Bajaj Finance

Rs7,452.50 - SELL

Piran Engineer Taking a breather

[email protected] Heightened valuations at risk from slowing growth, rising competition
+91 22 6650 5006
Bajaj Finance (Bajaj) would likely undershoot investors’ expectations over the
Shreya Shivani medium term, in our view. A large base, decline in customer repeat purchase ratio
+91 22 6650 5056 and rising competitive intensity in core segments pose risks to its medium-term
Adarsh Parasrampuria loan growth. We believe the ‘fintech’ foray is an enabler in maintaining 20-22%
+91 22 6650 5057 AUM growth rather than a value driver over and above that. Valuation, on an
Mohit Surana absolute and a relative basis, both, is far higher than its own history/peers, which
+91 22 6650 5037 we believe is not justified. We value Bajaj using a residual income (RI) model
assuming 20% PAT Cagr over a 15-year period (FY23-38) and 5% terminal growth;
10 December 2021 we arrive at a TP of Rs6,000 (5.8x FY24CL BVPS) and initiate with a SELL rating.

India Lower customer acquisition and stickiness; no more a 35% loan growth story
We believe Covid’s impact on growth is here to stay. The auto loans segment, hit
Financial services by high NPLs, will see muted growth. Fintechs (partnered with banks and payment
Reuters BJFN.NS companies) and credit cards are increasingly posing a threat in the consumer
Bloomberg BAF IN durables financing segment, which is Bajaj’s key funnel for customer acquisition.
Priced on 10 December 2021 Mortgages, growing at 40%+ Cagr pre-Covid, have seen a slowdown sharper than
CNX Nifty @ 17,511.3 its housing finance peers. The customer repeat purchase ratio has declined from a
12M hi/lo Rs7,929.30/4,479.60 high of 58% in FY19 to 35% in 2QFY22. Hence, we expect a slowdown from 35%
12M price target Rs6,000.00
AUM Cagr pre-Covid to 22% AUM Cagr over FY21-24.
±% potential -19%
The ‘fintech’ story impacts only 40% of loan book
Shares in issue 601.6m
Bajaj is at the late stages of rolling out a digital transformation project,
Free float (est.) 44.0%
encompassing an upgraded consumer app with an ‘omnichannel’ experience, a suite
Market cap US$59.5bn
of payments products and sales/partner productivity. The payments foray is not
3M ADV US$119.1m expected to deliver large profits, but to enhance customer engagement. The
Foreign s'holding 23.6% omnichannel experience targets online shoppers, an area where Bajaj is a marginal
Major shareholders
player. While there is investor excitement about this project, we believe this would
Promoter Group 56.0% transform only c.40% of Bajaj’s business (sales finance, personal loans and rural
FPIs 23.6% lending). Other segments are likely to remain business-as-usual.

‘Bluest’ sky scenario priced in; valuations to gradually de-rate

Although Bajaj’s growth outperformance vs HDFC Bank is poised to shrink from
Blended ESG Score (%)* c.15ppt earlier to c.5ppt going forward, its PE valuation premium over the latter has
Overall 87.6 increased from 30% to 120% in the past two years. Its incremental market cap since
Country average 69.9 Covid, driven by the ‘fintech’ story, is larger than even PayTM’s, despite having a
GEM sector average 70.3
*Click to visit company page on clsa.com for details much-smaller customer and merchant base. Bajaj’s last three equity capital raises
increased book value per share by 56% - we do not foresee any more capital raises
Stock performance (%)
in the next 3-5 years. Bajaj trades at a similar FY23 price/sales ratio as Afterpay
1M 3M 12M (APT AU) despite lower growth. All these relative factors, plus our fundamental RI
Absolute (1.7) 0.3 55.4
model, validate our SELL rating.
Relative 1.1 (0.5) 19.6
Abs (US$) (3.5) (2.4) 51.6 Financials
Year to 31 March 20A 21A 22CL 23CL 24CL
Net profit (Rsm) 52,638 44,198 71,692 104,890 132,217
EPS (Rs) 89.5 73.6 119.2 174.4 219.8
CL/consensus (25) (EPS%) - - 101 101 99
EPS growth (% YoY) 29.0 (17.8) 62.0 46.3 26.1
PE (x) 83.3 101.3 62.5 42.7 33.9
PB (x) 13.8 12.3 10.6 8.7 7.2
ROA (%) 3.6 2.6 3.8 4.6 4.8
ROE (%) 20.2 12.9 18.2 22.4 23.2
Dividend yield (%) 0.1 0.1 0.2 0.4 0.4
Source: Bloomberg Source: www.clsa.com

CLSA and CL Securities Taiwan Co., Ltd. (“CLST”) do and seek to do business with companies covered in its research reports. As such,
investors should be aware that there may be conflicts of interest which could affect the objectivity of the report. Investors should consider
this report as only a single factor in making their investment decisions. For important disclosures please refer to page 79.
 Taking a breather Bajaj Finance - SELL

Financials at a glance
Year to 31 March 2020A 2021A 2022CL (% YoY) 2023CL 2024CL

Profit & Loss (Rsm)

Interest income 229,704 233,034 271,634 16.6 336,571 410,617
Interest expense (94,732) (94,140) (97,566) (120,465) (147,723)
Net interest income 134,972 138,894 174,068 25.3 216,107 262,894
Trading income - - - - -
Fee income 34,034 33,647 40,102 19.2 46,053 51,035
Other operating income 118 150 135 (10) 161 194
Non-interest income 34,152 33,797 40,237 19.1 46,214 51,228
Total op income 169,124 172,691 214,305 24.1 262,321 314,122
Staff & related costs (25,491) (24,967) (34,204) (39,335) (45,235)
Other operating expenses (31,117) (28,115) (39,792) (43,766) (50,125)
Total operating expenses (56,608) (53,082) (73,996) (83,101) (95,360)
Preprovision OP 112,516 119,608 140,309 17.3 179,220 218,762
Loan-loss provisions (39,295) (59,686) (43,427) (37,477) (40,090)
Operating profit 73,221 59,923 96,882 61.7 141,743 178,672
Other income/expenses 0 0 0 - -
Profit before tax 73,221 59,923 96,882 61.7 141,743 178,672
Taxation (20,584) (15,724) (25,189) (36,853) (46,455)
Preference dividends - - - - -
Profit for period 52,638 44,198 71,692 62.2 104,890 132,217
Minority interest 0 0 0 0 0
Net profit 52,638 44,198 71,692 62.2 104,890 132,217
Adjusted profit 52,638 44,198 71,692 62.2 104,890 132,217
Balance sheet (Rsm) 2020A 2021A 2022CL (% YoY) 2023CL 2024CL
Net loans 1,427,989 1,483,313 1,809,642 22 2,207,763 2,693,471
Cash & equivalents 13,827 21,762 42,216 94 78,490 105,783
Placements with other banks - - - - -
Other interest earning assets - - - - -
Total interest earning assets 1,441,817 1,505,075 1,851,857 23 2,286,253 2,799,254
Net fixed assets 13,210 13,668 15,034 10 16,538 18,192
Intangible assets 0 0 0 0 0
Other assets 188,887 196,526 170,815 (13.1) 196,437 225,902
Total non-interest earning assets 202,097 210,194 185,849 (11.6) 212,975 244,094
Total assets 1,643,914 1,715,269 2,037,706 18.8 2,499,227 3,043,348
Customer deposits 0 0 0 0 0
Deposits from banks - - - - -
Other int-bearing liabs 1,298,064 1,316,454 1,574,388 19.6 1,942,831 2,370,254
Total int-bearing liabs 1,298,064 1,316,454 1,574,388 19.6 1,942,831 2,370,254
Other non-int-bearing liabs 22,573 35,647 39,211 10 43,133 47,446
Shareholder funds 323,276 363,168 424,107 16.8 513,263 625,648
Other equity capital 0 0 0 0 0
Total liabs & equity 1,643,914 1,715,269 2,037,706 18.8 2,499,227 3,043,348
Total tier 1 capital 286,977 328,385 389,324 18.6 478,480 590,865
Total capital 337,412 370,183 429,032 15.9 526,130 648,045
Risk weighted assets 1,349,167 1,307,615 1,628,678 24.6 1,986,987 2,424,124
Average Risk weighted assets 1,197,616 1,328,391 1,468,146 10.5 1,807,832 2,205,555
Ratio analysis 2020A 2021A 2022CL (% YoY) 2023CL 2024CL
Net int inc growth (%) 38.8 2.9 25.3 24.2 21.7
Non-int inc growth (%) 58.7 (1.0) 19.1 14.9 10.8
Operating inc growth (%) 42.4 2.1 24.1 22.4 19.7
Net profit growth (%) 31.8 (16.0) 62.2 46.3 26.1
Net interest margin (%) 0.0 0.0 0.0 0.0 0.0
Cost/income (%) 33.5 30.7 34.5 31.7 30.4
Loans/deposits (%) 0.0 0.0 0.0 0.0 0.0
Gross NPLs/total loans (%) 1.7 1.8 2.1 2.0 1.9
Loan provisions/NPLs (%) 60.3 58.4 58.0 60.0 60.0
ROA (%) 3.6 2.6 3.8 4.6 4.8
ROE (%) 20.2 12.9 18.2 22.4 23.2
Tier 1 CAR (%) 21.3 25.1 23.9 24.1 24.4
CAR (%) 46.3 53.4 50.2 50.6 51.1
Source: www.clsa.com

Find CLSA research on Bloomberg, Thomson Reuters, FactSet and CapitalIQ - and profit from our evalu@tor proprietary database at clsa.com

10 December 2021 [email protected] 2

 Taking a breather Bajaj Finance - SELL

We would like to thank Evalueserve for its help in preparing our research reports. Ayush Gandhi (Strategy and Economics), Dhaval Parekh (Materials), Pratik Jain
(Auto), Vishesh Verma (Consumer) and Zen Javeri (Power, Infra and Capital Goods) provide research support services to CLSA.

Executive summary – Why SELL?

We initiate coverage with a SELL rating despite our admiration for the business
model and management’s execution over the past decade. It lies in our belief that
the next five years will neither be as rosy as the previous five nor as rosy as what
investors have priced into the stock. Due to a number of factors discussed below,
we do not expect current valuation levels to sustain over the medium term. Hence,
the stock is poised for a gradual valuation de-rating, in our view.

Five reasons to SELL

Figure 1

Multiple reasons to SELL the stock

Source: CLSA

Repeat customer purchases Repeat customer purchases declined over the past two years
down from 58% in FY19 to Bajaj has suffered from lower customer stickiness in the past two years, which is
35% in 2QFY22 the outcome of increasing competitive intensity, in our view. The share of existing
customers taking a new loan over the next 12 months increased from 28% in FY16
to 58% in FY19 but dipped to sub-30% in the pandemic. By 2QFY22, it picked up
only to 35%, a far cry from the mid-50s pre-pandemic. In our view, management’s
focus on the business transformation journey is to address this issue of declining
customer stickiness.

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Figure 2

Customer stickiness has declined in the past two years

Source: Company, CLSA; Calculated as the number of customers who took a loan in a year divided by outstanding
number of customers at the start of the year; Note: 2QFY22 number is annualised

Covid impact on growth here to stay

Mortgage growth slowdown While pre-Covid assets under management (AUM) growth used to be 35%+ YoY,
in FY21 sharper for Bajaj growth was not even across segments. It was driven by mortgages, auto loans,
compared to other HFCs consumer B2C and rural lending (all 40%+ YoY). The sales finance and commercial
finance segments had started to slow down even before Covid (sub-10% YoY).
During Covid, growth slowed down across all segments. What is notable is that
mortgage growth slowed down from 40%+ YoY earlier to 7% YoY in FY21. None of
the other HFCs witnessed such a sharp slowdown in growth. While it has picked
back up to 18% YoY in 1HFY22, we do not foresee it reverting to pre-Covid levels
of 40%+ YoY on a sustainable basis. In addition, as the company has burnt its fingers
in auto loans during Covid, it is unlikely to deliver healthy growth there. On the
sales finance front, given the company’s sheer market share and increasing
competition from fintechs/credit cards, we believe growth will at best be in line
with the industry’s. The segments we are most bullish on are consumer B2C and
rural lending, where the company could deliver 25-30% loan growth over a five-
year time horizon.

