture that spans across all aspects of their business. As of FY18, they served customers in over 200 cities through their pan-India network of 209 branches (and a Dubai office) and service centers of their registrar and transfer agent, which is supported by a network of 65,000 empaneled distribution partners across India, consisting of independent financial advisors, national distributors and banks.
  • Leadership is Deepak Parekh (Chairman), Keki Mistry (Non-Exec Director), Milind Barve (MD), Prashant Jain (CIO) and Piyush Surana (CFO).

Promoter – HDFC Ltd and Group – Snapshot and Financials

  • The HDFC group is a known financial conglomerate in India, with presence in housing finance, banking, life and non-life insurance, asset management, real estate funds and education finance. Listed companies of the group include HDFC Ltd., HDFC Bank, HDFC Standard Life Insurance Co. and GRUH Finance. HDFC Ltd is the holding company and is also engaged in financing the purchase or construction of residential houses and commercial real estate.
  • Income and PAT has grown at 14.1% and 19.5% CAGR resp. over 5 years.

jainmatrix investments, hdfc amc ipoFig 2 – HDFC Financials

  • HDFC Ltd. share price gained 19.5% CAGR over the last 5 years and CMP is Rs 1,970.
  • HDFC Ltd. has visible signs of pick-up in demand for mortgage loan led by improving affordability, attractive incentive from PMAY scheme and introduction of RERA which augurs well for sustained growth in loan book for HDFC over the next 3-5 years. Further, the performance of its various financial business subsidiaries/associates has improved substantially over the last few quarters.
  • The key risks are 1) Aggressive competition among the HFCs 2) Unstable interest rate environment.
  • HDFC has a market cap of Rs 3,33,106 cr. to be ranked #6 in India.
  • HDFC is a prestigious group with good ethics. It has rewarded shareholders and performed well over decades. The listed subsidiaries of HDFC Ltd. have generally retained these qualities.

News, Updates and Strategies of HDFC AMC

  • The average cost of acquisition of equity shares for HDFC ltd. has been Rs 19.53 over 2000-18 and for Standard Life Investments it is Rs 15.01 over same period.
  • HDFC’s business strategy is as follows: 1) Maintain strong investment performance 2) Expand their reach and distribution channels 3) Enhancement of product portfolio. 4) Invest in digital platforms to establish leadership in the growing digital space.
  • HDFC has grown by acquisition, taking over Morgan Stanley AMC (2014) and Zurich India MF (2003).
  • HDFC AMC sold its shares worth almost Rs 150 cr. to distributors in April 2018 before the upcoming IPO. These shares were offered to 190 distributors and advisers at Rs. 1,050/share. But SEBI in July 2018 directed HDFC to scrap this placement and to return the money it had collected with a 12% interest. These shares were then acquired by PE firm KKR paving the clearances for the IPO. Prior to the share allotment, HDFC had sought approval for a special quota for distributors in its IPO, but SEBI rejected the proposal then because it was against a separate quota for distributors.

MF Industry Outlook in India

  • The economy has seen financial events such as demonetization, RERA implementation, GST and a crackdown on black money and shell companies. All these have rekindled interest in financial assets as compared to real estate and gold which were the most popular earlier.
  • Penetration of equities remains low, with only 2% of population having a demat or equity /MF ownership. Gold & real estate hold a large proportion of savings but have generated weak returns.
  • The regulations and disclosures around MFs have ensured good traceability and audit trails. SEBI has promoted MFs as good entry level equity and debt products, and MF asset growth has been good.
  • The MF industry’s AUM grew at a CAGR of 24.9% from Rs. 7 lakh cr. in FY13 to Rs. 21.4 lakh cr. as of Mar 2018, supported by strong investor inflows of Rs. 9 lakh cr. FY17 & FY18 have been remarkable for the industry, attracting around 68% of the Rs. 9 lakh cr. net inflow, with equities leading the charge. Equity-oriented funds (including balanced and excluding ETFs) attracted 60% of the total net inflows in FY17 & FY18. Supported by these strong inflows, growing participation from individual investors and rising equities, the assets surged 42.3% in FY17 and 21.7% in FY18. During FY18, the fresh investments in MFs grew by 22.2% to Rs. 3.9 lakh cr. in the FY 2018.
  • The growth in the AUM has been supported by a favorable macro environment, the rising of capital markets, foreign fund inflows as well as growing investor awareness.
  • Today there are 41 AMCs operating comprising 7 promoted by PSB’s, 2 by financial institutions, 25 by private sector and 7 by foreign players (including JV’s). The Indian MF industry is concentrated with the 10 large AMCs having 80% of the industry AUM. ICICI Prudential AMC, HDFC, Reliance, Birla Sun Life and SBI Funds are the 5 largest with 57% of AUM.
  • The MF industry is expected to grow at a CAGR of 20% between FY18-22, with the AUM expected to grow to Rs. 45 lakh cr. by Mar 2022. Growth rates are expected to be higher in FY19 due to buoyant capital markets and increase in retail participation, after which it may taper down. Stock broking firms too perform very well when markets are in a bullish phase.
  • Global asset management firms have struggled in India as independent MF firms. Many sold out and exited. They have had a better success rate on partnering with Indian firms as the MF JV promoter.
  • India’s MF penetration (AUM to GDP) at 12.8% is much lower than the world average of 62% and also lower than developed economies like US (101%), France (76%), Canada (65%) and UK (57%) and even emerging economies like Brazil (59%) and South Africa (49%). This is expected to grow fast.

