After covering the banking sector and it’s two most recognized banks (HDFC and Kotak Mahindra), in this article, we shift our focus to the NBFC Sector. Without 2 thoughts, the leader of this sector is Bajaj Finance! So let’s see what makes Bajaj Finance the consumer financing giant it is today!
About Bajaj Finance
Bajaj Finance Limited(BFL/BAF) is a deposit-taking Non-Banking Financial Company (NBFC-D) registered with the Reserve Bank of India (RBI). BFL has a diversified lending portfolio across retail, SME, and commercial customers with a significant presence in urban and rural India. It accepts public and corporate deposits and offers a variety of financial services products to its customers. It has two 100% subsidiaries: (i) Bajaj Housing Finance Ltd. (‘BHFL’ or ‘Bajaj Housing’), which is registered with National Housing Bank as a Housing Finance Company (HFC); and (ii) Bajaj Financial Securities Ltd. (‘Bfinsec’), which is registered with the Securities and Exchange Board of India (SEBI).
Bajaj Finance has created immense wealth for its shareholders from 2007 to 2020, delivering a CAGR of an eye-popping 46%. The company has definitely come a long way as the stock was Rs 35 on 02/01/2007 and Rs 4923 at the top in Feb 2020, delivering a staggering absolute return of 14065% or 140.65x!
Bajaj Finance has been in news a lot lately for a lot of reasons –
We see above that Bajaj Finance has fallen from its peak of Rs 4923 to Rs 1915, a fall of 60%+. Now definitely, we all have been told the news and have seen data that concludes that Bajaj finance is a great business, right? Well, to just bust that myth, even great businesses can correct heavily (and have corrected heavily in the past. During the 2008-Recession, Kotak Mahindra Bank lost its value by 84.9%!) as everything including valuations has a limit.
So what’s the reason for the fall this time?
One of the main reasons for the fall in the whole financial sector space (Banks and NBFCs) including Bajaj Finance is mainly due to the Covid-19 uncertainties and business disruption. To simplify, a bank is a business of lending and since most of the businesses are virtually doing 0 sales or operating at dismal capacities, some or good part of the repayment of loans will be a big doubt posing a very big risk to financial firms in particular!
The Origins of Bajaj Finance
Originally incorporated as Bajaj Auto Finance Limited on March 25, 1987, the non-bank singularly focused on providing two and three-wheeler finance. After 11 years in the auto finance market, Bajaj Auto Finance Ltd launched its IPO. Bajaj Auto Finance Limited became Bajaj Finance Ltd (BFL) from September 2010.
In 1994-95, Bajaj Auto Finance came out with an initial public offer and was listed on the BSE and NSE. Initially, the company was promoted by erstwhile Bajaj Auto Ltd and Bajaj Auto Holdings Ltd.
The complete history of how Bajaj Finance came into being and how Bajaj Auto was demerged is given here – De-merger information.
Products of Bajaj Finance
It has a history of adding products rapidly to its overall portfolio.
Shareholding pattern of Bajaj Finance
Bajaj Finance also has China’s central bank PBOC as a shareholder! I checked March 2020 shareholding pattern but their name doesn’t get disclosed as they are holding less than 1%. It will be interesting to see the investor PPT this time and see their stake this time!
Also BAF has no shares pledged.
Loan Book breakup of FY09 vs FY20 –
This is how the loan book of Bajaj Finance has evolved from FY09 to FY20(9MFY20).
Bajaj Finance 14 year history in numbers –
We clearly see the phenomenal growth of Bajaj Finance above. Its profit has increased 100x from FY07-20, its AUM increased 56x and its Customer franchise increased 17x from 2.5 million in FY08 to 42.6 in FY20. All this has been done while keeping its asset quality under check.
Business Model of Bajaj Finance and How it earns money?
Bajaj Finance is known in the nonbank lending industry for its customer-profiling algorithms and short loan durations. Among the hundreds of parameters used, for instance, is the store visit time of the potential borrower — a data point that allows the company to assess creditworthiness.