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Figure 3

Some high-growth AUM growth rate pre-Covid (9MFY20, YoY, %) - Two segments that were fast growing prior to
segments pre-Covid may Covid are likely to slow down
not grow as fast post-Covid

Source: CLSA

Figure 4 Figure 5

Unlike peers, Bajaj’s mortgage segment growth declined sharply Our view on product-wise growth in the near and medium term
(%)
Product Segments Near-term Medium-to-long term
Auto Loans 5-10% 10-15%
Sales Finance 15-17% 15-17%
Consumer B2C 25-30% 25-30%
SME 25-30% 25-30%
Rural 30-35% 30-35%
Commercial 35-40% 15-20%
Mortgages 15-20% 20-25%

Source: Companies, CLSA; Note: Individual loan growth for HDFC and home Source: CLSA
loan growth for LICHF taken

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Figure 6 Figure 7

Both Amazon Pay Later and Bajaj Finserv EMI card options Fintechs like ZestMoney available on online ecommerce sites
available at check-out

Source: Amazon Source: Nykaa

Figure 8

Increasing competition from No-cost EMI options by bank credit cards to give tough competition to Bajaj in the online space
credit cards

Source: Amazon

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Figure 9

Expect 22% AUM Cagr over We expect 22% AUM Cagr over the medium term
FY21-24 vs 35% Cagr over
FY17-20

Source: Company, CLSA

Strong correlation of profits Bajaj Finance - Like an HDFC Bank, just eight years younger
of both companies (HDFC We note a very strong resemblance and correlation of Bajaj’s PAT with that
Bank on an 8-year lagged delivered by HDFC Bank eight years prior. Both HDFC Bank and Bajaj are
basis) considered best-in-class retail lenders with high return ratios and good corporate
governance. What if, in FY14, HDFC Bank was valued at the same multiple Bajaj is
valued at today? Would the outcome of HDFC Bank’s share price over FY14-22 in
that scenario give us a sense of the outcome of Bajaj’s share price over FY22-30?
Note that this calculation implicitly implies that in FY30, Bajaj should trade at a
valuation similar to what HDFC Bank trades at currently, given the similar profit
trajectory and other attributes. The table below shows the returns an investor
would have made in HDFC Bank over FY14-22 had it been valued at 7x (Bajaj’s
current multiple) back then. We note that the IRR of the investment would have
been a mere 6%, underperforming the Nifty 50 by 800bp.

Figure 10 Figure 11

PAT trend very similar (Rs bn) Only 6% IRR had HDFC Bank been priced at Bajaj’s current
multiple in FY14
FY16 net worth (Rs bn) 727

Assumed PB multiple (x) 7.0

Assumed market cap (Rs bn) 5,087

Current market cap (Rs bn) 8,343

IRR over eight years 6%

Nifty 50 CAGR 14%

Relative underperformance 800bp

Source: Companies, CLSA Source: HDFC Bank, CLSA; Note: All numbers are for HDFC Bank

Conversely, if Bajaj were to trade at HDFC Bank’s current multiple eight years
hence, the IRR of the investment would be only 10%. To arrive at this, we assume a
20% networth Cagr for Bajaj over the next eight years.

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Figure 12
If Bajaj were to be valued at
HDFC Bank’s current If Bajaj’s multiple converges to HDFC Bank’s current multiple of 3x eight years later, IRR would be
multiple eight years later, only 10%
then the IRR of the FY23 net worth (Rs bn) 514
investment would be only FY31 net worth (Rs bn) 2,212
10% PB multiple - HDFC Bank (x) 3.0
Market cap of Bajaj after 8 years (Rs bn) 6,570
Current market cap (Rs bn) 4,471
IRR 10%
Source: Bajaj, CLSA; Note: Assuming 20% CAGR in networth over FY23-31

Bajaj’s growth outperformance vs HDFC Bank is shrinking

Prior to Covid, Bajaj’s loan growth rate was consistently 10-15ppt higher than that
of HDFC Bank, which justified the valuation premium it got. Given the above-
mentioned factors, we expect that growth premium to shrink to ~5ppt in the
coming years.

Figure 13

Growth outperformance of AUM growth comparison of HDFC Bank and Bajaj

Bajaj over HDFC Bank is
likely to shrink

Source: Companies, CLSA

Bajaj’s valuation premium In the three years prior to Covid, the average PB valuation premium that Bajaj
to HDFC Bank expanded commanded to HDFC Bank was ~60%. This narrowed to ~40% in the peak of Covid
from an average of 60% wave 1 but recovered thereafter. Bajaj now trades at a 180% higher multiple than
pre-Covid to 180% now
HDFC Bank (8.2x vs 2.9x 1-year forward PB). This premium expansion has been
driven largely by investor expectations from the business transformation project.

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Figure 14

Comparison of PB valuation of Bajaj and HDFC Bank

Source: BBG, CLSA; Note: PB valuation on a 1-year forward basis

Figure 15

Divergence between Bajaj’s valuation premium at an all-time high despite lower expected growth outperformance
valuation premium and
expected growth
outperformance

Source: Company, BBG, CLSA; Note: Valuations calculated on 12-month forward PB basis; Growth outperformance
defined as loan growth of Bajaj minus loan growth of HDFC Bank

44x PE for Bajaj vs 20x for 120% PE valuation premium unjustified given shrinking growth outperformance
HDFC Bank (1-year We also analyse relative PE trends between HDFC Bank and Bajaj. Looking at PE
forward) against PB is helpful because it also factors in the return on equity (RoE) of the
entity. While Bajaj used to trade at a 30% PE premium to HDFC Bank prior to Covid,
it now trades at a 120% PE premium to the latter. We believe this premium is
unjustified given Bajaj’s shrinking growth outperformance versus HDFC Bank.

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Figure 16

While HDFC Bank’s PE has been stable over the years, Bajaj’s PE has been rising and now is at 120% premium to that of HDFC Bank

Source: Companies, CLSA; Note: PE valuation on a 1-year forward basis

Bajaj raised equity capital Further equity capital raises to not be as frequent as in the past 5-6 years
thrice in the past 5-6 years, To fund its strong AUM growth, Bajaj raised Rs144bn equity capital over the past
thereby significantly 5-6 years. When a company raises equity at a PB multiple greater than 1x, the
boosting BVPS transaction is accretive to book value per share (BVPS). Per our calculations, the
BVPS accretion due to these capital raises was 56%. As we expect growth to slow
down from 35% YoY earlier to 22% YoY now, Bajaj is unlikely to raise capital in the
next few years because a) its internal accruals would be largely enough to sustain
growth and b) its leverage is only 4.3x. In that case, investors would cease to benefit
from the BVPS accretion from equity capital raises.

Figure 17

Details of equity capital raises in the past few years

Rs mn FY16 FY18 FY20
Equity capital raised 14,000 45,000 85,000
Price (adjusted for split/bonus) 428 1,690 3,900
No. of shares issued (mn) 32.7 26.6 21.8
BVPS 139 276 540
Net worth assuming no capital raise in that year 60,266 113,577 239,150
No. of shares assuming no capital raise in that year 503 550 578
BVPS assuming no capital raise in that year 120 206 414
BVPS accretion due to each capital raise 16% 34% 31%
FY20 BVPS assuming no capital raise 347
FY20 BVPS accretion (cumulative) 56%
Source: Company, CLSA

Using a residual income model to arrive at our target price

Our long-term RI model We value the stock based on a residual income model. We believe the company can
indicates that FY38 PAT = deliver ~20% AUM Cagr over the long term. Our assumptions (detailed in the
1HFY22 AUM chapter on valuations) imply that the company would deliver 20% PAT Cagr over 15
years from FY23 to FY38. To put these numbers in perspective, FY38 PAT would

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be equal to current AUM. Also, assuming steady RoA of ~4.5%, this implies that
Bajaj would be as big as what HDFC currently is by FY28, as big as HDFC Bank +
Kotak Mahindra Bank currently is by FY33 and bigger than what State Bank of India
+ ICICI Bank is by FY38. Yet, we arrive at a target price of Rs6,000 (5.8x BVPS/27x
EPS – FY24).

Figure 18 Figure 19

RI model implies 20% PAT Cagr over FY23-38 What Bajaj’s loan book will be assuming RoA is maintained at FY23
levels of 4.6%

Source: CLSA Source: Companies, CLSA; Text in red highlights the current loan book size of
that bank/HFC

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The most diversified NBFC

Rs1.7trn assets under Bajaj Finance has been in business for the past three decades. It started as a captive
management auto financier for Bajaj Auto and later diversified into other segments. Today, the
company is present in multiple product segments across retail and corporate
lending and is among the largest non-banking financial companies (NBFCs) in India
with assets under management (AUM) of Rs1.7trn.

Multi-product lender with core focus on retail lending

85-90% of the loan book is Bajaj Finance is present across most lending products, though predominantly in
in retail lending; it also has retail lending. Barring auto loans, the company targets affluent and mass-affluent
tie-ups with two banks for customers and not the lower-income segment of customers in all its products. Retail
credit card distribution lending accounts for 85-90% of its total loan book. Mortgages make up nearly a
third of its total loan book. Bajaj also does consumer durables loans, auto finance,
personal loans, SME loans and corporate loans. Given that it cannot give credit
cards being an NBFC, it has tied up with RBL Bank and DBS Singapore for
distribution of co-branded credit cards.

Figure 20

A third of the AUM is in Well-balanced AUM mix

mortgages while 20% is in
personal loans (consumer
B2C)

Source: Company, CLSA; Note: Consumer B2B refers to auto, consumer durables and lifestyle financing; Consumer
B2C refers to personal loans

Three percent market share in the $600bn retail credit market in India
Bajaj Finance has an Per our bottom-up calculations, total retail credit (non-agricultural) in India, across
estimated 3% market share banks and NBFCs, amounts to Rs46trn. While the industry was growing at high-
in Indian retail lending, per teens Cagr prior to the IL&FS crisis, overall growth slowed down after that. Bajaj
our calculations has steadily gained overall market share in retail lending – up from 1.2% in FY14 to
3.1% in FY21.

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Figure 21 Figure 22

Retail credit trend (banks + NBFCs) Share in retail lending

Source: RBI, CLSA; We did a bottom-up calculation to arrive at retail lending Source: CLSA
for NBFCs; Note: does not include agricultural credit

Figure 23

Bajaj gained ~200bp market Bajaj’s market share in retail lending nearly doubled over the past five years
share in retail loans over
the past seven years

Source: Company, CLSA

The original BNPL player

Consumer B2B lending a touchpoint for customer acquisition…
Bajaj Finance offers While Bajaj was not the first company to foray into consumer durables lending, it
interest-free consumer was the first to do it successfully and ramp it up. In this business, the company
durable and digital product charges a subvention from the manufacturer of the product it lends against, while
loans no interest is charged to the customer. However, Bajaj does take a nominal
processing fee from the customer. The typical loan tenure is ~six months and Bajaj
earns an IRR of 22-24% on this product. This business in today’s parlance is ‘BNPL’
– Buy Now, Pay Later.