Financials of HDFC

  • HDFC revenues, EBITDA and PAT grew at 19.9%, 19.2% and 19.1% CAGR in 5 years, see Fig 3.
  • Margins for 5 years are flat but high double digits due to good exposure to equity assets. Given the high revenue growth, flat margin is a good achievement. Absolute profits have grown fast.
  • HDFC had a RoE of 33.4% in FY18 and RoCE of 49.1%. The return ratios are high and excellent.
  • HDFC paid dividends of Rs. 405 cr. in FY18 (including DDT). The dividend payout ratio is high at 56%.
  • HDFC has been Free Cash Flow positive in the last 5 years. This is good CF management, see Fig 4.
  • 76% of the pre IPO equity shares have been pledged by a non-promoter shareholder. None of the shares held by the promoter or promoter group have been pledged.
  • The issue has been priced at Rs. 1,100 share which translates to a P/E of 32.3 times. The market cap/AUM is 8%. This is aggressive and makes the issue expensive.

jainmatrix investments, hdfc amc ipoFig 3 – Financials, Fig 4 – HDFC Cash Flow jainmatrix investments, hdfc amc ipo

Benchmarking

We benchmark HDFC against other Indian and global AMCs. See Exhibit 5. Only Reliance Nippon is a pure AMC, other Indian firms have NBFC and broking businesses. US firms are for comparison.

  • The asking PE and P/B is high. HDFC has moderate 3 year sales and PAT growth. The NBFC business segments of Indian firms has allowed faster growth.
  • The Debt is low, but again for non AMC business, the debt is necessary so it not comparable.
  • The margins are at the higher end amongst most peers from the industry. This is a positive.
  • The return ratios historically also have been very high and robust among comparable peers.
  • Note – The USA companies data is for CY2017, Exchange rate is Rs/$ of Rs 68.

jainmatrix investments, hdfc amc ipo Exhibit 5 – Benchmarking

Positives for HDFC and the IPO

  • HDFC has a market leadership in the Indian MF industry of #2 on AUM and #1 on equity AUM. Their market share of total AUM was 13.7% and of actively managed equity-oriented AUM was 16.8%.
  • HDFC has a trusted brand and strong parentage of HDFC group. The holding company and the 3 other listed group firms have done well on the stock markets. HDFC Standard Life Insurance Co was the most recent to list in Nov 2017. It has also done well post listing, up 65% on IPO price.
  • HDFC MFs have performed well with a solid approach, philosophy and risk management.
  • HDFC has a superior and diversified product mix distributed through a multi-channel distribution network. Their product mix enables them to operate through various market cycles, cater to specific customer requirements and reduce concentration risk. Strong distribution relationships also ensure the commitment of the channels for new launches and investor support and confidence.
  • HDFC has consistently had assets and profit growth.
  • HDFC has an experienced and stable management & investment teams.

Risks and Negatives for HDFC and the IPO

  • The valuations are high in terms of P/E, P/B and market cap/AUM.
  • HDFC had overextended its distributor benefits pre-IPO, and was ordered by SEBI to avoid a conflict of interest and revoke the distributor allotment of shares. HDFC realizes the importance of distributors, but needs to take care to not cross the legal or market accepted limits.
  • The global macros are looking cloudy. Trade war tensions between USA – China can escalate. A diplomatic conflict with Iran is playing out. Oil prices are trending higher. Brexit threatens the UK economy. Europe and the Euro are looking weak with poor economic outcomes for the region. In this situation a sharp deterioration on any of these parameters can affect Indian investment climate.
  • AMCs are closely regulated by SEBI and is subject to changes or tightening of norms. For example in July 2014, the holding period for long-term capital gains tax on debt MFs was increased from 12 to 36 months. It is possible that regulatory changes can affect their business in future.
  • SEBI in Oct 2017 issued a circular to categorize and rationalize the MF schemes. MFs are classified into 5 groups, i.e., equity, debt, hybrid, solution oriented and other schemes. These 5 groups have 36 categories of schemes, and only 1 scheme per category is permitted by a MF. This has resulted in many MF schemes being merged, renamed and repurposed in the industry. HDFC has complied with the SEBI changes, but the rationalization may have a adverse impact on their brands and business.
  • Competition from existing and new MFs could reduce their market share or put pressure the fees.
  • The tax on Long term Capital Gains from equity was introduced in budget 2018 in Feb at 10%, from zero earlier. This caused a correction in markets, particularly the mid and small cap stocks.
  • Competition to the MF industry is from alternatives like the PMS industry, AIF/ Hedge Funds, Private equity markets and direct equity advisory services. Many of these are the next steps for MF investors after they have started their investment journey with MFs.
  • HDFC has defocused from PMS and other segments and appears to focus on Mutual Funds.

