Ujjivan Financial Services Limited

Ujjivan Financial Services  - A pure play on financial inclusion

About Ujjivan: 

Established in 2005, Ujjivan is the 3rd largest MFI in India with a gross loan book of ~INR 6,588 crores and an active customer base of ~35.8 lac borrowers across India. Ujjivan has a Pan-India presence through its 469 branches in 209 districts of which 185 branches are in 91 under banked districts. Ujjivan started rolling out small finance banks in mid February in Bengaluru. 

Products offered by Ujjivan:

Some of the products offered by Ujjivan are:

• Group Loan ( includes business loans, agriculture and allied loans, family loans, education loans, etc.)
• Individual Loans ( includes home improvement loans, business loans, education loans, etc.)
• Secured Individual loans
• Secured Individual home loans
• Secured and unsecured business loans for the MSME sector
• Pragati Individual loans ( these come with insurance cover )
• Ujjivan Small Savings Bank ( more on this later !!!)

Lets now get down to actually learning and understanding more about Ujjivan and what could be a more better way than starting with the Management Discussion and Analysis (MD&A) of FY16 Annual report. For those who do not know what an MD&A is - It is the single most important part of the Annual report where we can actually understand the business from the Management's perspective, dynamics and growth drivers of the business and gauge the confidence of the Management in the future prospects.

So lets delve deep into the MD&A. For the ease of reading I have highlighted the important factors in the MD&A and mentioned my thought process to (click here).

Some of the Key highlights of the MD&A are:

• Loan growth of ~65% from FY15 to FY16
• Higher growth the in the Individual loan segment which is high risk but higher NIMs
• 53% growth in disbursements
• Improvement in efficiency with cost to income ratios coming down, borrower per field staff increasing and loan book per branch increasing, decrease in loan processing time 
• Increase in NIMs due to both change in borrowing mix by reducing dependence on banks for finance and better and more diversified product mix with value added products like Pragati Loans.
• Healthy repayment rate of 99.8% & NPAs under control with GNPAs comfortably under the industry average
• 61% of disbursement by way of cashless route (This is precisely the reason Ujjivan has been able to sail through the Demonetization worries as we will see later)
• One important aspect on the service - They state that their service quality program is the differentiating factor in the MFI sector (and mind you the MFI sector is extremely competitive with many players). With this program dormant/ dropout account holders are met by customer representatives for exit interviews and Ujjivan was able to retain ~44% of these customers after addressing their concers. This is commendable and helps in customers being sticky

Effects of DeMo on Ujjivan:

As we all know that India was faced with in Nassim Nicholas Taleb's words a 'Black Swan Event' - Demonetization. In order to gauge the effects of DeMo on Ujjivan let's have a look at the extracts of the latest (Q3FY17) investor presentation (click here) and the conference call transcript (click here). As with the MD&A I have highlighted the important points and written my commentary and thought process.

Key highlights of the investor presentation: 

• Collections/ Repayment rate was down to 88.2% in Dec 16 but improved to 91.1% by Jan 17 (and as per the con call transcript page 13 and 14 the Management seems to be confident to achieve the 99% repayment rate)
• Disbursements have been a key concern as they have reduces by ~24% over Q2FY17 and 0.5% over Q3FY16 (My sense is that this is a temporary phenomenon and normalcy should resume soon)
• The higher provisioning shows conservatism on part of the Management (If you read between the lines on page 4 of the con call transcript, we can gauge that if things go right and normalcy resumes as expected a significant portion of this provisioning could be written back in the next qtr. boosting profits)
• Inspite of the DeMo scare credit quality has been under check as shown by the GNPA and NNPA ratios which are under control
• Improvement in NIMs from 9.3% in FY15 to 10.5% in FY16 and 13.22% in Q3FY17 (Expect this to come down, more on this when we discuss its foray into small finance bank)
• Pan-India presence - Ujjivan is the largest MFI in India in terms of geographical spread. This helps mitigating regional specific shocks --- Remember what happened to SKS Microfinance !!!
• We could expect 'other expenses' to be on the higher side for the time being as Ujjivan is in the transition phase as it becomes a SFB