In the consumer durables space, management claims to have a ~70% market share
of the subvention pool (not loan book) of manufacturers and a ~25% market share
of the total consumer durables sold in India. Per our calculations, its market share
in total consumer durables loans should be ~50%. In ‘lifestyle’ finance, which
includes lifestyle goods like furniture, it has a much smaller presence.

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Figure 24

Consumer B2B sales finance snapshot

Consumer durable lending Loan book Rs126bn
book of Rs126bn Annual disbursements Rs600bn-650bn
Products White goods, mobile phones, other 'lifestyle' goods like furniture
IRR 22-24%
Average ticket size Rs30k for consumer durables and Rs50k for lifestyle financing
Number of touchpoints 80k+
Nature of lending Secured, but value of collateral diminishes quickly
Other details Bajaj will not deliver the product to an address other than the one
mentioned in the customer's ID proof
Source: Company, CLSA

Figure 25 Figure 26 Figure 27

Bajaj cons. B2B loan book (Rs bn) Market share in consumer durables Expanding distribution reach

Source: Company, CLSA Source: RBI, Company, CLSA Source: Company, CLSA

Figure 28

Indicative size of the consumer electronics industry in India

Source: Havells India Ltd.; Note: 1cr = 10m

…leading to cross-sell of other products over time

Personal loans cross-sell Customers who service their consumer durables loans regularly are offered other
book forms 60% of total lending products – primarily personal loans and mortgage loans. While the company
personal loans started with cross-sell personal loans only, it later ventured into salaried personal
loans for new-to-Bajaj customers too. The ‘personal loans cross-sell’ book is now

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larger than the consumer durables lending book and accounts for 60% of total
personal loans.

Figure 29

Consumer B2C snapshot

Loan book Rs337bn
Products Personal loan cross-sell (PLCS) and salaried personal loans
IRR 13-17%
Average ticket size Rs150k-200k for PLCS and Rs600k-700k for salaried personal loans
Nature of lending Unsecured
Average tenure 3 years
Source: Company, CLSA

Figure 30 Figure 31

Consumer B2C book doubled over FY18-21 Loan book mix between PLCS and salaried PL

Source: Company, CLSA Source: Company, CLSA

Fifth-largest player with 5% market share in personal loans

Among the top five players Prior to Covid, personal loans were a key focus segment for the company as
in personal loans, but evidenced by the 45% loan book Cagr over FY16-20. Bajaj is the fifth-largest player
market share low at 5% in this market, ahead of several banks too. Despite this, the company accounts for
only 5% of the total personal loans market in India. We believe this product will
remain a core focus area for the company given the low penetration and healthy
yields.

Figure 32 Figure 33

Personal loans book size comparison across large players (Rs bn) Market share trend

Source: Companies, CLSA Source: CRIF High Mark, CLSA

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The company’s asset quality in this segment is largely in line with that of the
industry. While its Stage 2 ratio is slightly higher at 3.4% vs 2.2% for the industry,
its Stage 3 is 220bp lower at 4.3%.

Figure 34

Bajaj’s asset quality in Comparison of asset quality metrics with the industry (personal loans only, FY21)
personal loans is largely in
line with that of the
industry

Source: CRIF High Mark, CLSA; Stage 3 for Industry may include the written-off portfolio too

Mortgage segment helps in scale-building and risk reduction

Mortgage business helps In the mortgage segment, the company deals primarily in home loans and LAP. Bajaj
the company to generate disburses home loans from only 46 locations in India (primarily urban markets).
scale as well as reduce Hence, at Rs4.7m, its average ticket size is larger than that of other housing finance
overall credit costs companies. Around four years back, Bajaj incorporated a housing finance subsidiary
and started doing all incremental mortgages from the subsidiary itself. Currently,
82% of the total mortgage AUM of the company is housed under Bajaj Housing
Finance.

Figure 35 Figure 36

Bajaj HFC loan mix Loan book trend

Source: Company, CLSA; Note: this loan mix is representative only of Bajaj Source: Company, CLSA
HFC and not the entire mortgage book of Bajaj Finance

Auto loans now less than Legacy auto lending business now a small part of the balance sheet
10% of AUM Being part of the Bajaj group, Bajaj Finance has historically funded two-wheelers
and three-wheelers sold by Bajaj Auto. So far, the company has been funding only
Bajaj Auto vehicles. Around 15 years ago at the time of the Global Financial Crisis,
auto loans accounted for more than half of the total loan book. This has now fallen

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to less than 10% of the overall book. Historically, Bajaj used to finance ~35% of the
2Ws and ~20% of the 3Ws sold by Bajaj Auto (though it increased meaningfully in
the two years prior to Covid). This makes it one of the largest 2W financiers in the
country. The company may also explore possibilities of partnerships with other 2W
manufacturers in the future.

Figure 37 Figure 38

Auto financing book grew 3x+ over FY16-20 but declined later Bajaj is among the largest 2W financiers in India

Source: Company, CLSA Source: Company, CLSA; Note: Assuming 2W lending to be 75% of total auto
finance

While this product is a high IRR one (22%-24%), the associated operating expenses
and credit costs are also high. As seen in the chart below, the 0dpd book (ie, book
that is not overdue) for the auto loans segment is far lower than that in other
segments. This is because a) unlike in other segments, Bajaj does not target only
the mass-affluent customer base in this segment, and b) 2W/3W lending is a higher
delinquency product for the industry too compared to personal loans/mortgages.

Figure 39

Asset quality of the auto Share of loans that is not overdue – Pre-Covid to exclude the impact of Covid (%)
lending book is far worse
than that of other segments

Source: Company, CLSA; as of 9MFY20

SME lending to professionals and businesspersons

Bulk of the SME lending In addition to consumer loans, Bajaj also makes small-ticket loans for business
book is unsecured purposes. Loans to professionals are largely to doctors and chartered accountants.
In this doctor loans segment, Bajaj’s proposition is unique – it has a list of over 1m
doctors to whom it offers pre-approved business loans. This helps in reducing

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turnaround time for the borrower. The average ticket size in loans to professionals
is ~Rs1m. Apart from professional loans, Bajaj also gives loans to small
businesspersons with an average annual turnover of ~Rs150m. The bulk of the SME
lending book is unsecured. As a result, yields are high at 14-18%. The average ticket
size of these loans is ~Rs0.7m.

Figure 40 Figure 41

SME lending – Going slow since the onset of Covid-19 Loan mix – Increasing focus on professional loans

Source: Company, CLSA Source: Company, CLSA

Commercial lending a low-risk, low-return business

40-45% of the commercial In this business, Bajaj caters primarily to a variety of industries such as auto
lending book is loans ancillaries, pharma, light engineering and specialty chemicals. These are high-ticket
against shares (LAS) loans given to well-rated borrowers with varying loan tenures. Apart from this, the
other key segment is loans against shares, which includes IPO funding too. Overall,
the commercial lending business is a low-yielding, low-risk business. The GNPL
ratio has typically been negligible, except in the case of one-off events like the
default by Karvy Stock Broking. Bajaj has increased focus on this segment post
Covid.

Figure 42 Figure 43

Commercial lending has grown strongly post Covid Proportion of loans against shares typically at 40-45%

Source: Company, CLSA Source: Company, CLSA

Rural lending small but growing fast

Rural lending has better In rural lending, Bajaj does gold loans in addition to some of the products it does in
asset quality metrics than urban locations. The rural lending book comprises primarily consumer durables
urban lending loans, digital/lifestyle loans, personal loans and gold loans. The company operates
in nearly 2,000 locations in a hub-and-spoke model. It does not lend to customers

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with agricultural income alone. Bajaj also uses unconventional underwriting metrics
like the customer’s electricity bill and car owned. Over the years, management has
consistently stated that the credit culture in rural areas is better than that in urban
areas.

Figure 44 Figure 45

Rural lending loan book up 3x since FY18; fastest growing segment Total overdue portfolio (0dpd+) lower in rural areas (%)

Source: Company, CLSA Source: Company, CLSA; Note: numbers as of 9MFY20 to exclude the one-off
impact of Covid

Widespread distribution network leads to large customer pool

53mcustomers since The company is present at over 100k touchpoints across the country, in addition to
inception its 3,000+ own branches. As a result, it has managed to acquire over 50m customers
since inception. Its annual customer addition has been 8m-9m in the past couple of
years (barring FY21, the year of Covid-19).

Figure 46 Figure 47

50m+ customer base since inception Run-rate annual new customer addition of 8m-9m

Source: Company, CLSA Source: Company, CLSA; Note: 1HFY22 number annualised

Repeat customer purchase has declined over the past two years
Cross-sell (loans to existing In our view, there are two ways to analyse customer stickiness –
customers) improved from
54% in FY16 to 64% in ∑ Out of 100 loans disbursed in a particular year, how many were disbursed
FY21 to existing customers.

∑ Out of 100 customers, how many come back again to take a loan in the next
3/6/12 months.

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On the former, Bajaj improved the cross-sell ratio from ~55% in FY16 to 70% in
FY20, but it dipped to 65% in FY21.

Figure 48

Drop in the cross-sell ratio Cross-sell ratio improved over FY16-20 but dipped in FY21
in FY21 is counter-intuitive,
as one would have expected
the company to disburse
primarily to existing clients
in the pandemic year

Source: Company, CLSA; Cross-sell ratio is calculated as the number of loans disbursed to existing clients divided
by total number of loans disbursed during the year

However, on the second metric (repeat customer purchase), there has been some
deterioration from FY19 peaks. The share of customers taking repeat loans over a
12-month period increased from 28% in FY16 to 58% in FY19 but dipped to sub-
30% in the pandemic. By 2QFY22, which was a relatively normal quarter in terms
of growth, the repeat purchase ratio improved only to 35%.

Figure 49

Repeat customer purchase Repeat customer purchase trends

is significantly lower than
pre-Covid levels

Source: Company, CLSA; Calculated as the number of customers who took a loan in a year divided by outstanding
number of customers at the start of the year; Note: 2QFY22 number is annualized

Leveraging its customer base to cross-sell co-branded credit cards

Prior to the pandemic, Bajaj has tied up with RBL Bank and more recently DBS Bank India to distribute co-
distribution income branded credit cards to its customer pool. While the commercial agreements
accounted for nearly half of between the two players have not been disclosed publicly, we believe Bajaj earns a
the incremental fee income
one-time referral fee as well as a share of the card spends and collection fees. Note
for the company
that RBI does not allow risk-sharing in co-branded credit cards. It is safe to say that

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the contribution of this partnership is significant as depicted by the sharp rise in

distribution fee income in the past 3-4 years. Prior to the pandemic, distribution
fees accounted for nearly half of the incremental fee income for the company.
However, credit card distribution took a hit due to Covid. The number of co-
branded cards distributed by Bajaj has almost halved from the ~200k-cards-per-
quarter level in 2019. As a result, its incremental market share dipped from a peak
of 8% in FY20 to 5% in FY21 and 1HFY22.

Figure 50 Figure 51

Largest credit card issuers in India (cards in force, m) RBL-Bajaj has lost incremental market share since the pandemic

Source: RBI, CLSA; As of Sep ‘21 Source: RBI, CLSA; Note: includes co-branded cards of RBL with Bajaj only

Figure 52

Distribution income was Distribution income up nearly 5x over FY18-20, largely driven by RBL partnership, in our view
40%+ of total fee income in
FY20

Source: Company, CLSA

Rs6bn fee income potential from the RBL Bank tie-up

Bottom-up analysis on the We attempt to calculate, bottom-up, the fee income potential from the partnership.
fee income potential from In this, we assume a one-time referral fee of Rs1,500 per card paid to Bajaj. We
the RBL Bank co-branded assume annual spends of Rs150k, increasing at 5% every year. We also assume that
card tie-up Bajaj makes 40% of the spend revenue and is reimbursed 40% of the collection
costs. This implies that Bajaj would earn ~Rs6bn fees from the RBL Bank tie-up in
FY23.

