Regulatory moves hold key

Amid various developments, SKS Microfinance’s stock has fallen about 25 per cent since the beginning of this month as against a 1.3 per cent rise in NSE Nifty. While the company sacked its CEO earlier this month, the Andhra Pradesh government’s new ordinance which puts restrictions on microfinance institutions (MFIs) coupled with the news of possible capping of lending rates of MFIs, eclipsed the splendid results which the company declared on Friday for the September quarter.

Q2 results good
The MFI’s top line grew by 77 per cent, while its bottom line rose to 116 per cent year-on-year in the September quarter. A 69 per cent increase in the gross loan portfolio and slower growth in costs boosted the stock’s performance. A dip of 0.2 per cent in its gross non-performing assets was the icing on the cake. Thanks to the seasonal nature of the MFI business, results in the second half are expected to be higher owing to the harvest and festival season.

New rules
Following the suicides in Andhra Pradesh, which led to MFIs coming under the scanner, a majority of the large MFIs (including SKS) operating in the country have agreed to extend the tenure of micro loans from 50 weeks to 75 or 100 weeks — this will result in the weekly instalment going down from Rs 225 to Rs 175 for every Rs 10,000 worth of loan. Experts believe this move will have a huge impact on their financials as the increase in tenure, without raising interest rates, will lead to lower profits and could also hit their asset quality. “Allowing such restructuring would induce even regular clients to default and substantially impact future credit behaviour,” noted JP Morgan’s analysts in their report

SKS, India’s largest MFI, currently lends at a rate of 26.7 per cent and derives about 27 per cent of its business from Andhra Pradesh. While the high revenue concentration is not comforting, the risk of other states following in Andhra Pradesh’s footsteps exists.

While a cap on the interest rates of MFIs is highly unlikely as it could render the business unprofitable, competitive intensity to lower rates (with NGOs like Ujjivan cutting rates to 22-24 per cent) may push MFIs including SKS to reduce rates to around 24 per cent levels. This measure is potentially margin-constrictive for the company.

The road ahead
While there is still regulation-related uncertainty surrounding the stock, JP Morgan analysts expect SKS to report an EPS of Rs 48.4 for 2010-11 (up 80 per cent year-on-year) and Rs 73 for 2011-12. Analysts expect the SKS loan book to grow 35-38 per cent CAGR over FY10-13 and the return on equity to be in the range of 23-24 per cent during FY11-13, from about 22 per cent in 2009-10.

While the stock’s near-term movement will be influenced by news pertaining to regulations, the key challenge for SKS is to develop a business model that would help sustain profitability within the constraints of reasonable rates and normal collection practices. Meanwhile, analysts are divided on the stock with a majority of them having a neutral to bearish rating.