Bajaj Finance is a success story in the consumer durable financing. The banking sector ignored this segment because of low-ticket value, higher operational cost including difficulty in recovering loans in case of bad debts. But Bajaj Finance came out with an app-based model (with EMI facility) by tying up with manufacturers in segments such as mobile phones, TV, fridge, and even furniture.
So the 5 factors which help Bajaj Finance earn money are as follows –
Interest cost on loans is distributed across three levels — manufacturer, dealer and the customer. The charge varies depending on the product, EMI financing option and the sourcing dealer.
Zero Cost EMI – Zero Cost EMI schemes at the face of it may look like a free lunch but there are no free lunches in this world. These are never 0% as IRR to BFL but almost 10 to 20% of IRR (internal rate of return) due to processing fees, advance EMIs, subventions from dealers, retailers, manufacturers, etc!
Tie up with Brands/Retailers – BAF has tied up with a lot of brands and retailers such as Flipkart, Amazon, Croma, Future Group, Yatra, Paytm Mall, MakeMyTrip, Bajaj, RBL Bank, Vivo online store, Choose My Bicycle and many more. This helps retailers in financing their goods sold and BAF earns fees on this too!
Tie up with Manufacturers – NBFCs offer zero-interest finance by charging interest to the manufacturer or dealer. Subvention charges range from 2% to 10% of the product price and depend on the tenure, product specification. Subvention costs are considered as selling/promotional expenses by OEMs. With financiers ramping up their tie-ups with the product manufacturers, overall competitive intensity is rising.
Processing Fee/ Late Payments – This is one of the big revenue earners for financial lending firms. Processing fees can range from 1-3% with late payments being 24-40% per annum!
Cross-Selling – As of Q3FY20, we see that their cross-sell franchise represents 76% of their total franchise which is a very big number! In FY15 this number was just 48% showing how BAF has been getting synergy benefits due to this!
Example – They take a certain percentage at every stage: 7-12% from manufacturers to finance the product. + 2-3% from dealers (actual shopkeeper) in some cases. Let’s assume, I buy a Samsung fridge worth 50,000, BAF will take 7-9% from Samsung & around 1-3% from Shopkeeper. (I guess shopkeeper model is now slowly being changed. Now only the Manufacturer pays, But not in the case of all manufacturers.) I am using these figures because in FY19 their interest income was 11878 Cr on an AUM of 115888 Cr, a yield of 10.25%.
BAF Cross Selling – Biggest differentiation?
One of the major reasons behind Apple being a successful company is that they create a cross-selling ecosystem of hardware and software which is hard to leave (Customer stickiness is there, an Apple user doesn’t migrate to other hardware/software major)! If you have an iPhone, then you buy an iWatch, then apps on the App Store, and so on. Therefore from this, we can extrapolate that it is an amazing strategy to cross-sell to the same customer and retain him with the company through multiple products/services. This is something we see in Bajaj Finance as well. If a customer has a mortgage loan with BAF, then he may take his other loans from BAF only as his KYC will be done already and he will get better EMI offers by being an existing customer.
Now Bajaj Finance has been clocking high growth and been acquiring customers at a fast speed! That brings us to the question – what about risk?
It has deeply invested in its risk organization structure that includes dedicated credit risk units for each business vertical; business-specific units, viz., underwriting, risk containment, and fraud control; and horizontal risk analytics, business intelligence, and operational risk management unit. This deep structure ensures granular risk management of the portfolio. Its strategy of ‘acquire and cross-sell’ to manage cost and portfolio risk, based on the axiom that an existing customer poses significantly lower credit risk than a new customer, ensures lower risk across portfolios.
Most businesses in BFL are focused on acquiring mass affluent customers — who represent a bigger wallet, larger cross-sell opportunities, and lower risk. BFL’s lending portfolio is diversified across various secured and unsecured products to meet almost all the needs of the customer.
It is known for its customer-profiling algorithms and short loan durations. Among the hundreds of parameters used, for instance, is the store visit time of the potential borrower (other parameters include the bureau score, age, income level, employer, repayment history, and many more factors) – a data point that allows the company to assess creditworthiness.