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Figure 53

A framework for bottom-up calculation of fee income from RBL Bank tie-up
Assumption FY22CL FY23CL FY24CL FY25CL
Cards in force (m) 2.5 3.4 4.4 5.5
New cards issued (m) 0.9 1.0 1.1
Card referral fee (Rs) 1,500
Referral income for Bajaj (Rs bn) (A) 1.4 1.5 1.6
Annual spend (Rs '000) 150 158 165
Total spends (Rs bn) 443 613 816
Interchange fee 1.5%
Bajaj share of total spend revenue 40%
Bajaj share of spend revenue (Rs bn) (B) 2.7 3.7 4.9
Collection cost per card (Rs) 1,500
Bajaj share in collection cost 40%
Bajaj collection cost reimbursement (Rs bn) (C) 1.8 2.3 3.0
Total income for Bajaj (Rs bn) (A+B+C) 5.8 7.5 9.5
Source: CLSA

Fee income far superior to other lending entities

Fee income was 2% of One unique aspect about the company is the high levels of fee income it generates.
average AUM pre-pandemic Over FY16-21, fee income grew at a 47% Cagr, far higher than the 28% Cagr in
(FY20) overall AUM. As a result, fee income increased from 0.9% of AUM to 1.6% of AUM
over this time period. What is interesting is that some components of fee income
are unrelated to AUM. For example, as discussed above, distribution fees from the
co-branded credit cards and annual fees from the Existing Member Identification
(EMI) card fall under this category. Lastly, fees from bounced cheques would also
be a meaningful contributor to the total fee income, in our opinion.

Figure 54 Figure 55

Fee income contribution has grown Fee mix trend (%)

Source: Company, CLSA Source: Company, CLSA

We attempt to calculate the fee income from bounce charges, bottom-up. Per
earlier corporate disclosures, the average pre-Covid bounce rate was 12%. We
assume bounce charges (net of charges paid to the bank) to be Rs300 per bounce.
Assuming an actual realization of 80% of the bounce charges from the customer,
we arrive at the annual fees from bounces at Rs5.5bn.

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Figure 56

Our bottom-up calculation of fees from bounce charges

Number of customers on book (m) 16.0
Normal bounce rate 12%
Number of bounces per month (m) 1.9
Average charge per bounce (Rs) 300
Bounce charges per month (Rs m) 576
Annual bounce charges (Rs b) 6.9
Actual realisation from customer 80%
Annual fees from bounce earned (Rs bn) 5.5
Source: CLSA; Note: all of the above numbers are our assumptions

Figure 57

Bajaj’s total fee income to Bajaj’s fee income is in line with that of most large banks (%)
loans is similar to that of
HDFC Bank and ICICI Bank

Source: Companies, CLSA; Fee income taken as a % of average loan book

Flexi loans – Not a cause for concern for us

Rs400bn+ ‘flexi’ loan book ‘Flexi’ loans refer to loans where there are different terms of repayment compared
to the usual EMI. For example, loans with principal moratorium and interest-only
payments are considered flexi. Flexi loans were launched in 2013 for loan against
property (LAP) customers as an alternative to overdraft/cash credit facilities by
banks. It was then extended to personal loans, professional loans, LAS, etc. Flexi
loans usually command 25-50bp higher yield compared to regular loans and have
annual maintenance charges of 25-100bp. Also, flexi loans have only marginally
higher loan losses than non-flexi loans of the same category. Per the last disclosures
around a year back, the company had a flexi loan book of Rs430b. This accounted
for roughly one-third of Bajaj’s total AUM.

Here are some key disclosures (dated around a year back) on the adoption of flexi
loans across product segments –

∑ 60% of LAP/lease rental discounting (LRD) is flexi

∑ Entire loan against shares and gold loan portfolio is flexi

∑ 90% of the doctor loan portfolio is flexi

∑ 90% of salaried personal loans are flexi

∑ 65% of SME portfolio is flexi

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Figure 58

Flexi loan mix (not exhaustive)

% share of flexi Total AUM (Rs bn) Flexi AUM (Rs bn)
LAP/LRD 60% 102 61
LAS 100% 40 40
Gold loan 100% 16 16
Doctor 90% 71 64
Salaried PL 90% 113 102
SME 65% 127 82
Total 365
Source: Company, CLSA; Note: AUM data is either as of 1QFY21 or FY20 (if the former is not available); Note that
we do not have the exhaustive breakdown of the flexi loan book

75% of flexi loans do not We are not too worried about flexi because -
have a moratorium period
∑ Per management, 75% of all flexi loans were originated as flexi and not
converted to flexi

∑ Over 75% of flexi loans do not have any moratorium period

∑ Flexi is not offered in higher-delinquency products like auto loans and sales
finance (consumer durables loans)

What happens if Bajaj becomes a bank?

We have no view on whether RBI will allow industrial houses to promote banks.
However, from the point of view of an NBFC, the question of converting into a bank
arises when it is too large to raise adequate debt capital from the system (banks
and debt capital markets). Given the size of the balance sheet and expected growth
rates, we do not believe Bajaj will be ‘too large’ in the medium term. Its alternative
borrowing sources, deposits and ECBs, have scaled up well and should provide
enough debt capital for growth in the next few years, in our opinion. However, here
are some pros and cons of becoming a bank -

Figure 59

Pros and cons of an NBFC becoming a bank

Pros Cons
CASA deposits Drag on margins from CRR/SLR requirements
Lower Capital Adequacy Ratio requirement Enhanced regulatory scrutiny
Support from RBI in times of distress Inability to engage in certain lending products
(land funding); cap on loan against shares > Rs2m
Can launch own credit cards Added cost of running liability branches
Other fee income sources like forex fees Compliance with ‘priority sector lending’ norms
Source: CLSA; CASA - Current Account, Savings Account; CRR – Cash Reserve Ratio; SLR – Statutory Liquidity
Ratio

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Figure 60

SWOT analysis

Source: CLSA

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The fintech transformation

Bajaj’s business Bajaj has initiated its next leg of business transformation by working on its digital
transformation plan capabilities and offerings. The project started in Nov-19 and was initially expected
to complete in four years. Nevertheless, the company is on track to complete it in
just above two years, despite bulk of the past two years being spent in Covid. The
aim of this digital transformation is offer products and services to end customers at
higher velocity and lower costs. Towards this, it is creating an omnichannel
framework – one which will give the customer an option to toggle between online
and offline channels in a frictionless manner. As part of the plan, the company is
Bajaj invested Rs2.84bn for working on five different digital capabilities, which are i) Bajaj Pay for consumers,
a 20% stake in Bajaj Finserv ii) Bajaj Pay for merchants, iii) proprietary marketplace, iv) productivity apps and v)
Direct.
partnerships. In addition to this, Bajaj invested Rs2.84bn for a 20% stake in Bajaj
Finserv Direct (BFD), a digital financial products distribution platform owned by
Bajaj Finserv. BFD delivered revenue of Rs1bn in FY21.

Figure 61

Bajaj’s digital transformation plan encompasses many facets across payments, marketplace and productivity

Source: CLSA

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Figure 62

Timelines for pending rollouts

3-in-1 app Dec-21
Sales One app Jan-22
Merchant app Feb-22
Source: Company, CLSA

3-in-1 financial services app Bajaj will offer a 3-in-1 financial services app by updating its existing Experia App.
being developed; app This essentially means that the customer can transact in three clicks. The updated
currently has 12.9m app will integrate three of the five digital capabilities – ‘Bajaj Pay for consumers,’
customers
‘proprietary marketplace’ and ‘partnership apps.’ The app will go live in mid-
December 2021.

Figure 63

App upgrade expected on 3-in-1 app for payment, lending, marketplace and other services
15 December 2021

Source: Bajaj Finance

EMI Card and EMI store

The 3-in-1 consumer app will also give customers the option to apply for a digital
Over 372k new digital EMI EMI card and manage EMI transactions via the app. It will also have an EMI store
cards issued in 2Q22 (marketplace) wherein a customer can buy a product online (and be fulfilled by a
merchant offline) via a loan from Bajaj.

Figure 64

EMI card and store seeing healthy traction

Category Update
EMI Card - Over 372k new cards issued in 2Q22
- Expect a quarterly run-rate of 500k
- ~30% of these customers obtained a loan in 90 days
EMI Store - Visits increased from 10.2m in 4Q21 to 29.7m in 2Q22
- This has led to 248k new loans in 2Q22 (expect run-rate of 500k)
- 30,135 SKUs and 25,031 merchants as of September 2021
Source: Bajaj Finance, CLSA

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Increasing competition from fintech players

BNPL space evolving The BNPL segment is fast evolving now with the entry of new-age fintech players
rapidly with competition that are offering BNPL loans at the offline store via digital modes (QR codes) and
from fintechs and credit also partnering with online ecommerce players for the same. We highlight the
cards
presence of multiple EMI options for end customers at the check-out points of
popular ecommerce websites.

∑ Fintechs entering partnerships: What is interesting here is that new-age fintech

players are partnering with payment and other platforms to offer their services.
For example, ZestMoney has partnered with Pine Labs in over 85k stores, where
Pine Labs will put ZestMoney QR codes. Customers simply have to scan the QR
code to register with ZestMoney and obtain the loan (no human intervention
needed). ZestMoney is also present on Google Pay, offering BNPL solutions to
the latter’s customers. Capital Float has tied up with Razorpay to offer BNPL
loans via their payment gateway.

Figure 65

Key BNPL players and their presence at different channel for consumers
India’s large BNPL players Presence at
and their presence across check-out point i) Online stores ii) Offline stores iii) In app store
of…
channels
Yes (via Bajaj Finserv EMI
Bajaj Yes (Bajaj Finance Kiosks) Yes
Card)
Yes (Flipkart, Amazon, Nykaa, Yes (via partnership with Pine
ZestMoney No
Myntra, MakeMyTrip etc.) Labs; ZestMoney QR code)
Yes (Amazon Pay Later/other
Capital Float No No
merchants)
Source: CLSA

Figure 66 Figure 67

Both Amazon Pay Later and Bajaj Finserv EMI card option available Fintechs like ZestMoney available on online ecommerce sites

Source: Amazon Source: Nykaa

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Figure 68

ZestMoney is now on Google Pay, giving it access to the latter’s 70m+ customers

ZestMoney is now on
Google Pay

Source: Google Pay app, CLSA

Competition from Credit cards with ‘No-cost EMI’ options

We also highlight a large number of bank credit cards offering interest-free loans to
customers. The loan is interest-free as the bank offers a discount of an amount
equivalent to the interest cost. This makes the offering similar to that by Bajaj.

Figure 69

Increasing competition from No-cost EMI options by bank credit cards

credit cards

Source: Amazon

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Figure 70

Bajaj no-cost EMI vs credit card no-cost EMI

Source: Amazon

How global peers fare in BNPL

We analyse basic financial metrics of some of the largest BNPL players globally -
Klarna, Afterpay and Affirm. These players have increased revenue 2-4x in the past
two years. Klarna was profit-making prior to FY19 while Afterpay and Affirm are
loss-making. Note that the former is unlisted while the latter two are listed.
However, Afterpay has inked an agreement to be sold to Square at a valuation of
$29bn in an all-stock deal.