Overall Opinion and Recommendation

  • In India there is a massive trend of financialization of assets, a move away from physical / guaranteed assets like real estate, gold and FDs, towards equity and debt.
  • The MF industry is witnessing a massive growth with total AUM’s growing rapidly in the last 10 years. The number of new investors and their portfolios has grown significantly from retail investors. In fact the domestic driven MF industry has emerged as a foil to the FII investors in India.
  • The #2 player by AUM, HDFC AMC is well managed financially, has a great brand, high margins and return ratios, low CAPEX and cost structure.
  • Valuations look high in terms of PE 32.3 times, P/B 10.7 times and market cap/AUM at 8%. However we have seen that in emerging sectors/ industries the excelling high quality players can command very high valuations (think Avenue Supermarts in Retail and group firm GRUH Finance in rural home loans). HDFC certainly faces high competition, but can pull ahead and become #1 by AUM in the next few years. So a good track record, robust financial performance, sectoral tailwinds, reputed management team and strong promoter identity makes this IPO attractive.
  • Opinion: Investors can SUBSCRIBE to this IPO.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or known financial interests in HDFC AMC. He has a stake in HDFC Bank. Punit Jain may apply for this IPO in the Retail category. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Varroc Engineering IPO – An Auto-matic BUY

  • 25th June 2018
  • Mid Cap of Rs. 13,000 cr.
  • Industry – Auto Ancillary; IPO Opens 26-28th June at Rs. 965-967
  • Valuations: P/E 28.9 times TTM
  • Advice: SUBSCRIBE

JainMatrix Investments, Varroc IPOSummary of Report

  • Overview: Varroc Engineering is a global tier-1 auto component firm. They design, make and supply exterior lighting systems, plastic and polymer, electricals-electronics and precision metallic components to passenger car, CV, 2W, 3W and off highway vehicle OEMs directly worldwide.
  • India and global revenues are split 35:65 so they have good international presence.
  • Varroc’s FY18 revenue, EBITDA and PAT were Rs. 10,417 cr., Rs. 985 cr. and Rs. 451 cr. resp., and they grew at 13.1%, 12.9% and 18.2% CAGR in 4 years.
  • At a FY18 PE of 28.9x, valuations appear fair. It has a healthy balance sheet with conservative financials. It has good Indian and global presence.
  • Key Risks: 1) High Competition 2) Currency Risks 3) Downturn in macro-economic environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Other Auto Sector reports from JainMatrix Investments

Here is a note on Varroc Engineering (Varroc) IPO. You may also Download the PDF file – JainMatrix Investments_Varroc Engineering IPO_June2018

IPO highlights

  • The IPO opens: 26-28th June 2018 with the Price band: Rs. 965-967 per share.
  • Shares offered to public number 2.01 cr. The FV of each is Re. 1 and market lot is 15 numbers.
  • The IPO will raise Rs. 1,955 cr. while selling 15% of equity. The offer will be completed via an Offer for Sale (OFS) by existing shareholders of Rs. 1,955 cr. and there is no fresh issue of shares.
  • The promoter (Tarang Jain) owns 86.3% of Varroc which will fall to 85% post-IPO. The other investors 1) Omega TC Holdings (a PE firm) and 2) Tata Capital Fin. Serv. are fully exiting their 13.7%.
  • The selling shareholders are both Tata group firms that invested in Varroc in Mar 2014. The cost of acquisition was Rs. 162.4/share, so they are getting ~5x returns in 3+ years.
  • The IPO share quotas for QIB, Non Institutional Buyer (NIB) and Retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 55-60/share. This is a positive.