BFL leverages its large customer franchise to build robust yet nimble risk and propensity models as well as policy rules to best serve customers with offers that are most appropriate for them. To do this, BFL has deeply invested in analytics to build models to support decisions, implemented
Machine Learning (ML) models in addition to classical logistic regressive models and is deeply investing in Artificial Intelligence (AI). These models and decision trees are deployed on state-of-the-art technologies like decision engines with real-time processing capabilities. These enable ‘get now’ and ‘straight-through processing’ to constantly push towards a smoother and frictionless experience for our customers. While doing so, BFL is mindful of the customer’s privacy and ensures customer consent is obtained for any cross-sell offerings.
They are also actively investing and deploying capabilities in Artificial Intelligence (AI) and Machine learning (ML) in the area of facial recognition, optical character recognition (OCR), natural language processing (NLP), and voice. These technologies enable frictionless customer experience at various touchpoints.
Click on hyperlinks to know the milestones achieved by the company in the mentioned period.
About the CEO
The CEO of Bajaj Finance is Sanjiv Bajaj. Having worked on the Bajaj Auto Limited(BAL) shop-floor in the early nineties as a management trainee, he went on to complete his MSc in Manufacturing Systems Engineering from the University of Warwick, UK, before returning to BAL. After an MBA from Harvard Business School in 1997, he did ten straight years at BAL, involving himself in various functions from finance to exports until the demerger in 2008.
Company Management Commentary over 8 Years
Have the management achieved what they guided for over 8 Years?
Out of the 25 times they have guided or given guidance for, they have achieved guidance 20 times, translating into an 80% success rate. It has achieved its guidance 1 time partially.
One thing to note here is that management always guided for 25% AUM FY growth but always ended up growing 30-40%. Analysts said why don’t you revise to upward growth targets, but the management said they want to be conservative.
What differentiates Bajaj Finance from other NBFCs? (Probable Moats)
ALM (Asset Liability Management)
Asset Liability Management is how the financial institution lends (asset) from its borrowings (liabilities). After the IL&FS crisis, the ALM crisis blew up as many financial firms were funding long-term assets by short-term liabilities (Borrow short term and lend long term). If the short term financial instruments market sees credit events, the costs may shoot up badly. (Lots of banks and NBFCs saw their costs shooting up due to ALM mismatch and the liquidity drying up in the money markets.)
Unlike other NBFCs who face ALM problems, here, in the case of BAF, we see that they don’t have this problem. This is because Bajaj does the opposite of what most NBFCs do, they lend short term(1-3 years) and borrow long term(3 years and above). Notice the positive mismatch shown above which shows their inflows are more than outflows in all maturity or time period of buckets. Its loans close in less than three years and some are as short as six months, leaving little room for asset-liability mismatches. One of the main reasons for Bajaj Finance doing well!
We see Bajaj Finance has been following disciplined ALM management over the past 8 years –
Huge Cross-Selling – As of Q3FY20, we see that their cross-sell franchise represents 76% of their total franchise which is a very big number!
Low cost of Marketing – In this article itself, we saw before that Bajaj Finance has a tie-up with almost all the big retailers/manufacturers/brands (along with their own data collection) that gets them a massive database of potential customers for their other services, without spending on marketing. Bajaj has a very low customer acquisition cost because of this very reason. They do a lot of data analytics with this data and use it to cross-sell other products like home loans, personal loans, insurance, etc. They have automated processes that generate offers and market it to customers through email, SMS, etc based on repayment data and much more.
Outsourcing – The company has outsourced most of its back and mid-office functions, which help them to save costs. In FY11 they spent 30 Cr (2.2% of net worth) on these outsourcing expenses and in FY19 they spent 210 Cr (1.1% of net worth). Now a question arises, why this outsourcing, won’t it be cheaper and better to do this in-house? The next point explains why outsourcing works for BAF.
