Reblog: IPO Review – Aavas Financiers Ltd.

Aavas Financiers is entering the primary market on Tuesday 25^th September 2018, to raise up to Rs. 400 crore via fresh issue of equity shares of Rs. 10 each and an offer for sale (OFS) of upto 1.62 crore equity shares by 4 promoter group entities and 2 top management personnel, both in the price band of Rs. 818 to Rs. 821 per share. Representing 27.93% of the post issue paid-up share capital, total issue size is Rs.  1,734 crore at the upper end of the price band, of which, OFS accounts for 77%. Issue closes on Thursday 27^th September and listing is likely on 8^th October.

Company Overview:

Aavas Financiers, established by listed NBFC AU Small Finance Bank (formerly AU Financiers) in March 2012, as AU Housing Finance, is a Jaipur, Rajasthan head-quartered affordable housing finance company, providing home loans of Rs. 8 lakh average ticket size to 60,000 customers, through its 166 branches in tier 2 to tier 6 towns across 8 Indian states, with gross loan book of Rs. 4,356 crore (30-6-18).

• Geographically, loan book is heavily concentrated, with 4 states (Rajasthan, Gujarat, Maharashtra, Madhya Pradesh) accounting for 92.5%, with Rajasthan alone accounting for 46.6% of the gross loan book.
• Product-wise, loan book is split 76% as home loan and 24% as other mortgage loans, including loan against property. Company serves only retail customers, with zero developer loans.
• Customer-wise, 64% of loans are to self-employed individuals, 61% to economically weaker section and low income group, earning less than Rs. 50,000 per month, while 36% of loans are to first-time borrowers (new to credit).

Financial Performance:

Given the low base due to short operating history, company’s loan book and net profit have grown at 69% CAGR for 3 years, between FY15-18. But growth seems to be tapering off, as FY16 loan growth of 99% contracted to 60% in FY17 and to 51% in FY18. Point to be driven home is high growth rates are not sustainable and already moderating.

Interest income grew 50% YoY in FY18 to Rs. 456 crore, on 47% YoY rise in disbursements to Rs. 2,051 crore, leading to 65% jump in net interest income (NII) to Rs. 267 crore, benefiting from declining interest rate scenario and improvement in company’s debt rating. Net profit jumped 63% YoY to Rs. 93 crore, resulting in an EPS (diluted) of Rs.15.21 for FY18. Q1FY19 interest income stood at Rs. 144 crore, as June quarter disbursements grew to Rs. 547 crore, resulting in NII of Rs. 88 crore and net profit of Rs. 29 crore, leading to an EPS (diluted) of Rs.4.05 for June quarter.

With effect from 1^st April 2018, company has adopted new accounting standards IndAS, wherein, increase in interest income has been off-set by rising employee cost, leading to EPS (diluted) of Rs. 4.20 for Q1FY19. Key monitorables under the new accounting norms are:

1. NPAs acceleration risk as expected credit loss methodology (ECL) is adopted – gross NPAs of Rs. 17 crore as of 30-6-18 under old norms increased to Rs. 23 crore as per Stage 3 classification of IndAS, as of that date.
2. Bulging employee expenses, as fair value method applied to value ESOPs (which compares options grant price with listed share price) vis-à-vis intrinsic value under Indian GAAP – FY18 employee cost of Rs.73 crore increased to Rs.112 crore under IndAS (as per special purpose financials presented in RHP).

Current equity stands at Rs. 73.72 crore, post warrant conversion and grant of ESOPs in June/ August 2018, with net worth of Rs. 1,274 crore and BVPS of Rs. 173, as per IndAS. While FY18 net interest margins (NIMs) of 7.25% are industry-leading, company’s return on average equity (RoE) of 11.2% is the lowest among all listed housing financing companies, which range between 17%-26%. Moreover, RoE has been on a downward trajectory, which was over 24% in FY15. Company’s current gearing ratio is just 2.3x which does not let it trade on equity and hence the low RoE ratio. Current fund raise of Rs. 400 crore will augment the denominator by 30%, delaying improvement in the ratio in the near term.

In the macro environment of rising interest rates, another risk looming on the company is the composition of its loan book. 47% of its gross loan book, as of 30-6-18, is on fixed rate of interest with average yield of 15.73%, meaning spreads on these loans will contract going forward. Only 53% of the loan book advanced to customers is on floating rate (average yield of 12.20%) as against 69% of its own total borrowings, securitisation and assignments being on floating rate. Thus, while company will have to pay more on 69% of its borrowings, only 53% of its advances will be re-priced higher, creating a mis-match on 16% of its existing book, impacting NIMs adversely.