Figure 71 Figure 72

Top global BNPL players and their valuations/market cap Klarna Bank AB is a Swedish fintech company

Source: BBG, CLSA Note: Klarna Bank AB is unlisted and valuation is as of the Source: BBG, CLSA Note: Year end as of December
latest fund raise in June 2021

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Figure 73 Figure 74

Afterpay (Australia-based) financials Affirm Holdings Inc. financials (US-based)

Source: BBG, CLSA Note: Year end as of June Source: BBG, CLSA Note: Year end as of June

Late entrant into the payments space in India

With the launch of the Bajaj Pay app for consumer and merchants, the company
aims to scale up the payment offering for its 53m customers and 100k merchants.
Bajaj currently has 3.1m wallet customers and expects to add 5m-7m customers
annually going forward.

Figure 75

Being a late entrant, Bajaj Apps - monthly active customer base

Pay dwarfs in comparison
to other wallets in terms of
customer base

Source: Companies, CLSA; Note: Bajaj numbers are for overall wallet customers

Bajaj Pay for consumers

Payment services for wallet The integrated 3-in-1 consumer app includes United Payments Interface (UPI),
customers include UPI, PPI, Prepaid Payment Instrument (PPI), EMI card and credit card services, collectively
EMI Card and credit cards termed as Bajaj Pay for consumers. In Jan 2021, Bharat Bill Pay System (BBPS) went
live on the consumer app. Further, in Mar 2021, UPI was launched in a closed user
group; the final version should go live by mid-December. In May 2021, RBI granted
authorisation to Bajaj Finance for issuance and operation of prepaid instruments
(PPI) with perpetual validity.

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Figure 76 Figure 77

Bajaj Pay’s UPI was launched in a closed user group in Mar-21 Top UPI players and their monthly transaction value

Source: NPCI, CLSA Source: NPCI, CLSA

We compare Bajaj Pay’s offerings with those of peers. We note that the company
is charging fees for loading money into the wallet via debit card/UPI/net banking,
unlike PayTM, which offers this service for free.

Figure 78

Comparison of charges of Bajaj and PayTM wallets

Activity Bajaj Pay Wallet PayTM Wallet
Account opening Free Free
Load money in wallet Up to 2% via credit card/debit card/ UPI/ Up to 2.5%-3% via credit card or prepaid card;
Net banking Free via other sources
Payment at merchant Free Free
Payment to utility bill/recharges/DTH Up to 2% Upto 3% (incl. taxes) per transaction
Transfer from wallet to wallet Free No charge
Transfer from wallet (full KYC) to bank Up to 5% Up to 5% but a full discount is currently
offered to all customers
Source: Bajaj, Paytm, CLSA

Applied for new licenses: Bajaj has applied for two new licenses that will help it
improve customer engagement, in our view.

∑ Bharat Bill Payment Operating Unit (BBPOU): Bajaj went live with Bharat Bill
Pay System (BBPS) on the app in early 2021. On the other hand, the BBPOU
license will allow it to become an aggregator in the BBPS ecosystem. As an
aggregator of payments related to bills under Bharat Bill Pay, it can charge the
billing company, agents and customers who are a part of the ecosystem. The
fees/charges are not regulated by NPCI and are agreed upon by all the BBPOUs
in the system.

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Figure 79

Bajaj has applied for The Bharat Bill Payment System

BBPOU license

Source: Ministry of Electronics and IT, CLSA

∑ Payment aggregator: These entities facilitate acceptance of various payment

instruments by ecommerce sites and merchants from customers for completion
of their payment obligations without the need for merchants to create a
separate payment integration system of their own. They are different from the
payment gateways that provide technology infrastructure to route and facilitate
processing of an online payment transaction without any involvement in
handling of funds. This license should support Bajaj Finance in merchant
acquisition, in our view.

Revenue potential from payments meagre even at a hypothetical 10% market

share
Having been disrupted by UPI, which is free of cost, payments is not a large
revenue-generating business in India. We analyse what the revenue potential for
the company as a payments facilitator would be if it were to reach even a 10%
market share across various payment streams. For this, we assume 20% Cagr in
industry volumes over FY21-24 and also assume that, hypothetically, there would
also be take rates on UPI (2bp for P2P and 10bp for P2M). Even in such a scenario,
the topline contribution from the payments business to Bajaj would be less than
2%.

Figure 80

Bottom-up analysis of hypothetical revenue potential from the payments foray for Bajaj
Industry annual Industry annual Market share Take rate Revenue (Rs bn)
transactions - FY21 (Rs bn) transactions -FY24 (Rs bn) assumption (bp)
UPI P2P 34,815 60,161 10% 2 1.20
UPI P2M 6,221 10,750 10% 10 1.08
Credit card 6,321 10,924 10% 20 2.18
PPI 1,977 3,416 10% 5 0.17
Total revenue (Rs bn) 4.6
Share of FY24 revenue 1.5%
Source: NPCI, RBI, CLSA

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Targeting acquisition of 3m-4m small merchants annually

Management targets 3m- Bajaj has an offline base of 100k merchants, which have gross annual revenue of
4m merchant acquisitions $80bn-100bn. What the company essentially targets is to handle a large share of
annually leveraging on its the total payments pool of these merchants rather than a large share of just the
feet-on-street
financing pool. In addition, Bajaj intends to use its large feet-on-street of 15k+
employees to tie-up with smaller merchants and offer its payment solution to them.
Management believes it could add 3m-4m merchants annually using its own feet-
on-street. At this run rate, in two years, Bajaj could have as many merchants as
Bharat Pe currently has.

Figure 81 Figure 82

Key fintech players and their offline merchant base Total merchant base of India at 65m

Source: Companies, CLSA Source: Redseer, PayTM, CLSA

Productivity app to assist operating efficiency

Four apps to improve Bajaj is developing apps to improve efficiency and productivity of employees,
productivity and efficiency channel partners and merchants. As a part of the same, four applications, namely
in system Sales One App, Merchant App, Collection App and Partner App, are under
development. Among them, Sales One has gone live in phases and the complete
rollout will happen by Jan 2022. A new debt management services app has also
gone live for 9,000 employees and 34,000 agents. These initiatives should result in
the cost-to-income ratio gradually settling down at ~30% over the next 2-3 years.

Figure 83

Expect C/I ratio to reach Bajaj Finance’s cost-to-income ratio to steadily decline
30% by FY24

Source: Company, CLSA

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Competition rising with the entry of Big Tech

Competition in the Indian financial services industry has intensified over the past
few years with the entry of not just fintechs but also Big Tech. Both Amazon and
Google have entered the payment space and currently have 50m-75m monthly
active users. Meta’s Whatsapp has also started offering payment services. It is
expected to benefit greatly from its monthly active user base of over 400m. Apart
from payments, these players have also ventured into wealth management, lending
and deposits via tie-ups with other players.

Figure 84

Increasing competition in Big Tech and its entry into Indian financial services
Indian financial services
space

Source: CLSA

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Scaling up the mortgage segment

Bajaj Housing Finance Bajaj Finance has been in the mortgage business for more than a decade. This
subsidiary incorporated in business is a mix of home loans, loans against property (LAP), lease rental
2018 discounting (LRD) and builder loans. Over the past decade, this segment has
accounted for ~30-40% of loans. In FY18, Bajaj incorporated a housing finance
subsidiary and started doing all incremental business from that subsidiary.
Currently, 82% of the mortgage business of Bajaj is in that subsidiary – Bajaj
Housing Finance.

87% of home loan Unlike its larger peers, Bajaj HFC is not present all over the country. For example, it
customers are salaried does home loans from only 46 locations in the country. Note that 87% of its home
while another 5% are loan customers are salaried.
professionals
Figure 85

Bajaj HFC product snapshot

Loan book (Rs bn) Loan mix Ticket size (Rsm) Locations
Home loans 316 71% 4.7 46
LAP 57 13% 5.4 13
LRD 46 10% 250 8
Developer Finance 25 6% 150-350 8
Source: Company, CLSA; As of 1HFY22

Share of non-core loans higher than that of peers

67% of the total AUM of The mortgage book has been a key growth driver for the company in the few years
Bajaj HFC is core home prior to Covid. It more than doubled from ~Rs200bn in FY17 to Rs462bn in FY20.
loans Currently, in the HFC subsidiary, two-thirds of the total AUM comes from home
loans while the rest is from LAP, LRD and builder loans. The share of non-core loans
(ie, LAP, LRD and builder loans) is higher than that of its peers.

Figure 86 Figure 87

Mortgage book Cagr of 35% over FY17-20 Share of home loans has declined to 67%

Source: Company, CLSA Source: Company, CLSA; Note that this decline in share of home loans is just
for the subsidiary and not necessarily for the consolidated loan book

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Figure 88

Share of non-core loans Bajaj Housing Finance’s share of non-core loans higher than that of peers
(LAP, LRD, etc) for Bajaj
HFC at ~30%

Source: Companies, CLSA

Less than 2% market share in home loans

Bajaj’s home loan market Bajaj has historically been among the smaller players in the home loan market in
share below 2% India. The home loan industry in India is dominated by top five players, which
together form 63% of the total market. Bajaj, with sub-2% market share in home
loans, is a significantly smaller player.

Figure 89 Figure 90

Bajaj has less than 2% market share in home loans The top five players form 63% of total market, as of Mar-21

Source: CLSA Note: Includes an assumed home loan portion of mortgage book Source: Companies, CLSA
of Bajaj Finance; Bottom-up analysis done

The impact of Covid on Sharp slowdown in growth during Covid; how fast will it pick up?
mortgage loan growth was The mortgage book has been a key growth driver for the company in the few years
significantly worse for Bajaj prior to Covid. This business was growing at 35-40% YoY and contributed nearly
than for other HFCs
40% of incremental loans during the period. When Covid struck in FY21, growth
declined sharply from 36% YoY in FY20 to 7% in FY21. Such a sharp reduction in
growth was not witnessed by other large HFCs like HDFC and LIC Housing Finance.
What is interesting is that such a sharp slowdown in loan growth typically happens
in short-tenure products due to the high run-down rate and not in long-term loans
like home loans.

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Figure 91

Mortgage book growth Segment-wise AUM growth performance in the Covid year (%)
declined to 7% in FY21
from 36% in FY20

Source: Company, CLSA

Figure 92

Sharp slowdown in Bajaj’s Core housing loan segment’s growth rate – Bajaj witnessed a sharp slowdown compared to peers
home loan book growth
post Covid

Source: Companies, CLSA; Note: some assumptions used to calculate pure home loan book for Bajaj

We do not expect Bajaj to In our view, the key thing to watch out for is how fast loan growth picks back up.
revert to a sustainable So far in 1HFY22, the mortgage book growth picked up to 17% YoY. Whether it
35%+ Cagr in home loans goes back to the 35%+ YoY level remains to be seen. Given the heightened
given heightened
competitive intensity in home loans post Covid, we do not expect Bajaj to revert
competition
back to 35%+ Cagr sustainably in this segment.

Liability structure different from peers; NCD cost in line with parent
65% of borrowings from Unlike HDFC and LIC Housing Finance that have a relatively smaller proportion of
banks at an average cost of bank borrowings and a larger proportion of market borrowings and deposits, Bajaj
7.0% in FY21. HFC relies more on bank borrowings (65% for Bajaj HFC vs 25-30% for HDFC/LIC
Housing Finance). Typically, bank borrowings are more expensive than market
borrowings unless they are linked to external benchmarks like repo rate. Bajaj HFC’s
bank borrowings are at a cost of 5.17% to 8.35%. The average cost of bank
borrowings in FY21 was 7%.

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The incremental cost of non-convertible debentures (NCDs) for Bajaj HFC is in line
with that of the parent and peers like LIC Housing Finance, but higher than that of
HDFC. However, we believe HDFC’s recent issuance at a 4.25% coupon rate is more
of an aberration than the norm as it is linked to the 3-month Treasury Bill rate.