Introduction

  • Varroc is a global T1 (tier-1 companies directly supply to OEMs) automotive component group. It’s FY18 revenue, EBITDA and PAT were Rs. 10,417 cr., Rs. 985 cr. and Rs. 451 cr. resp.
  • They design, mfg. and supply exterior lighting systems, plastic-polymer, electricals-electronics, and precision metal components for PVs, CVs, 2W, 3W and off highway vehicle OEMs worldwide.
  • They are the 2nd largest Indian autocomp. group and a leading T1 mfg. and supplier to Indian 2-3W. It is also the 6th largest global auto lighting firm with 4% market share and $1 billion in sales and one of the top 3 independent exterior lighting players (by market share in 2016). Source: News reports.
  • Varroc started with the polymer business in 1990, and grew organically by adding business lines, like electrical and metallic and diversified products. Inorganic expansions – in 2012 Varroc acquired Visteon’s global lighting business, now known as Varroc Lighting Systems (VLS). In 2013, they acquired Visteon’s holding in a 50/50 JV with Beste Motor Co. Ltd. for auto lighting in China, Varroc TYC (China JV). They acquired 70% in auto accessories firm Team Concepts in 2018.
  • Varroc has 2 primary business lines, namely (i) VLS with the design, mfg. and supply of exterior lighting systems to passenger car OEMs worldwide. VLS has a portfolio of lighting products including Halogen, Xenon/high-intensity discharge, LED, OLED, Flex LED and LED pixel headlamp, catering to 5 segments in external automotive lighting. (ii) India Business with the design, mfg. and supply of auto components in India, to 2W and 3W OEMs, including exports. This offers products across 2 product lines, polymers/plastics, electrical/ electronics and metallic components. See Fig 1.

Fig 1- Varroc’s FY18 Segment Revenue/ Fig 2 – Varroc Geographic Revenue

  • Varroc has a global footprint of 36 mfg. facilities spread in 7 countries, with 6 facilities for the VLS, 25 for their India Business and 5 for others. In FY18, their largest customer contributed 18.6% of their revenue and their top 5 customers contributed 59.9% of revenue.
  • VLS has relationships with auto OEMs across the premium, mid-range and mass market pricing spectrum, like Ford, Jaguar Land Rover, Volkswagen, Renault-Nissan-Mitsubishi, Groupe PSA, FCA, a European car and an American electric car maker. The global lighting business has 185 patents.
  • Within India the 25 mfg. and 5 R&D centers form a footprint in the auto hubs, close to customers. Varroc has supplied to Bajaj Auto for 28 years across product lines, it is the largest customer contributing 18.6% and the top 6 are 50%. Other 2W customers are Honda, Royal Enfield, Yamaha, Suzuki and Hero. Export are to global 2W makers namely KTM and Volvo.
  • Leadership is Tarang Jain (MD age 56), Naresh Chandra (Chairman, 83), Ashwani Maheshwari (CEO India), T.R. Srinivasan (CFO) and Arjun Jain (head, electricals, 28). Tarang, Naresh and Arjun are related as Promoter, father and son. Stephane Vedie is the CEO of Varroc lighting, based out of USA.

Endurance Technologies – Snapshot and Varroc connection

  • Endurance Technologies is an India-based company, which makes aluminum casting (including alloy wheels), suspension, transmission and braking products. Endurance is connected with Varroc as Anurang Jain (MD Endurance) is the twin brother of Tarang Jain (Founder promoter of Varroc).
  • Income and PAT has grown at 11.6% and 17.5% CAGR resp. over 5 years. Endurance Tech had  its IPO in Oct 2016 at Rs. 472, the share has gained 176% since to Rs. 1,304.

JainMatrix Investments, Varroc IPO

  • Endurance Tech is perceived as a stable, fast growing and a high quality firm.
  • The Varroc promoters are related to the promoters of Bajaj Auto & Endurance. However even though Endurance Tech is owned by a brother, the two firms have separate businesses and different product offerings for the same customers, so they don’t compete directly. The two brothers had an amicable business split in 2002.

News, Business Notes and Strategies of Varroc

Varroc’s business strategies are:

  1. To focus on growth markets for VLS with new plants in Brazil and Morocco, to supply the South American, southern European and North African markets.
  2. To focus on increasing customer revenue for the India business.
  3. To invest in R&D, design, engineering and software capabilities and capitalize on future trends.
  4. Pursue strategic JV’s and inorganic growth opportunities.
  • In Feb 2018, Varroc entered into a JV in India with Dell’Orto S.p.A., a customer, for the development of electronic fuel injection control systems for 2W’s and 3W’s.
  • Varroc is setting up a mfg. facility in Brazil, one in Morocco and 2 in India.
  • Varroc in June 2018 opened an office in Tokyo to expand its global footprints. With this, they can now target Japanese OEMs for project management and engineering, lighting and electronics.
  • As per Tarang Jain, in the lighting business they want to be in the top 3 globally, while for the 2W business, they want to grow in India and also tap South-East Asia as they are the biggest markets. The revenue target is Rs. 20,000 cr. by FY21, double from FY18, through organic & inorganic growth.
  • Organic investments are going be about Rs 850 crore annually. Varroc has four successful acquisitions in the past, of the lighting business of US-based Visteon Corp, Tri OM for 2W lighting, IMES Poland & Italy for forging business and a small Indian firm which indicates their M&A success.
  • Varroc’s chief of Sales & Marketing Vikas Marwah quit in Apr 2018 after just 5 months. It appointed T R Srinivasan in Oct2017 as CFO taking over from B Padmanabhan, who retired after a 10-year stint.
  • Varroc is eyeing surface LEDs to drive future growth. Surface-LED technology uses thin layers of micro-optic filters and conventional LED light sources to achieve the homogeneous appearance generally associated with OLEDs. The metallic division is also targeting to grow 30% CAGR.

