Customers wait to exchange banknotes at a Syndicate Bank branch in Dadri, Uttar Pradesh, India. (Photographer: Anindito Mukherjee/Bloomberg)

Why Analysts Prefer Equitas Holdings Over Peers

Equitas Holdings Ltd. remains the most preferred bet by analysts despite giving worst returns among peers in the past one year as small finance banks struggled to recover from the setbacks of the note ban and farm loan waivers.

Shares of the microlender-turned-small finance bank fell 3.4 percent in the last one year compared with 32 percent and 10 percent gains in AU Small Finance Bank Ltd. And Ujjivan Financial Services Ltd., respectively.

Yet, 15 out of the 19 analysts tracked by Bloomberg have a ‘Buy’ rating, with the stock trading 25 percent below the consensus one-year target price. Their optimism stems from its clean-up of microfinance bad loans, which jumped twofold after the note ban, and falling share of microcredit in its loan book.

That, according to UBS and Bernstein, will help Equitas the most as erstwhile microlenders recover from the pain of demonetisation. Prime Minister Narendra Modi’s move to scrap 86 percent of the currency in circulation had hurt recoveries as borrowers, typically from low-income groups, ran out of cash. In some states, they also stopped repaying in hope of farm loan waivers, adding to the lenders’ troubles.

Equitas’ profit rose 127 percent year-on-year to Rs 35.4 crore in the quarter ended June, driven by fall in provisions. Here’s what helped the lender:

Change In Asset Mix

The company lowered its microfinance exposure from 46 percent to 28 percent of its total book.

Recovery In Loan Growth

After a slowdown that lasted several quarters, Equitas’ assets under management grew nearly 27 percent annually—led by its non-microfinance segment which rose 59 percent year-on-year. Its microfinance book, too, grew 6 percent sequentially after six straight quarters of contraction.

Improving Asset Quality

The lender’s bad-loan ratio remained stable after a clean-up in the previous financial year.

Improving Operating Efficiency

Equitas’ operating expenses rose as it opened new branches, resulting in a higher cost-to-income ratio. The bank’s management said it will leverage its existing branch network and improve productivity without major expansion or hiring. The bank’s cost-to-income ratio has been steady at around 76 percent. The pace of growth in operating expenses has been falling.

Deposit Mobilisation

Total deposits account for nearly half of total funding, with low-cost current and savings accounts contributing a third of it.

Falling Cost of Funds

The lender’s cost of funds fell to 8 percent from 9.2 percent in the year-ago quarter. However, its yield on loans also fell to 19.2 percent from 21 percent, offsetting part of the gains.

Valuations

While Equitas and its closest competitor Ujjivan Financial Services have rebounded from their 52-week lows, they are still inexpensive compared with pre-note ban valuations. Equitas trades at a price-to-book multiple of 2 times compared with 2.2 times for Ujjivan and 5 times for AU Small Finance.

A key difference lies in the composition of their account books. Equitas’ non-microfinance portfolio contributes around 72 percent compared with Ujjivan’s 10 percent.

Saurabh Rathi, senior research analyst at IIFL Securities, expects the cost of borrowing for Equitas to reduce on the back of higher deposits, given its diversified profile and branch expansion. Equitas’ loan book is growing faster than Ujjivan’s, he said, adding that Ujjivan is also facing challenges in client acquisition.

Brokerage Take

UBS

  • Maintains ‘Buy’, but revised the target price to Rs 240 from Rs 250—that still implies an upside potential of 65 percent.
  • Preferred pick in the small-finance banks category.
  • Superior growth and upcoming banking franchise at attractive valuations.
  • Expects assets under management to grow over 30 percent during FY20-23.
  • Strong traction in deposits to continue.
  • Cost-to-income ratio to decline to 62 percent in FY21 from the current 76 percent.
  • Strong loan growth and improvement in return on equity of 18-20 percent to drive re-rating in the next 12 months.

Bernstein

  • Maintains ‘Outperform’ rating and a target price of Rs 210—an upside potential of 45 percent.
  • Growth recovery on track and operating leverage is kicking in.
  • Needs to gain confidence on asset quality.
  • Stable asset quality in the next few quarters will drive re-rating.
  • Absolute numbers of bad loans remain a key watch.