Objects of Issue and Shareholding Pattern:

Company is raising Rs. 400 crore via fresh issue proceeds which will strengthen the already-strong capital adequacy ratio (CAR) of 61%, vis-à-vis regulatory requirement of only 12%.

In Feb 2016, AU Small Finance Bank had sold 90.1% of its stake in the company to PE investors, valuing the company at Rs. 1,055 crore, 2.5 years ago. While AU still holds 6.8% stake, it is not participating in the Rs. 1,334 crore OFS. PE firms Lake District / Kedaara Capital and Partners Group ESCL are now the promoters, holding a combined stake of 83.6%. The 4 promoter entities make up for 94% of the OFS, post which, their aggregate holding will drop to 60.4%. Senior management team holds a sizeable 7.2% stake in the company currently, and 2 members are participating in the OFS making up for the balance 6% share.

An interesting play of events has unfolded at the company. In March 2018, it raised Rs. 400 crore via rights issue (primary sale) wherein, existing shareholdings (including promoters) bought shares from the company at Rs. 430.50 a piece. Two months hence, on 20^th June 2018, company filed draft red herring prospectus (DRHP) with SEBI for IPO, wherein promoters offered to sell part of their shares via an OFS. What transpired within just two months, that promoters changed their mind and were putting some shares on the block? One may argue that company is in needs of capital and hence OFS structured to make the issue sizeable. However, company is not in dire need of the Rs. 400 crore fresh issue proceeds, as it has just raised Rs. 400 crore in March via rights, as also future growth can be funded via external loans, as gearing ratio remains at abysmally low (and management has guided to increase it to 5-6x). Thus, only explanation remains that IPO is being undertaken to provide a part-exit to the promoters, who bought cheaper from the company (in primary issue) and are looking to sell higher (at nearly double price) to public (secondary sale) within just 6 months. Unfair on the promoters’ part to knowingly pocket the gains at the cost of the company (March fund raising could very well have been via a public offer, so that company could fetch higher price for its shares or current fresh issue size could be higher). This definitely doesn’t go down well in the books of corporate governance, and especially so for a company professionally controlled and managed by marquee and respected global names.

Valuation:

At Rs. 821 per share, company’s market cap will be Rs. 6,453 crore, which is 148% of the loan book. On post-issue BVPS of Rs. 213, PBV multiple stands at 3.9x and at 3.7x on FY19E, which are both aggressive. Based on PE multiple too (54x), issue pricing is very steep. No other housing finance company in the listed space is ruling at such excesses, except for Gruh Finance, whose PE multiple is still lower at 51x, although PBV multiple at 13x, given its HDFC parentage, existence of over 3 decades, sector leading RoE of 26%+ and consistent zero net NPAs.

Below is the peer comparison with listed housing finance companies, showing how Aavas’ IPO is valued richly:

Despite very small loan book, Aavas’ valuation muliples are higher than leader HDFC itself on all three counts – PBV, PE and Market cap to loan book. Except for NIMs, Aavas does not score over all of its peers. Its growth of 50% is on such a low base. Indiabulls Housing and PNB Housing both grew at comparable 35% and 48% YoY respectively in FY18, on much large base of over 10x, and ruling at PBV multiples below 3x with lower net NPAs of 0.3% and 0.2% against 0.4% for Aavas. Thus, valuation of Aavas is extremely steep and unwarranted.  

Moreover, recent IPOs performance of loan providers such as CreditAccess Grameen and Indostar Capital have been very lackluster, with share price ruling 15% and 26% lower, respectively. These two companies share similarities with Aavas in terms of healthy growth life cycle, backed by marque foreign investors, 11-12% RoE, mid-size companies with loan book of about 5,000 crore. Concern over adverse effects of rising interest rates have not spared biggies like HDFC and Bajaj Finance of the world, let alone newbies like these. In short, secondary market conditions are not supportive of such premium valuations, which makes subscription at current IPO rates risky.

Conclusion:

While company’s growth rates due to small base and high NIMs are attractive, extremely premium valuations, recent corporate governance practice and rising macro concerns make it an avoid. Better to stock up on the larger peers ruling lower, with stronger fundamentals as well as a proven track record.

The original review is by Geetanjali Kedia, appears on sptulsian.com and is available here.