Relentless focus on the smallest of costs – In Q1FY20 the management said “We run a reasonably high variable cost model that is one point. I can dial up and dial down. 70% of my technology runs on cloud infrastructure, allows me to dial-up, down dial at a far more rapid pace than anybody in the country. That is point number one. My ‘point of sale’ people are temp staffing, allows me to dial-up, dial down. I am giving you texture so that we are all on the same page. My mid-office, the back office is run by BPO companies, can do dial-up, and dial down in 90 days. Level 4, we would like to remain a disciplined company in terms of managing costs. Sandeep has a unit, which fundamentally runs a financial planning analysis wing, whose goal is to take out blind spots on costs. This year’s goal alone is that Rs.250 Crores of cost has to be taken out. I am just giving you texture so that we are all doing a disciplined conversation on the way we run business rather than a transient conversation. So that is really on the management of cost and our approach to managing expenses and cost.”
Faster TAT (Turn-around time of loans) – BAF is known for its customer-profiling algorithms and short loan durations. Among the hundreds of parameters collected and used, for instance, is the store visit time of the potential borrower (other parameters include the bureau score, age, income level, employer, repayment history, and many more factors). This collection of data gives them access to a lot of variables associated with a lender and then helping them decide the credit-worthiness and repayment probabilities. All this is done and the loan is disbursed within 2 minutes! In some segments, it is less than 15 seconds (They reduced the approval time for Durable and Lifestyle Financing from their own benchmarked time of 15 minutes to 5 seconds flat by 2011.) I had personally taken a Zero cost EMI in Dec 2019 from a leading bank’s NBFC/consumer lending arm and it took me 3 hours!
Liability mix/ Various sources of funding –
We see that BAF is dependent on 6 sources of funding mainly Despoits, Bank Loans, NCD, Subordinate Debt, Short term Borrowing, and External Commercial Borrowing (ECB). On the other hand, other NBFC’s may be dependent on 2-3 just sources. This shows the cautious nature of management by diversifying its liability mix.
At this stage, we must congratulate management for reducing % of Bank borrowings and increasing % of Fixed deposits. This is similar to a retail liability franchise (CASA) which is being chased by banks. Of course in the bank’s case, the overall cost of funds becomes very less, but since Bajaj Finance being an NBFC, they need to give higher rates for their FDs.
Deposit Taking – BAF has built a good liability franchise with stickiness (meaning the FD holder sticks with BAF. This is important as then the base of liabilities keeps getting bigger and FDs become a stable source of funding). I quote this from their Q3FY20 concall “Fixed deposit book has crossed the Rs. 20,000 Crore mark, which is 76% growth. 61% of our book is retail, pure retail, with an average deposit of Rs.3 lakhs and an average tenure of 35 months. We launched the SDP (Systematic Deposit Plan) to further utilize our retail deposit program. We continue to work towards growing this part of our balance sheet.”
Granular Loan Book – The Bajaj Finance mortgage portfolio, according to the management commentary, consists of borrowers who are salaried for the last two years with an annual income of Rs 11-13 lakh. In the SME loan book, BAF only deals with SMEs having a turnover of Rs 5 to 16 crores. Two-wheeler and B2B business is highly granular by being present in 2300 cities and towns in India. The consumer B2C loans are expended to the customers who have a bureau score of 750 and above. A score of 750 and above is considered good credit. (65% of its B2C loans given to score of 750 and above).
Massive Reach – It does business through 986 urban locations and 1,193 rural locations with over 1,07,100+ distribution points.
Strong brand name and track record – The Bajaj Group has a robust brand name and is among the oldest business houses. Through various companies, the group has a presence across several industries. The financial services business has been in existence since 1987 through BAF and also has a strong presence in life and non-life insurance business in India.
Diversified player – This 33-year-old non-bank finance company has a well-diversified range of financial services which spans consumer, payments, rural, SME, commercial & mortgage lending.
Rapid Product Addition – We see here the pace of rapid product additions by BAF in its overall portfolio. This reminds me of the quote “If a window of opportunity appears, don’t pull down the shade.”
Product Innovation – BAF continuously innovates by coming up with newer products & being a part of the supply chain of almost every industry. Bajaj recently launched the Bajaj Health EMI Card which you can use to convert your Hospital, Pharmacy & Diagnostic bills/Payments into EMI. Bajaj finances everything from your house to your furniture to now your medical bills!