Figure 93 Figure 94

Borrowing mix - Peer comparison (%) Bajaj HFC’s cost of NCDs is similar to that of peers

Source: Company, CLSA Source: BBG, CLSA; Note: timing of NCD issuance may vary by a couple of
months across peers but is among the most recent issuances; HDFC bond is
linked to 3-month Treasury Bill

First player to slow down in LAP shows management prudence

Reduced ticket size in LAP Bajaj Finance was among the early entrants in the LAP segment in India. However,
when asset quality issues by 2015-16, the market started getting ‘overheated’ with extreme competition and
for the industry began in higher risk-taking by the industry in general. Given the scenario, the company
2015-16 slowed down on growth. It also reduced the average ticket size from ~Rs20m to
~Rs10m (and further to Rs5m now) and started migrating from an agent-sourced
model to an own-sourced model. As a result, while the overall loan book continued
to grow 35%+ YoY, the LAP book was largely stable over a few years.

Figure 95

Share of LAP AUM dropped Share of LAP AUM declined between FY15-17
from 25% to 14% over
FY15-17 given
management’s prudence

Source: Bajaj Finance, CLSA

Asset quality better than that of peers

Gross stage 3 of 0.4% for Over the past three years (FY19-21), Bajaj HFC’s slippage ratio has ranged between
Bajaj HFC is lowest in HFCs 10-40bp. Credit costs, too, have been relatively muted at 20-80bp. With a GNPL
ratio of 0.4%, Bajaj HFC has one of the lowest GNPL ratios among HFCs in India.

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Figure 96 Figure 97

HFC asset quality – peer comparison Bajaj HFC credit cost and slippage ratio trend

Source: Companies, CLSA Source: Companies, CLSA

Expense ratio, though improving, is higher than that of peers

Expense ratio, at 1.1%, Given the low spreads in any prime mortgage lending business, it is imperative to
significantly higher than have a low cost structure to deliver healthy profitability. The mortgage business has
peers’ inherent operating leverage in the first few years of scale-up given the long tenure
of the loan book. In addition to this, the company has proactively tried reducing
sourcing costs. As a result, Bajaj HFC’s expense ratio has declined from 2.8% to
1.1% over FY19-21. This is still higher than that of peers like HDFC and LIC Housing
Finance that are at ~30bp. Note that all the operating expenses for the mortgage
business are booked in the subsidiary, while 18% of AUM is still with the parent.
Hence, the expense ratio looks higher. Adjusted for this, the expense ratio would
be ~90bp.

Figure 98 Figure 99

Expense ratio declining due to operating leverage… …but still higher than that of peers (%)

Source: Company, CLSA Source: Companies, CLSA

DuPont analysis
High-single-digit RoE for Here is a comparison of the DuPont ratios of Bajaj HFC to its peers -
Bajaj HFC

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Figure 100

DuPont comparison with peers (%)

Bajaj HFC HDFC LICHF PNBHF
FY20 FY21 FY20 FY21 FY20 FY21 FY20 FY21
Interest Income 9.1 8.3 12.0 10.3 9.3 8.7 9.4 9.6
Interest Expended 6.4 5.7 8.5 6.7 7.1 6.4 7.2 6.8
Net Interest Income 2.7 2.6 3.5 3.6 2.2 2.3 2.2 2.8
Other Operating Income 1.4 0.8 0.3 0.3 0.1 0.1 1.0 0.6
Total Income 4.1 3.4 3.8 3.9 2.3 2.4 3.2 3.4
Operating Expenses 1.3 1.0 0.4 0.4 0.3 0.3 0.7 0.6
Operating Income 2.7 2.5 3.4 3.4 2.0 2.1 2.5 2.8
Provisions/write offs 0.5 0.7 1.6 0.7 0.5 0.6 1.5 1.1
PBT 2.2 1.8 1.8 2.7 1.6 1.5 1.0 1.7
Tax 0.6 0.5 0.2 0.5 0.4 0.3 0.2 0.4
Reported PAT 1.7 1.3 1.6 2.2 1.2 1.2 0.8 1.2
Leverage 5.5 6.0 5.8 5.4 12.4 11.9 10.5 8.9
RoE 9.1 7.8 9.1 12.1 14.3 14.4 8.3 11.0
Source: Companies, CLSA

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AAA rating; strong performance on deposits

Given its parentage and strong performance over the past decade, Bajaj is one of
the few AAA-rated NBFCs in India. As a result, not only is its borrowing cost
competitive with other large NBFCs like HDFC, but also it is able to borrow money
in times of tight liquidity.

Balanced borrowing mix

Bajaj Finance has a balanced borrowing mix with the share of bank borrowings at
~30% and that of market borrowings near 50%. Within market borrowings, the
share of short-term borrowings (commercial paper, CBLO) stood at only 7% as of
FY21.

Figure 101

Balanced borrowing mix Borrowing mix as of 1HFY22

with lower dependence on
short-term money

Source: Company, CLSA

Commendable performance on the deposit front

Bajaj is the second-largest Bajaj started accepting deposits around 5-6 years back and has scaled up
deposit-accepting NBFC in immensely. It now has the second-largest depositor base among NBFCs, after
India HDFC. Importantly, its deposit rates are competitive with peers, suggesting that the
strong deposit traction has not come with high interest costs.

Figure 102 Figure 103

Bajaj has the second-largest deposit base among NBFCs after The total deposit base has grown over 10x in the past five years
HDFC

Source: Company, CLSA Source: Company, CLSA

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Figure 104

Bajaj’s deposit pricing is competitive with that of peers

Cost of deposits (%) 12-month tenure 36-month tenure
Bajaj 5.65 6.80
HDFC 5.75 6.00
LICHF 5.25 5.75
PNBHF 5.90 6.60
MMFS 5.50 6.71
STFC 6.50 8.08
Source: Companies, CLSA

Gradually reduced dependence on bank borrowings over the years

Bank borrowings accounted Like most NBFCs, in its initial days, Bajaj was more dependent on banks for its
for 32% of total borrowings borrowings. However, over the past 6-7 years, it has steadily reduced dependence
as of FY21 on banks by diversifying into other sources like market borrowings and deposits.
While there was an interim blip during FY18-20 due to the IL&FS crisis, the share
of bank borrowings again declined in FY21. Note that borrowings from capital
markets are typically cheaper than from banks. Also, despite having a high share of
short-term loans, the company has been relatively conservative in borrowing short-
term money. Over the years, it has typically ranged between 5-10% of total
borrowings.

Figure 105 Figure 106

Less reliance on short-term money Diversified the borrowing mix by reducing share of banks (%)

Source: Company, CLSA Source: Company, CLSA; Note: Market borrowings include non-convertible
debentures and commercial paper

Short loan tenure eliminates any risk from asset-liability mismatch

36% of loans mature in a Barring the mortgage book, most of Bajaj’s loan book is of a short duration.
12-month period Consumer durable loans have tenures less than one year, while personal loans have
up to three years typically. As a result, for the consolidated entity, typically ~35%
of the loans mature in a year compared to 31-32% of borrowings. Over the past
several years, Bajaj has maintained a positive asset-liability maturity (ALM) gap of
Rs50bn-130bn. Note that this excludes the liquidity that the company carries on
the balance sheet.

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Figure 107 Figure 108

Share of loans/borrowings maturing within 12 months Assets maturing within 12 months have always exceeded liabilities

Source: Company, CLSA Source: Company, CLSA

While a short loan tenure is good for an NBFC when it comes to ALM, it is bad in
times of muted disbursements. In those cases, the loan book runs down quickly,
causing a drag on loan growth. This is what happened to the company in FY21 –
given a high run-down rate, its AUM growth declined from 27% in FY20 to 4% in
FY21.

Margins higher than most peers

Consumer B2B and B2C Given its loan mix, Bajaj generates high yields of 16-17%. This is driven by the
products are high-yielding consumer B2B (auto and consumer durable loans) and SME segments, offset by
products lower yields in the mortgages segment. This, coupled with a low cost of funds,
results in high margins for the company.

Figure 109

IRR of key products

Auto 22-26%
CD & Lifestyle 23-25%
Business loans 17-20%
PLCS 16-26%
Professional loans 14-17%
Salaried personal loans 14-16%
LAP 10.5%
Commercial 10-12%
Home loans 8.5-10%
Source: Company, CLSA; Note: Data taken from 2QFY18 PPT; Yields today would be different – for example, the
company offers home loans starting at 6.7%

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Figure 110 Figure 111

Bajaj’s cost of funds is better than that of most well-rated peers Spreads have been healthy for the past several years (%)
(%)

Source: Companies, CLSA; Note: FY21 data Source: Company, CLSA

Reduced expense ratio by 150bp over the past five years

Sharp decline in the One unique aspect of the company is its lean operating model. Management has
expense ratio was one-off always found ways to digitise processes and reduce costs. In addition, with the
due to Covid share of loans cross-sold to existing customers increasing, per-unit operating
expenses have also come down. As a result, over FY16-21, the expense ratio
declined 150bp to 3.5%. While FY21 may be an exceptional year due to low travel
costs, employee incentives, etc, the expense ratio has still declined 100bp+
structurally over the past five years.

Figure 112 Figure 113

Total operating expenses trend Expense ratio has consistently improved over the years

Source: Company, CLSA Source: Company, CLSA

Business transformation project to further reduce C/I ratio

Management has guided for Over the past two years, Bajaj has worked on its business transformation project,
C/I ratio to decline to 28-
as described in the previous chapter. The productivity apps would lead to
30% post the business
transformation from 34- streamlining of processes which in turn would lead to cost savings. Management
35% pre-Covid expects the C/I ratio to sustainably drop to 28-30% once the business
transformation is complete.

Can Bajaj have a fully-digital consumer durable loan at an offline POS?

Currently, consumer durable financing at offline stores happens with an employee
of the company sitting at the store and on-boarding customers. Many BNPL players

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have now started operating in this space digitally. For example, one of the larger
BNPL fintechs has put up its QR code at the merchant’s location. After scanning of
the QR code and entering the necessary details, the loan is disbursed to the
customer. This makes it a very opex-light business model. In the future, if the
company could fully digitise the whole process, it would lead to reallocation of
employees to other functions and further cost savings for the company.

Steady improvement in PPoP margin over the years

8% operating profit margins With improving net interest margins, rising fee income contribution and falling
expense ratio, Bajaj has delivered a steady improvement in operating profit (PPoP)
margins over the years. At 8%+, Bajaj’s PPoP margin in FY21 was higher than all
other large NBFCs, barring the specialized gold financiers like Muthoot Finance.

Figure 114 Figure 115

Operating profit margin steadily improving PPoP margin higher than other all peers barring gold financiers (%)

Source: Company, CLSA Source: Company, CLSA

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Asset quality to normalise

A hallmark of the company is its consistent asset quality performance over the past
decade (barring the Covid-19 impact). This has been driving by careful customer
selection coupled with a balanced portfolio approach – ie, a high share of mortgage
lending reduces the overall asset quality risk of the company.

GNPL ratio and credit costs stable over the years

GNPL ratio has been largely During the Global Financial Crisis (GFC), Bajaj’s asset quality was severely hit due
stable at 1.5-1.8% over the to product concentration (a large proportion of book concentrated in auto loans).
past several years The GNPL ratio hit 17-18% in FY09. The new management took up the role of
cleaning the loan book and diversifying the product suite. Since the clean-up, Bajaj’s
asset quality ratios have been largely steady over the years. Its GNPL ratio has
largely been range-bound between 1.5-1.8% with credit costs at similar levels.

Figure 116 Figure 117

GNPL ratio has been range-bound over the past several years Credit costs largely stable until Covid struck

Source: Company, CLSA Source: Company, CLSA

Figure 118

The company wrote-off Write-offs jumped in the Covid year

5.4% of AUM over the past
two years

Source: Company, CLSA

~30% of non-employee expenses spent in recovery efforts

Given its focus on asset quality, the company invests heavily in collections. It has a
4,000+ strong collections force and has tie-ups with several collection agencies.