Lets now look at some statistics that help us understand the potential of the Micro Finance Industry in India

• As per a recent news article India has ~13% of its population which is unbanked this figure is ~167 million. Moreover, the article goes on to say that the GoI acknowledged in June 2016 that ~40% of the country is 'outside the ambit of formal banking'. 
• ICRA estimates the potential size of microfinance market at INR 2.8-3.4 trillion over the next 3 years. This results in an ~30%-35%  annual CAGR.

This gives great opportunities to Ujjivan for growing and expanding its foot prints in the country and ride on the current government's goal of financial inclusion. MFIs in general have an added advantage over commercial banks ('CB') in tapping the hinterlands of the country as the very business model on which MFIs work is not economical for CBs. CBs are reluctant to cater to these segments due to low ticket sizes of loans, lack of documentation, high branch costs,etc.

Small Finance Bank - Big opportunities !!!

Ujjivan commenced it's SFB operations in Bangalore with 5 pilot branches in mid-February 2017. Lets look at some basic benefits and risks one would expect:

Major Benefits:
1. Low cost of funds as they will now have access to CASA
2. One stop shop for all financial products
3. A wider products base and better risk management avenues

Short-term risks:
1. Large one-time transition costs
2. Slow down in growth in the short term as all efforts will be towards transitioning
3. As SFB it will have to maintain SLR/CRR as per RBI guidelines, which will be a drag on returns

The risks I believe are short-term in nature and with the pedigree Management on board they should be able to manage this pretty smoothly. Ujjivan expects convert all the existing branches to the SFB in the coming months.

Historical Parameters of Ujjivan:

Peer comparison:

I have provided a peer comparison of the listed MFI stocks based on some important parameters. Certain items have been written in red font. These are some of the differentiating factors when compared to Ujjivan. Lets discuss those.

• Bharat Finance Inclusion (BFI): NIMs @ 10% are lower than Ujjivan, Loan per branch is ~INR 6 crs which is 55% lower than Ujjivan showing poor operating efficiency. Mcap of 1.34x shows rich valuations compared to Ujjivan. It has a very good CRAR ~36%, highest in the industry

• Equitas: Cost to income is extremely high at 60.9% when compared to Ujjivan's 49%. There is little geographical diversity as Equitas is a south based MFI. Loan per branch too is INR 10 crs. 

• Satin: Cost to income is extremely high at 61% when compared to Ujjivan's 49%. It has the highest leverage ratio 5.5x which is alarming, so essentially a major component of ROE in the benefit of leverage and not profitability and efficiency (remember du-pont anlalysis). It is pre-dominantly north based (mainly UP). The major red flag in this company is its promoters pledging ~5% of their equity stake. I would refrain from investing in such companies unless there are other factors which are extremely compelling and I see none here.

Conclusion:

As we have seen the MFI industry is in a sweet spot to reap the benefits of the financial inclusion in India and according to me Ujjivan is that cherry on the cake. Pan-India presence, low NPAs, High NIMs, well capitalized and most importantly a pedigree Management which is extremely conservative and at the same time growth oriented are some of the strong points of Ujjivan. The Management has proved its might by sailing smoothly through the DeMo period. 

At 3x Price/Book Ujjivan is priced lower to BFI and Satin inspite of having a much superior working whereas if we compare to Equitas it is tad bit more expensive but again with much higher NIMs, lower cost to income ratio, a pan-India presence, etc. And as Buffet says: 

'Price is what you pay, Value is what you get'

I would surely consider having an exposure to Ujjivan in my portfolio and keep adding on corrections.

Disclaimer: I am not a SEBI registered research analyst. This blog only contains my personal views about the stock market and equities. Any investment done should be post your own analysis and risk assessment. My family portfolio has ~5% exposure in Ujjivan at lower levels.

Constructive feedback is appreciated !!!