But enough of good things or achievements now, let’s see its performance during crisis and its risks.
Bajaj Finance comparison with peers during crisis
I always believe to judge a company by not how it grows during good times but how it insulates itself and makes the best of the opportunity during a crisis. With that let’s see how Bajaj Finance fared during these 2 major crisis in India –
We can notice how Bajaj Finance grew 40% in the period of demonetization. Its net income and net profits grew while its asset quality was stable. For other players, net profits fluctuated and so did provisions. It is safe to say that Bajaj Finance came out stronger after the demon period. Also, it is not entirely an apple to apple comparison, but this example is just to show how other’s made larger provisions and had a hit on their asset qualities.
While other NBFCs were grappling with existential crisis because of ALM mismatches in the immediate aftermath of the IL&FS crisis, Bajaj Finance, by contrast, expanded its loan book by 38% in this period. While others were scrambling to change their liability mix and tinker their business models, BAF was growing comfortably.
The management in Q2FY19 (the quarter when the crisis hit) said this “It was a pretty strong quarter for the company. Overall liquidity remains comfortable. We remain open for business across all lines. The last time around when we saw liquidity squeeze or freeze, we were at Rs. 24,000 Crores AUM. Today we are having Rs.1,00,000 Crores AUM. We will have another squeeze five years from now so that you are all clear. It is part of the financial system, events differ, every time squeezes happen. Last time around, it was a taper tantrum. This time, it is about the failure of a non-bank, five years from now it will be something else. It will teach the good companies to take the message and build a stronger business model, which is the way we look at it.”
About the Bajaj Group
The origins of the Bajaj group date back to 1926—the year it was founded by Jamnalal Bajaj, a freedom fighter, philanthropist and close confidante of Mahatma Gandhi. It is said that Gandhiji treated Jamnalal as his fifth son. In 1931, at the behest of Mahatma Gandhi, Bajaj founded a sugar factory in Lakhimpur Kheri of Uttar Pradesh, paving the way for the formation of what was originally the flagship company of the group, the Hindusthan Sugar Mills Ltd, renamed Bajaj Hindusthan Ltd in 1988.
How to pick a good NBFC?
Over the last 18 months, the NBFC +HFC sector has seen liquidity issues that turned into solvency issues for some and even business model tweaks for several others. But, over here a very interesting phenomenon has taken place – Just like you have rationed your expenses towards necessary avenues because you know you have to save, even Banks have rationed their capital towards stronger NBFCs (It’s even more interesting to note that in the recent LTRO/TLTRO operations only a few banks/strong firms got the capital. Just 23 hours ago, we have come to know that Banks have parked a record amount of 8.5 lakh cr in Reverse repo as Banks become risk-averse, this is the highest single amount day ever! ). Few players have seen minimal impact until now and benefitted from the lower cost of funds as the funding market gets concentrated on one side in favor of a few companies.
After going through all of the above, we come to know that a good NBFC has the following characteristics –
Good ALM management – Its best if they have a positive surplus in ALM. It means they have more inflows than outflows, giving them a cushion if credit markets move opposite to them.
Good Underwriting – An NBFC should give loans to good borrowers. To quantify this, I mean to say borrowers who have a good credit score. A NBFC should not go on a rampage of lending and clocking growth for the sake of it.
Should slow down sometimes – In certain segments, if signs of stress are visible, the company should slow down. Please note I said signs of stress, not stress, which means the NBFC has to keep an ear to the ground and keep a stock of what is happening in a certain sector so as to tinker with its loan book. (Here’s a history of their slowing down, click to see the details)
Gains market share in crisis – Now this point will automatically take place if the NBFC makes sure of above points. During periods of crisis, the strong gets stronger because of their strong practices. Why? Because when other weaker NBFCs scramble to raise capital or get back repayments, the strong ones are busy accelerating their growth!
Stable funding costs or lowers funding costs – In times of crisis or liquidity crunches, RBI lends to strong banks which in turn lend to strong companies or strong NBFCs. Credit rationing takes place and in a nutshell only the strong balance sheet NBFCs get capital.