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The company spends ~30% of total non-salary expenses on collections. This

number spiked to 41% in FY21 due to the pandemic.

Figure 119

Recovery expenses Trend in recovery expenses

comprise ~30% of total
non-employee expenses of
the company

Source: Bajaj, CLSA

Mortgage business lowers the overall credit cost

The overall steady-state credit cost of the company, at 1.7-1.8%, is superior to
NBFC peers like Shriram Transport Finance (SHTF) and Mahindra & Mahindra
Financial Services (MMFS). But what is interesting is that if one excludes the credit
costs of the subsidiary, the residual credit costs of the other segments is actually at
par with or higher than that of MMFS or SHTF. What this implies is that Bajaj has
balanced the risk of the other segments by growing the mortgage business.

Figure 120

Credit costs of the parent Mortgage business helps lower consolidated credit costs for the company (%)
significantly higher than
that of the subsidiary

Source: Company, CLSA

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Figure 121

Comparison of credit costs Credit costs for the parent similar to those of vehicle financiers (%)
of the parent with NBFC
peers

Source: Companies, CLSA

What happened in Covid?

Aggression in auto lending pre-Covid led to asset-quality troubles
Around 4-5 years back, Bajaj would typically fund 35% of two wheelers and three
wheelers (2Ws/3Ws) sold by Bajaj Auto. This ratio increased to 50%+ by FY20.
Given aggressive lending in prior years and impact of Covid-19 on collections,
especially in this segment, the GNPL ratio spiked from 6% in FY20 to 16% in
1HFY22.

Figure 122

Sharp rise in funding Sharp increase in financing penetration between FY18 and FY20…
penetration of Bajaj Auto
loans just prior to Covid

Source: Company, Bajaj Auto, CLSA

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Figure 123

GNPL ratio in auto loans …led to a GNPL ratio spike post the Covid shock
stood at 16% as of 1HFY22

Source: Bajaj, CLSA

Slippage ratio tripled over FY19-21 leading to higher write-offs

5.5% of loans slipped into Historically, Bajaj’s slippage ratio has been 1.5-2%. It increased to ~4% in FY20 due
NPL in FY21 vs a to certain large exposures (Tanglin, Karvy) and further to 5.5% in FY21 due to the
normalised rate of 1.5-2% impact of Covid-19 on collections. As described above, auto loans was the hardest-
hit segment of all in terms of asset quality. Given higher slippages, write-offs also
jumped from Rs10bn to Rs56bn over FY19-21.

Figure 124 Figure 125

Slippage ratio shot up in FY20 due to certain large exposures and Bajaj wrote off nearly Rs80bn over the past two years
in FY21 due to the impact of Covid

Source: Company, CLSA Source: Company, CLSA

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Figure 126

7% cumulative credit cost Credit costs were largely stable until Covid hit
over FY20-21

Source: Company, CLSA; Note: Credit costs in FY20 would have been 1.9% if not for the Rs14bn Covid provision
taken in 4QFY20

What is the current situation?

Net slippage ratio getting close to normal
Net slippage ratio in Prior to Covid, Bajaj used to have a net slippage ratio (gross slippages less upgrades
2QFY22 was 60-80bp and recoveries) of 1.6-1.8% annualized. While there was a spike in FY21 due to the
higher than normal first wave and in 1QFY22 due to the second wave, the net slippage ratio moderated
to 2.4% in 2QFY22. Hence, it is about 60-80bp higher than normal and would
probably normalise by 4QFY22, in our view.

Figure 127

Net slippage ratio was 1.6- Net slippage ratio moderated in 2QFY22 but is still 60-80bp higher than pre-Covid levels (%)
1.8% pre-Covid

Source: Company, CLSA; Note: Numbers are annualized

GNPL ratio in most segments largely back to pre-Covid levels

Barring auto lending, most of Bajaj’s lending segments are largely back to pre-Covid
GNPL ratio levels by 1HFY22. The only exception here is rural consumer B2C (ie,
personal loans) where the GNPL ratio is at 3.1% vs 1.3% pre-Covid.

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Figure 128

Asset quality has Barring auto loans and to some extent, consumer B2C, all segments’ GNPL ratios are back to pre-
normalized across most Covid levels
segments

Source: Company, CLSA

Figure 129 Figure 130

Stage 2 loans normalizing Adequate provisioning on Stage 2 + 3 loans

Source: Company, CLSA Source: Company, CLSA

Forecasting normalised credit costs in FY23

Given the improving economic environment and the provision buffer already
created, we expect credit costs to fully normalise in FY23 and beyond. On a
sustainable basis, Bajaj should deliver 1.6-1.8% credit costs going forward.

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Figure 131

Normalized credit costs Trend in credit costs going forward

from FY23

Source: Company, CLSA

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AUM growth to slow down; RoE healthy

While Bajaj delivered 35%+ AUM Cagr prior to Covid, we believe reverting to those
levels again will be a challenge given a) larger base (AUM up ~2.5x in the past four
years) and b) lower growth in certain segments due to asset-quality issues coupled
with increasing competition in other segments.

Our AUM growth estimates are below management’s guidance of 25-27% YoY
Prior to Covid, Bajaj used to deliver healthy 35% YoY AUM growth consistently over
many years. However, growth was not even across all segments. Growth was driven
by mortgages, auto loans, consumer B2C and rural lending (all 40%+ YoY). The sales
finance and commercial finance segments had started to slow down even before
Covid (sub-10% YoY).

Figure 132

Varying growth rates across AUM growth rate pre-Covid (9MFY20, YoY, %)
segments – mortgages, auto
finance and consumer B2C
were key growth drivers

Source: Company, CLSA

During Covid, growth slowed down across all segments. What is notable is that
mortgage growth slowed down from 40%+ YoY earlier to 7% YoY in FY21. None of
the other HFCs witnessed such a sharp slowdown in growth. While it has picked
back up to 18% YoY levels in 1HFY22, we are sceptical of it returning to pre-Covid
levels of 40%+ YoY on a sustainable basis. In addition, as the company has burnt its
fingers in auto loans during Covid, it is unlikely to grow it at a rapid pace. On the
sales finance front, given the sheer market share of the company and increasing
competition from fintechs and credit cards, we believe growth will, at best, be in
line with that of the industry. Upside to growth could come from targeting new
business segments for BNPL such as travel and edtech. The segments we are most
bullish on are consumer B2C and rural lending, where the company could deliver
25-30% loan growth over a 3-5 year time horizon.

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Figure 133

Some high-growth Two segments that were fast growing prior to Covid are likely to see a slowdown in growth
segments pre-Covid may
not grow as fast post-Covid

Source: CLSA

Figure 134 Figure 135

Unlike peers, Bajaj’s mortgage segment growth declined sharply Our view on product-wise growth in the near and medium term
(%)
Product Segments Near-term Medium-to-long term
Auto Loans 5-10% 10-15%
Sales Finance 15-17% 15-17%
Consumer B2C 25-30% 25-30%
SME 25-30% 25-30%
Rural 30-35% 30-35%
Commercial 35-40% 15-20%
Mortgages 15-20% 20-25%

Source: Companies, CLSA; Note: Individual loan growth for HDFC and home Source: CLSA
loan growth for LICHF taken

Figure 136

Expect 22% AUM CAGR We expect 22% AUM CAGR over the medium term
over FY21-24 vs 35% CAGR
over FY17-20

Source: Company, CLSA

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Margins to revert to pre-Covid levels

Expect 10.6-10.8% NIM Prior to Covid, Bajaj used to deliver 10-10.5% net interest margins. This dipped to
going forward 9.5% largely on the back of lower yields driven by interest reversals and lower
growth in high-yielding products. With asset quality troubles now behind, the
interest reversal impact will not recur. On the cost of funds side, the company has
been able to reduce it marginally in 1HFY22. Hereon, we do not foresee any
meaningful reduction in the cost of funds.

Figure 137 Figure 138

Trend in yields and cost of funds (%) Expect margins to normalise in FY23

Source: Company, CLSA Source: Company, CLSA

Opex to jump 40% in FY22 off a low base; 30% C/I ratio by FY24CL
C/I ratio higher in FY22 due In FY21, total operating expenses declined 6% YoY to Rs53bn, given lower overhead
to collection expenses expense. This was despite a larger outgo in collection costs. In 1HFY22, while the
overhead expenses have reverted to normal, collection costs have further
increased. In our view, collection costs (included in ‘fee & commission expenses’
line item) would rise 45% YoY in FY22. Thereafter, the increase in FY23 should be
meagre (our estimate is 5% YoY). In addition, overhead expenses should grow at a
15% Cagr from FY23, lower than the 22% Cagr in AUM that we estimate. This
should be driven by some operating leverage as well as the rollout of the business
transformation project. Our C/I ratio of 30% in FY24 is largely in line with
management’s guidance of 28-30% post completion of the project.

Figure 139 Figure 140

Growth trends across various line items – growth in Share of fee/commissions in total opex up from 17% to 24% over
fee/commissions to jump in FY22 and moderate thereafter (%) FY19-22CL, driven largely by higher collection costs (%)

Source: Company, CLSA Source: Company, CLSA

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Figure 141

Expense ratio to decline in We expect the expense ratio to moderate to 4% by FY24

FY23 driven by lower
collection expenses and
operating leverage

Source: Company, CLSA

Asset quality troubles behind, credit costs to normalise

Stage 2/3 are only Over the past six quarters, ~7% of the loan book slipped into NPL (net of
marginally higher than pre- upgrades/recoveries). This is significantly higher than the normalized annual net
Covid levels now slippage rate of 2%. The company stepped up its provisions and provided over 50%
of the incremental slippages since Covid (over and above the incremental standard
asset provisions made). With the macroeconomic situation stabilising, new NPL
formation hereon should revert to pre-Covid levels. Consequently, we believe credit
costs should also normalise from FY23.

Figure 142 Figure 143

Stage 2/3 only 140bp/90bp higher than pre-Covid levels (%).. …and provision coverage across Stage 2/3 largely maintained (%)

Source: Company, CLSA Source: Company, CLSA

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Figure 144 Figure 145

GNPL ratio to improve from 2.5% in 1HFY22 to 1.9% by FY23 (%) Credit costs to decline from Rs60bn to Rs37bn over FY21-23

Source: Company, CLSA Source: Company, CLSA

Normalised RoE at 22% far superior to that of most NBFCs

Bajaj has one of the best Given normalisation of margins and credit costs, coupled with improvement in the
return ratios in the NBFC expense ratio, Bajaj’s profit is likely to jump sharply in FY23. Over FY20-23, our
space after the specialised estimates imply a 21% PAT Cagr (adjusted for one-off Covid provision taken in
gold financiers
4QFY20) vs a 16% AUM Cagr over the same time period.

As a result, we estimate RoA to improve to 4.5%+ and RoE to improve to 22%+ by

FY23. At those levels, Bajaj’s return ratios are higher than all NBFC counterparts
barring the specialised gold financiers.

