The Hindu Business Line : Bajaj Auto Finance: Invest

Attractively priced offer, promising business outlook and a well-capitalised balance-sheet are factors that inspire confidence in the rights offer of Bajaj Auto Finance.

Shareholders may consider subscribing to the rights offer of Bajaj Auto Finance (BAF). Attractive valuations, healthy business outlook and likely improvements in key operational metrics post completion of rights issue are the promising features of this offer.

Attractive valuations

The offer is made at a price of Rs 325 per share. This is at a discount of about 17 per cent to the prevailing market price and works out to a price-to-book ratio of 1.2 on post issue net worth. This appears undemanding compared to its peers, such as Sundaram Finance and Cholamandalam DBS, which are quoting at a price-to-book multiple of about 1.5-1.7 times. Return on shareholders' funds (ROE) for the company has been lower compared to the industry average mainly on account of its larger capital base and lower leverage. However, its return on assets has been superior at about 3.5 per cent owing to its exposure to high-yielding segments. Expansion in its equity base by 60 per cent (assuming conversion of warrants issued to promoters only) may further impact the ROE in the near term. We, however, believe that as the company scales up its business and increases its leverage, ROE is likely to improve.

Promising business outlook

BAF operates in high-growth and high-yielding segments of retail finance. About 60 per cent of its total disbursements are in the two-wheeler and three-wheeler financing. This segment has shown a strong momentum over the last three years clocking a CAGR (compound annual growth rate) of about 45 per cent. Yields in this segment are attractive at about 15-22 per cent.

According to CRIS INFAC, the outstanding portfolio of the two-wheeler finance market is expected to reach Rs 30,800 crore by 2009-10 from about Rs 18,100 crore now. The organised two-wheeler finance market is estimated at Rs 26,500 crore in 2009-10. This presents a lucrative market for the company. Further, its loan to value ratio at about 75 per cent now, leaves reasonable room to improve. Average tenure of loans is also likely to increase due to a rise in average ticket size of loans. These factors are likely to have a positive impact on its profitability.

BAF has also managed to slowly step up its disbursements to finance consumer durables, personal computers and consumer loans. As yields in these segments are higher than those on two-wheeler loans by about 5-8 percentage points, a wider portfolio apart from reducing the concentration risk is likely to improve its spreads.

With a pan-India presence and a strong distribution reach, BAF is well placed to cater to the growing needs of the rural and semi-urban market. Its recent initiatives of starting loan shops (direct marketing) and increasing rural reach are likely to augur well over the medium- to long-term.

Well-capitalised balance-sheet

BAF's capital adequacy ratio stood at 24 per cent in September 2006. The infusion of about Rs 400 crore through the rights offer is likely to improve this.

As such, the company is unlikely to face constraints in funding growth. Its debt-to-equity ratio, at about 2:1 post issue, offers it significant room to improve its leverage. Level of bad loans at 2.3 per cent is not worrying either considering that it operates in relatively riskier segments. Though there has been a spike in the absolute level of bad loans over the last few quarters, it has largely been on account of changes in accounting norms on recognition of bad loans.

Key concerns

As BAF finances only Bajaj Auto vehicles, concentration risk remains fairly high. A slowdown in sales of Bajaj Auto is likely to have an adverse impact on the company's profitability. Higher operating costs are also an element of concern. Higher costs have been largely because of lower average ticket size of loans. We believe that, going forward, improvement in loan-to-value ratio is likely to help it in containing costs. Further, any delay in implementation of growth plans may result in lower ROE over a longer period of time.

Offer details

On offer are 1.2 crore shares at a price of Rs 325 per share in the ratio of 6:10 and 52.4 lakh non-convertible debentures of Rs 500 each with detachable warrants in the ratio of 1:4.

The offer opened on December 15 and closes on January 15. J M Morgan Stanley is the lead manager to the issue.

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