Stable or improving asset quality during periods of stress – This is again an outcome of good underwriting practices which helps in stable asset quality in times of stress.
Why do NBFCs die out?
NBFC death triangle – 1. The high cost of funds and absence of support from any parent company leading into credit squeeze 2. ALM mismatch means borrowing short term & lending long term 3. Poor asset quality for any NBFC showing all three characteristics will have less chance to survive
(Above NBFC Death Triangle para articulated by Swarnashish Chatterjee)
What is up with the stock fall?
Like we mentioned at the very beginning of the article, Bajaj Finance is facing heavy correction due to systematic risks in the market arising out of Covid. So let’s see where stress may arise for Bajaj Finance –
Mortgage Loans – With the exception of loans under Rs 2 lakh, most home loan categories have shown default rates of 2% or lesser in recent years. Historically default rates on mortgage rates have been low. Lower-income segments have seen low defaults in the past, but except that other categories may see concerns.
Consumer B2C Loans – With salary cuts and job losses becoming the norm, this segment which is basically personal loans is seeing increased concerns about an increase in defaults. These loans are mostly unsecured and recoveries could be low if defaults rise. 35% of borrowers here have a bureau score of less than 750. The management said this “The rest(35%) have no bureau scores” and “come from markets where bureau hits are low due to low penetration of financial products,”. With no score (No repayment history), this customer set will definitely add to the concerns.
At this point, we should ask – what is the viability of these ratings? They were implemented after 2008-2009 & never been tested against a recession. If there’s one thing I know, Models can’t be trusted because variables change!
SME Loan book – SMEs have gone through a lot of disruptions being Demon, GST, and now COVID. BAF is known to deal with good turnover SMEs here, but nonetheless, repayments will take longer.
In short, they will get affected and their loan mix may change depending on the risks management sees and agrees to avoid or take, their NPAs will rise for sure like other NBFCs but Bajaj Finance is most probable to survive and come out stronger in the aftermath.
Management commentary on Covid Impact
Company has faced these 3 issues in the last 4 years. But, Covid is the most brutal event ever. Protecting the balance sheet is the primary aim right now. Liquidity, capital position, strong loss provision and deposit franchise. Company to hold all the current costs at same level till October. However, they will increase investment in collection infra.
Out of the 3 scenarios built by BAF, the one we can assume is this one – The management said if “Lockdown opens on 15 may, then Months of April and May will see Zero business, structural impact on all lines of business, June at 50% capacity/demand level, return to normalcy of 100% planned volume in Q4. Forced to take a harsher view on Operational Expenditure and explore a 12-15% cut (compared to 7-8% now), credit costs to be higher by 70-90% higher on YoY basis on a full-year basis. In this RBI should announce a one-time restructuring.”
As of yesterday’s closing price of Rs 2071, Bajaj Finance trades at a Price to book value of 4.07x and 24 times its earnings. According to Screener Data, the best-case scenario for BAF was 36x earnings, and the worst-case scenario is 23x earnings. (For Financial firms, PBV is the most tracked metric). (PBV Calculated by taking Sept 2019 balance sheet reserves amount and adding QIP of 8500 Cr to it)
So does it mean its time to buy BAF stock? I think more fall is expected to come as earnings will go down, and more provisions would have to be made for doubtful assets and slippages/credit costs will increase. The clearer picture will anyways emerge Q1FY21 onwards as this quarter will see the majority of borrowers opting for a moratorium. The stock is on my watchlist and I will definitely try to give it a serious thought if the stock falls below 1700. (I will add a very small qty below 1700 and wait for more fall. Do also note that this price may never come, as no one knows what will happen with stock prices. Great businesses when bought at exorbitant prices will not benefit the shareholder, so its imperative to have a margin of safety or not pay extra.)
As per a media article, The lowest target on the stock, by Bernstein, is currently at Rs 1,740. The highest, by Jefferies, is Rs 5,100, as of January 2020. Among the targets updated since April, the highest target is set by HSBC at Rs 3,700.
Disclosure – Please do not construe this article as a piece of investment advice. It is written simply for educational purposes.