Automotive Exterior Lighting Industry Outlook

  • The global auto exterior lighting market had revenues of USD 17.8 bn. in 2016. Revenue grew 4.5% (FY11-16) CAGR and is expected to grow at 4.3% (FY16-21).
  • Globally, the market growth drivers are (a) increased LED penetration (b) technology innovation (c) design differentiation and (d) higher lighting content per vehicle.
  • The global auto exterior lighting industry comprises more than 20 players around the world. The main 8 players are Koito Mfg. Co., Magneti Marelli, Valeo, Stanley Electric Co., Hella KGAA Hueck & Co, Varroc Lighting Systems, SL Corporation and ZKW, which generated US$16.3 bn. in revenue, representing 91% of the total global auto exterior lighting revenue.
  • Varroc’s market share in the exterior lighting segment in India at present is reported to be 8%.

Financials of Varroc

  • Varroc’s revenues, EBITDA and PAT grew at 13.1%, 12.9% and 18.2% CAGR in 4 years, see Fig 4.
  • The 3 year PAT growth is modest. Varroc as a part of its strategy focuses on cost optimization.
  • Margins are in a range of 7.5-9.5% for EBITDA and 3-4.5% for PAT over the last 4 years. The margins are low, but at par with other OEM suppliers in the industry.

JainMatrix Investments, Varroc IPO

Fig 4 – Financials

  • Note: The FY15 figures are Indian GAAP, and FY16-18 are IND-AS numbers.
  • Varroc has a RoE of 15.9% for FY18 while the 3 year average RoE stood at 16.1% (FY16-18). The RoCE stands at 16.2% for FY18. These return ratios are moderate.
  • Varroc has been Operational Cash flow (CFO) positive in last few financial years. This is a positive. They have typically been investing available CFO for CAPEX i.e. funding expansion plans from internal accruals. It has generated FCFE in the last 3 years. See Fig 5.
  • The current D/E ratio is 0.42 which is moderate. There is ample room for the management to grow faster by raising debt. However Varroc has guided that they would not want a D/E of over 1.
  • The dividend payout ratio is low because of CAPEX needs, the FY18 ratio was 1.37%.

JainMatrix Investments, Varroc IPO

Fig 5 – Varroc’s Cash Flow  

Benchmarking

We benchmark Varroc against other comparable Indian auto ancillary companies. See Exhibit 6.

  • The PE post IPO is fair. PE ratio of Varroc is in the mid-range amongst its peers.
  • The 3 year sales and PAT growth are next to only Motherson indicating stability.
  • Margins in FY18 have improved and are also in the mid-range. The RoE for FY18 stood at 15.9% and RoCE at 16.3%. The return ratios are fair, not very low. The dividend yield at 0.05% is low.
  • In many ways, Varroc appears to be executing a strategy similar to Motherson, but are at about 1/5 the size in terms of revenue, PAT and target market cap.

JainMatrix Investments, Varroc IPO

Exhibit 6 – Benchmarking

Positives for Varroc and the IPO

  • IPO pricing and valuations are fair and at lower end of the peers.
  • Varroc has shown good financial performance and operating efficiency recently.
  • The MD appears to be hiring professionals at the next level / reporting to him, which should strengthen the firm and enable it to grow to the next level.
  • Varroc has a consistent track record of organic and inorganic growth. It has strong customer relationships with high quality OEMs in India, NorthAm and Europe.
  • Varroc has a proven business model and strategy, as seen with the success of Motherson Sumi. There is ample room to grow for Varroc in the sector globally.
  • Strong competitive position in attractive growing markets for VLS.
  • Low cost, strategically located mfg. and design footprint. Varroc has located its facilities primarily in low-cost countries but near major auto markets. They are making investments to expand into Brazil and Morocco, which would keep costs low yet deliver easily to their customers.
  • Robust in-house technology, innovation and R&D capabilities. The VLS business has 964 engineers located in 9 R&D centers, which are located in the Czech Republic, India, China, Mexico, Germany, the USA and Poland. Their R&D teams are focused on quick adoption of technology, enabling them to grow their product portfolio in line with customer expectations and industry developments.
  • Focus on expansion in auto electronics, an important trend in the industry.
  • The Varroc teams including the MD have good experience in the auto component sector.

