IPO Review: Equitas Holdings a bankable bet

Transition to a bank could put profits under pressure in near term; valuations are undemanding for a fast-growing company

Equitas Holdings is a diversified financial services company, catering to self-employed individuals and the micro & small enterprise (MSE) segment. It has three subsidiaries for its micro finance (under Equitas Microfinance), vehicle finance and MSE loans (Equitas Finance) and home loan (Equitas Housing Finance) businesses.

Expertise in lending to unbanked segments is a key strength and will drive future growth. Additionally, its experience in vehicle finance and MSE loans lends comfort on the management's ability to grow its upcoming Small Finance Bank (SFB), for which it got a licence from the Reserve Bank (RBI) in October 2015. Healthy growth in assets under management and in return ratios for both Equitas Microfinance and Equitas Finance is another positive.

The valuations also seem reasonable, at about 1.7 times the FY17 estimated price to book on a fully-diluted (post Initial Public Offer) basis, says Digant Haria, financials analyst at Antique Stock Broking. Larger peers such as SKS Microfinance and Cholamandalam Investment & Finance are trading at much higher valuations, of 3.8 times and 3.3 times the FY17 estimated book, respectively.

  While the going has been good so far, the company’s transformation and consequent scaling up of its SFB business will hurt return ratios and profitability in the initial one or two years. For, apart from the investments (required in branches, technology, personnel, etc) for the SFB, the company will also have to comply with regulatory requirements on priority sector lending, statutory  liquidity ratio and cash reserve ratio requirements, among others. Adoption of the 90 days non-performing asset recognition process versus 150 days currently can also lead to elevated provisioning, biting into the earnings.

However, the pressure on profit and return ratios will be due to regulatory reasons and to some extent to investments in scaling up the banking business, rather than pressure on the existing businesses. The management's successful record in cross selling and growing in various segments is a positive but deposit building will be gradual. As the SFB grows and achieves scale, these pressures could reduce. Investors with a longer term horizon could, thus, consider the issue.

A key reason for the IPO is to reduce foreign institutional investors' (FIIs') holding in the company, from 93 per cent to about 35 per cent. RBI norms cap the FII holding in an SFB to 49 per cent. Of the Rs 2,177 crore being raised through the IPO, Rs 720 crore will flow into the company, the rest being an Offer for Sale from existing investors. A large part of the inflow, Rs 616 crore, will be deployed in growing Equitas' three subsidiaries, the SFB and micro finance getting a major share.

Notably, the housing finance business is generating low return , those on average assets being only 0.7 per cent for the nine months ending December 2015. Thus, the management is going slow on this business. The micro finance subsidiary is the fifth largest in the segment and forms 53.3 per cent of the company’s consolidated assets under management (AUM). Vehicle finance and MSE finance contribute 25.5 per cent and 17 per cent of its AUM, home loans forming the rest.

Over-dependence on Tamil Nadu, about 60 per cent of its AUM, could expose Equitas to state-specific risks. While the overall asset quality metrics are strong, some segments such as vehicle financing could see increased pressure, on the back of gradual economic recovery.