Despite growth, valuation rerating unlikely for Ujjivan Financial

Higher costs to keep earnings growth and return ratios under pressure

Ujjivan Financial Services’ stock has remained under pressure due to lack of clarity on listing of its small finance bank and loan book concentration to unsecured micro finance, among others. The stock’s current valuation of around 2 times its FY20 estimated book value is 11-12 per cent below its historical average since its listing in 2016. The valuation picture is unlikely to improve significantly in the near term, thanks to increase in costs.

The likely elevated costs would hurt earnings growth and return ratios of the bank in the near term. Analysts at IIFL and Emkay Research estimate 10-20 basis point contraction in return on assets of Ujjivan in FY20 from 1.7 per cent in FY19.

After operationalising 287 banking outlets in FY19, Ujjivan aims to add 100 more outlets, including conversion of 50 asset centres, during the current fiscal. This coupled with running cost of the newly added outlets and additional hiring would push operating expenses northwards. The management expects cost to income ratio to remain high at 72 per cent in FY20 after 76.5 per cent reported in FY19. Although, it would reduce to sub-60 per cent levels by FY2022.

Further, investments to garner more low-cost deposits such as savings and current account would further add to the near term cost as benefits from these investments would not come immediately, opine analysts. Ujjivan’s efforts to have more share of low-cost deposits include family banking for micro finance customers, corporate interest banking, salary processing and cash management services, among others.

Yet, a likely strong loan book growth of 35-40 per cent in FY20 and better asset quality should restrict the overall cost impact. Also, Ujjivan is foraying into other non-micro segments such as vehicle financing, lowering dependence on micro finance business. Though existing customer base of about 4.6 million could give good push to the new products, lower yield on non-micro book could put some pressure on net interest margins (NIM). The management has guided for 10.5 per cent NIM in FY20, 60 basis points lower than FY19. Thus, stable margin is also a key for the Ujjivan’s strong long-term growth potential.

In the above backdrop, the stock is unlikely to see sharp upsides in the near term.