Risks and Negatives for Varroc and the IPO

  • General economic conditions like the global trade war and protectionism.
  • Auto ancillary sector is considered a working capital and an asset heavy business. New orders involve big additions to working capital, so Varroc will need to manage growth and financial health.
  • Competition is high and Varroc may face pressure on price or margins in future.
  • Varroc is subject to environmental and safety regulations that it has to adhere to.
  • Their success depends on the success and survival of the auto models launched by OEMs. Thus several key success factors for Tier-1 suppliers are out of their control.
  • Varroc’s business is dependent on certain principal customers, especially Bajaj Auto in India. Sales to their top 3 customers for VLS were 50.7% of revenue for FY18, indicating client concentration. However this is a typical auto B2B situation.
  • Labour unrest is always a challenge in a firm with many employees. We came across news of strikes or unrest in Varroc factories in Aurangabad in 2009 and 2017. However these were quickly resolved.

Overall Opinion and Recommendation

  • The Indian auto ancillary mfg. is a high potential space with fair domestic size and growth; there are also significant global opportunities. India has many competitive & comparative advantages, so many global auto firms have set up here; there is also a vibrant two wheeler OEM sector here.
  • In this sector, Varroc has grown to a good size, has improving margins and marquee customers. It has a healthy balance sheet with conservative financials. It has both Indian and global presence.
  • Management quality is excellent with a global vision, eye for controlled growth and financial prudence and in sync with key global auto trends. Governance appears good and transparent.
  • At a FY18 PE of 28.9x, valuations appear fair, but are not cheap. We do not see a near term gain.
  • Key risks are 1) High Competition 2) Currency Risks 3) Downturn in macro-economic environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

DISCLAIMER AND DISCLOSURE

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake, ownership or any other known financial interests in Varroc or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Bandhan Bank IPO – The New MFI Leader

  • Date 14th Mar; IPO Opens 15-19th Mar at Rs. 370-375
  • Large Cap: Rs. 44,780 cr. Mkt cap
  • Industry – Commercial Bank
  • Valuations: P/E 40.2 times TTM, P/B 4.9 times (Post IPO)
  • Advice: SUBSCRIBE 
  • Overview: Bandhan is a commercial bank focused on serving underbanked and underpenetrated markets in India. Bandhan Bank has the largest microfinance loan portfolio, with Rs. 21,380 crores as of FY17. Bandhan bank has a great brand recall, strong financial performance, good asset quality and an experienced management. It is the new MFI loans leader. Presence in underbanked East and NE regions and universal bank structure are key strengths. At a P/B of 4.93 times (post IPO), the valuation look expensive. However Bandhan has a focus and a leadership position. It also operates in niche geographies.
  • Risks: 1) Economically and politically sensitive sector 2) Significant exposure to unsecured loans.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Related Reports:

Here is a note on Bandhan Bank (Bandhan) IPO.

IPO highlights

  • The IPO opens: 15-19th Mar 2018 with the Price band: Rs. 370-375 per share.
  • Shares offered to public number 11.92 cr. The FV of each is Rs. 10 and market Lot is 40.
  • The IPO in total will collect Rs 4,473 cr. while selling 10% of equity.
  • The promoter & promoter group owns 89.6% in Bandhan which will fall to 82.2% post-IPO.
  • The offer will be both a sale by current shareholders (OFS) and also by issuing fresh shares. The OFS proceeds would be Rs. 810 cr. at UMP and fresh issue size is Rs. 3,662 cr.
  • The selling shareholders are IFC and IFC Investment Co. They are partly exiting through this IPO. The IPO is being launched as Bandhan needs to comply with the RBI’s direction of listing publicly and reducing promoter holding to 40% within the first 3 years of operations.

jainmatrix investments, bandhan bank ipo

Exhibit 1 – IPO Selling Shareholders

  • The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 30-35/share. This is a positive.

Introduction

  • Bandhan is a commercial bank focused on serving underbanked and underpenetrated markets in India. They have a universal banking license that permits them to provide banking services pan-India across customer segments. They currently offer a variety of asset and liability services designed for microfinance (MFI) and general banking, as well as services to generate non-interest income.
  • Revenues, NII and profit for FY17 were Rs. 4,320 cr., Rs. 2,403 cr. and Rs. 1112 cr. resp. It has 27,176 employees. 88% of their gross loans were micro loans (FY17). 96% of their loan book is unsecured.

jainmatrix investments, bandhan bank ipo

Fig 2a – Loan products

jainmatrix investments, bandhan bank ipo

Fig 2b Gross Loans and Fig 2c Loans Segments

jainmatrix investments, bandhan bank ipo

Fig 3a Regions and Fig 3b Segments FY17

  • Bandhan Konnagar was formed in 2001 as a NGO providing microfinance services to socially and economically disadvantaged women in rural West Bengal. It later became Bandhan Financial Services Ltd and subsequently got the conditional banking license in 2014.
  • Bandhan operated across 33 States and UT’s through 887 branches, 2,633 doorstep service centres and 430 ATM’s. The gross loans of Bandhan are displayed in Fig 2b and 2c. 58% and 23% of the loans were from East and NE regions resp. for 9M FY18. Hence there is a geographic concentration risk.
  • Bandhan generates 87% of revenues from retail banking business. See Fig 3(b).
  • Total borrowings were Rs 1,330 cr. (9M FY18) and the cost of borrowings was 7.9% (FY17).
  • Leadership is Chandra Shekhar Ghosh (MD & CEO), Sunil Samdani (CFO) and Biswajit Das (CRO).

News, Updates and Strategies of Bandhan

  • IFC had invested in Bandhan Feb 2016 at Rs 42.93 so for their partial exit they will get 7.7X returns.
  • The bank’s loan book grew at 51% CAGR over past 17 years, which slowed to a still strong 33% by 9M FY18. As per mgmt., in next 2-3 years a 33-35% growth in advances can be achieved.
  • RBI’s guideline is to reduce the promoter’s stake to 40% within 3 years from the date of start of business as a bank. Bandhan received the nod in June 2015, so this timeline is quite close.
  • Bandhan’s business strategy is as follows:
  • To maintain focus on micro lending while expanding further into other retail and SME lending.
  • To strengthen their liability franchise in order to provide a stable, low-cost source of funding.
  • To enhance their digital platform to improve customer acquisition and retention and reduce costs.

Micro Finance and Banking Industry Outlook in India

  • Financing needs in India have risen along with economic growth over the past decade. By complementing banks and other financial institutions, NBFCs help meet this need.
  • MFI is a volatile sector that can be badly affected by economic and political events. The Bank structure is better to house MFI activities, as can be seen by Bharat Financial merger with IndusInd Bank, and SFB license to several players by RBI. Bandhan has a good advantage here.
  • Bandhan has the largest overall gross micro-banking asset portfolio, with Rs. 21,380 cr. as of FY17. Amongst the banks (private as well as public), the micro loans given by Bandhan are more than 3 times the next player, SBI.
  •  It has an estimated 15-20% share in MFI.
  • Penetration of Microfinance is low in NorthEast India, which can be to Bandhan’s benefit. See Fig 4.

jainmatrix investments, bandhan bank IPO

Fig 4 – Micro Finance Penetration (Source: The Bharat Microfinance Report 2017)

  • The gross loan portfolio (GLP) of MFIs grew at 51% CAGR from FY13 to FY17. This growth was fuelled largely by the growth in GLP of some large players, such as Janalakshmi Micro-finance, Bharat Financial Inclusion, Ujjivan Financial Services and Satin Creditcare Network.
  • Banking credit growth slumped in the previous 2 fiscal years owing to asset quality and capital adequacy issues. However, as per CRISIL Research bank credit will rise owing to improvements in working capital demand, marginal pick-up in private investment, increased govt. spending on the infra, improvements in commodity prices, and expectations of a good monsoon season.
  • Though demonetisation affected the retail sector’s credit performance in FY17, which dropped 300 bps from FY16, growth remained higher than industrial and agricultural credit growth in FY17. The retail segment represents more than one-fifth (23% as of FY17) of overall banking credit, and in turn, derives a major share from housing finance, which accounts for 53% of retail credit by banks as of FY17. So the retail segment was negatively impacted by the demonetisation-driven slump in the real estate sector. Retail credit grew 16% YoY, while industrial credit contracted YoY by 2%.

Financials of Bandhan Bank

  • Bandhan’s revenues, NII and PAT over the years are in Fig 5.
  • Previous data is not shared as its business model changed from an NGO to NBFC to a bank.
  • Bandhan had a RoE of 25.01% and RoA of 4.5% in FY17. This is excellent as the return ratios are high and amongst the best in the industry. It has not declared any dividends in the last 5 years.

jainmatrix investments, bandhan bank

Fig 5 – Financials (FY18 is projected by extrapolating 9M results)

  • NIM’s for Bandhan have declined in the last few years, however the NIM’s were high at over 11% in FY16 which has gradually declined to 9.86% in 9M FY18. Currently, it earns a high yield on loans, however as the bank expands its loan portfolio to other segments and into general banking there could be significant drop in the NIM.
  • The gross loan and disbursement growth slowed in FY17 due to demonetization related issues.
  • Bandhan has a robust asset quality. The GNPA as on 9M FY18 stood at 1.67% whereas the NNPA’s stood at 0.8%. The NNPA’s for FY17 were as low as 0.4%. Priority Sector Loans constitute 31.6% of the total advances as of 9M FY18. 97.6% of the GNPA’s are from the PSL loans for Bandhan Bank.
  • As a universal bank, Bandhan has a CASA ratio of 33.22%. This is fair, and should grow in future.

Benchmarking

We benchmark Bandhan against peers, See Exhibit 6.

jainmatrix investments, bandhan bank ipo

Fig 6 – Benchmarking

  • Majority of the peers have reported losses in 2 of last 4 quarters. Prices have however kept up well.
  • PE of Bandhan is the lowest in the peer group. However it is low because the peer group companies have depressed earnings reported in the last 4 quarters.
  • In terms of PB, the valuations are in the mid-range at 4.93 times post IPO. The valuation looks expensive considering that 96% of Bandhan’s loan book is unsecured and they would be entering new categories which have lower margins.
  • The D/E ratio at 0.15 (diluted post IPO) is the best and lowest and hence gives Bandhan scope to aggressively lend. The CAR of Bandhan stood at 26.4% for FY17 as against RBI’s minimum requirement of 15%, which indicates that it is adequately capitalized.
  • The RoE is the highest at 25.01% and Bandhan has the lowest GNPA’s (9M FY18) amongst its peers. This is a positive. Bandhan also has the lowest cost to income ratio of 36.3%.

Positives for Bandhan bank and the IPO

  • As a universal bank, Bandhan has flexibility to operate across multiple product lines and with few restrictions. It is the leader in the MFI industry as other players are Small Finance Banks or NBFCs.
  • World Bank arm International Finance Corporation (IFC) is an investor/ promoter of Bandhan.
  • Bandhan has a strong presence in East & NE India, which are more agriculture and agro-commodity intensive regions. We feel it may have high scope to grow and penetrate deeper here.
  • Bandhan’s growth has been achieved despite difficult conditions in India’s MFI and banking industry. Events like the crisis in the southern state of AP in 2010, demonetisation in late 2016 and farm loan waivers, were challenges for the banking industry. But Bandhan did well.
  • In MFI, achieving volumes of loans is a powerful advantage as the costs of reach and distribution are shared across many loans. With a good marketshare and presence in East & NE, it has an advantage.
  • Bandhan has a large low cost distribution network. They operate in 33 States and UTs in India, reaching 1.2 crore customers. Bandhan’s distribution network is relatively low cost because of its ‘hub and spoke’ model of using DSCs and associate bank branches, and focus on tech initiatives, which reflects in their operating cost-to-income ratio of 35.4% & 36.3% for 9M FY18 & FY17, resp.
  • The asset quality of Bandhan is stable with NNPA’s at 0.80% for 9M FY18. Financially the firm is well managed with excellent return ratios, good margins and tight controls on costs. This is a positive.
  • Bandhan has a good management team. The founder, MD & CEO, Mr. Chandra Shekhar Ghosh, has 37 years of experience in Indian MFI. Members of their senior management have a track record that combines professional and entrepreneurial skills in microfinance and banking, with average 23.9 years of experience in finserv. 8 of 12 directors on the board are Independent Directors.

Risks and Negatives for Bandhan and the IPO

  • The valuations are on the higher side in terms of P/B at 4.93 times (adjusted post IPO).
  • Bandhan has a limited financial history and a rapidly evolving business which makes it difficult to evaluate their business and future operating results.
  • Bandhan’s micro finance loan portfolio is not supported by any collateral that could help ensure repayment of the loan, and in the event of non-payment by a borrower of one of these loans, they may be unable to collect the unpaid balance.
  • Bandhan handles cash in a high volume of transactions occurring through a dispersed network of branches and DSCs; as a result, they are exposed to operational risks, including fraud, petty theft and embezzlement, which could harm financial position.
  • Bandhan’s business relies significantly on their operations in the East and NE states, and any adverse changes in the conditions affecting these States can adversely impact their business. As of FY17, roughly 81% of Gross loans were located in such areas.
  • The microfinance sector is sensitive to economic, political and weather events

Overall Opinion and Recommendation

  • Microfinance sector carries out the critical role of financial services penetration into rural India. MFI’s have been operationally under stress since 2017 due to demonetization and GST rollout. The earnings were impacted due to a spike in defaults and business disruption. However the current signs are that this impact is over and the rural economy & demand is regaining strength.
  • Bandhan bank has a great brand recall, strong financial performance, good asset quality and an experienced management. It is the new MFI loans leader.
  • Presence in underbanked East and NE regions and universal bank structure are key strengths.
  • At a P/B of 4.93 times (post IPO), the valuation look expensive. However Bandhan has a focus and a leadership position. It also operates in niche geographies.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or known financial interests in Bandhan or any group company. Punit Jain intends to apply for this IPO in the Retail category. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.