Figure 146 Figure 147

Expect Rs100bn+ PAT in FY23CL RoA of 4.5%+ and RoE of 22%+ in FY23CL

Source: Company, CLSA Source: Company, CLSA

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Figure 148 Figure 149

FY23CL RoA – Bajaj next only to the gold financiers FY23CL RoE – Bajaj higher than all peers barring MUTH

Source: CLSA; Note: BBG estimates used for AAVAS and LTFH Source: CLSA; Note: BBG estimates used for AAVAS and LTFH

Figure 150

Not a big impact of rising Impact of 50bp increase in the cost of funds on FY23CL PAT
cost of funds on
profitability of the company

Source: CLSA; Note: Barring cost of funds, all line items unchanged

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 Taking a breather Bajaj Finance - SELL

Valuations
Five reasons to SELL
Why do we have a SELL rating despite our admiration for what management has
delivered, the business model and the outlook? It is on account of the following
factors:

∑ Covid has impacted growth momentum. The largest segment, mortgages,

was growing 40%+ YoY pre-Covid, but is at sub-20% YoY now. We do not
see it reverting to pre-Covid levels due to intense competition. The sales
finance business, which is the key channel for customer acquisition, will
face tough competition from fintechs and credit cards. The payments foray,
as per our calculations earlier, is unlikely to be a meaningful revenue-
contributor. Hence, in our view, the scope for positive EPS surprises in the
next five years is lower than it was in the previous five years.

∑ 20-30-40: The stock is more than priced for perfection (detailed below in
the note). Every 2-3 years, the PE ratio has increased 10ppt – from ~20x in
2016 to ~30x in 2018/19 to 40x+ now. The re-rating in the past was
justified as the company grew its PAT at 40%+ Cagr. Beyond the near term
rebound, we expect 20-25% Cagr in AUM and PAT, which implies that
valuations at 40x+ are not justified.

∑ We believe ‘fintech’-ish valuations can only be given to some segments like

consumer B2B sales finance, consumer B2C and rural lending and not to
the entire company. These segments make up less than 40% of the
consolidated AUM and probably 50% of the consolidated PAT. Other
segments like auto loans, mortgages or commercial loans are unlikely to
witness any ‘fintech’ innovation. Hence, giving a ‘fintech’ valuation to the
entire company, which we believe the street is doing, is erroneous, in our
view.

∑ Compared to pre-Covid, the company’s market cap has increased by

~Rs1.5trn. The bulk of this is based on the ‘fintech’ story. While the
outcome of the transformation project is yet uncertain, an incremental
market cap greater than that of India’s largest fintech, PayTM, has already
been created by investors. Note that Bajaj’s customer base is around one-
sixth that of PayTM.

∑ For bulk of the past decade, HDFC Bank and Bajaj were market leaders in
retail lending, and hence, preferred picks for investment managers. With
some ‘corporate’ banks now establishing a presence in retail lending, there
are more ways for portfolio managers to invest in the retail lending
opportunity in India.

Like an HDFC Bank, just eight years younger

We note a very strong resemblance and correlation of Bajaj’s PAT with that
delivered by HDFC Bank eight years prior.

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Figure 151

Very strong correlation PAT numbers of Bajaj strongly correlated with that of HDFC Bank eight years prior (Rs bn)
between PAT of Bajaj and
of HDFC Bank eight years
prior

Source: Companies, CLSA

If HDFC Bank had been What would happen if HDFC Bank had traded at Bajaj’s current multiple eight
priced at Bajaj’s current years ago?
multiple eight years ago, the Both, HDFC Bank and Bajaj are considered best-in-class retail lenders with high
stock would have delivered return ratios and good corporate governance. As seen above, there is a strong
only 6% Cagr over the past
correlation between the profits of both entities too (HDFC Bank on a lagged basis).
eight years
What if, in FY14, HDFC Bank was valued at the same multiple Bajaj is valued at
today? Would the outcome of HDFC Bank’s share price over FY14-22 in that
scenario give a sense of the outcome of Bajaj’s share price over FY22-30? Note that
this calculation implies that in FY30, Bajaj should trade at a valuation similar to what
HDFC Bank trades at currently, given the similar profit trajectory. The table below
shows the returns an investor would have made in HDFC Bank over FY14-22 had
it been valued at 7x (Bajaj’s current multiple) back then. We note that the IRR of
the investment would have been a mere 6%, underperforming Nifty 50 by 800bp.

Figure 152

Mere 6% stock price Cagr over eight years if an investor had bought HDFC Bank at Bajaj’s current
PB multiple in FY14
FY16 net worth (Rs bn) 727
Assumed PB multiple (x) 7.0
Assumed market cap (Rs bn) 5,087
Current market cap (Rs bn) 8,343
IRR over eight years 6%
Nifty 50 Cagr 14%
Relative underperformance 800bp
Source: HDFC Bank, CLSA

Conversely, if Bajaj were to trade at HDFC Bank’s current multiple eight years
hence, the IRR of the investment would be only 10%. To arrive at this, we assume a
20% networth Cagr for Bajaj over the next eight years.

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Figure 153

If Bajaj’s PB multiple converges to HDFC Bank’s current PB multiple of 3x eight years later, IRR
would be only 10%
FY23 net worth (Rs bn) 514
FY31 net worth (Rs bn) 2,212
PB multiple - HDFC Bank (x) 3.0
Market cap of Bajaj after eight years (Rs bn) 6,570
Current market cap (Rs bn) 4,471
IRR 10%
Source: Bajaj, CLSA; Note: Assuming 20% CAGR in networth over FY23-31

Growth premium vs HDFC Bank shrinking

Prior to Covid, Bajaj’s loan growth rate was 10-15ppt higher than that of HDFC
Bank, which justified the valuation premium it got. However, over the coming years,
we expect that growth premium to shrink to ~5ppt. If this scenario were to play
out, would the valuation premium continue?

Figure 154

Growth premium of Bajaj AUM growth comparison of HDFC Bank and Bajaj
over HDFC Bank is likely to
shrink

Source: Companies, CLSA

Not everything pans out how it is envisaged at the beginning

There have been several instances in the past where things did not pan out the way
they were predicted. While the following examples are minor, we want to drive the
point that not everything works out as initially envisaged, even for the best of
companies. For example –

∑ In 2015, lifestyle finance was envisaged to be as big as the consumer

durables book in a five-year span. However, it did not turn out that way.

∑ The REMI (retail EMI) and wallet financing business lost 2-3 years’ worth of
profits in one year and had to be re-engineered.

∑ Bajaj launched urban gold loans in 2016 as a cross-sell product to existing

customers and believed that the gold loan book could possibly reach $1bn
in 3-4 years. However, as of FY21, the overall gold loan book (urban and
rural) stood at Rs22bn ($300m), the bulk of which is rural gold loans.

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∑ The ~Rs170bn in mortgage loans on the parent balance sheet were

expected to wind down by Mar-21. However, as of Sep-21, there is still
nearly Rs100bn worth of mortgage loans on the parent balance sheet.

Higher RoE warrants a higher multiple, but how much is the question
We strongly believe that Bajaj’s higher-than-peer multiple is justified. But how
much is the question. Bajaj trades at a 140% valuation premium to HDFC Bank for
500bp higher RoE, a 215% premium to Muthoot Finance for marginally lower RoE
and a 150% premium to Chola for 100bp higher RoE.

Figure 155

Scatter chart – RoE vs PB of key banks and NBFCs

Source: CLSA

Multiples expanded sharply over the past year

Over the past year or so, there has been excitement on the Street on the outcome
of the business transformation project. While we do acknowledge it will help
improve cross-sell (resulting in better AUM growth) and reduce costs, the
magnitude of the former remains to be seen. Meanwhile the market cap of the
company has increased by ~$20bn, spurred by this excitement. Note that this
increase is more than the market cap of India’s largest fintech, PayTM.

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Figure 156

8.6x 12-month forward PB PB multiple has expanded beyond pre-Covid levels

Source: Bloomberg, company

Figure 157

Bajaj trades at 44x 12- The stock trades at 42x FY23 PE and 34x FY24 PE
month forward PE

Source: Bloomberg, company

PB valuation premium over HDFC Bank thrice the pre-Covid average

Until mid-2015, Bajaj used to trade at a discount to HDFC Bank as the business
model was relatively undiscovered by the investor community. As the company
started delivering strong numbers consistently, its PB multiple reached that of
HDFC Bank and then overtook it. In the three years prior to Covid, the average PB
valuation premium that Bajaj commanded to HDFC Bank was ~60%. This narrowed
to ~40% in the peak of Covid wave 1 (Apr-May 2020) but recovered thereafter.
Bajaj now trades at a 180% higher multiple than HDFC Bank (8.2x vs 2.9x 1-year
forward PB).

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 Taking a breather Bajaj Finance - SELL

Figure 158

Comparison of PB valuation of Bajaj and HDFC Bank

Source: BBG, CLSA; Note: PB valuation on a 1-year forward basis

Figure 159

Bajaj trading at 180% Bajaj’s valuation premium to HDFC Bank at an all-time high despite an expected narrowing growth
premium to HDFC Bank, outperformance
despite an expected
slowdown in growth
outperformance

Source: Company, BBG, CLSA; Note: Valuations calculated on 12-month forward PB basis; Growth outperformance
defined as loan growth of Bajaj minus loan growth of HDFC Bank

44x PE for Bajaj vs 20x for 120% PE valuation premium unjustified given shrinking growth outperformance
HDFC Bank (1-year We also analyse relative PE trends between HDFC Bank and Bajaj. Looking at PE
forward) against PB is helpful because it also factors in the return on equity (RoE) of the
entity. While Bajaj used to trade at a 30% PE premium to HDFC Bank prior to Covid,
it now trades at a 120% PE premium to the latter. We believe this premium is
unjustified given Bajaj’s shrinking growth outperformance versus HDFC Bank.

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 Taking a breather Bajaj Finance - SELL

Figure 160

While HDFC Bank’s PE has been stable over the years, Bajaj’s PE has been rising and now is at a 120% premium to that of HDFC Bank

Source: Companies, CLSA; Note: PE valuation on a 1-year forward basis

Figure 161

Valuation comparison – BAF a clear outlier, even when compared to some of the good banks and NBFCs
Company Price Mcap P/E P/B RoA RoE
(Rs) (US$bn) FY22 FY23 FY24 FY22 FY23 FY24 FY22 FY23 FY24 FY22 FY23 FY24
Bajaj 7,439 59.0 62.4 42.7 33.8 10.5 8.7 7.1 3.8 4.6 4.8 18.2 22.3 23.2
HDFC 2,842 68.1 23.8 19.6 16.7 2.7 2.4 2.1 2.3 2.4 2.4 11.7 12.9 13.4
LICHF 394 2.9 14.1 7.0 5.8 0.9 0.8 0.7 0.6 1.1 1.2 7.0 12.4 13.3
SHTF 1,494 5.4 13.3 9.6 8.9 1.5 1.3 1.2 2.3 2.9 2.9 12.6 14.8 14.2
CIFC 578 6.3 23.3 17.6 15.4 4.2 3.4 2.9 2.7 3.2 3.1 19.4 21.3 20.2
MMFS 165 2.7 37.7 9.1 7.8 1.3 1.2 1.1 0.7 3.0 3.1 3.6 13.9 14.5
MUTH 1,510 8.0 14.8 12.6 10.7 3.2 2.7 2.2 6.0 6.3 6.7 24.2 23.3 22.7
MGFL 175 2.0 9.6 8.4 7.2 1.5 1.2 1.0 5.6 5.7 5.8 20.4 19.8 19.6
ICICIB 755 69.4 18.3 14.0 11.8 2.6 2.2 1.9 1.8 2.0 2.0 14.3 16.3 16.7
HDFCB 1,527 112.0 22.9 18.4 15.7 3.5 3.0 2.5 1.9 2.1 2.1 16.3 17.4 17.4
AXSB 694 28.2 14.1 10.3 8.7 1.7 1.5 1.3 1.4 1.8 1.8 12.5 15.1 15.5
Source: CLSA; Prices as of close of trading on 9 th December, 2021

What about SOTP of mortgage and non-mortgage segments?

If one values the mortgage What if one does an SOTP of the mortgage business and the other businesses?
business at 3x FY24 PB, the What is the implied multiple of the other businesses? Bajaj currently trades at 6.9x
implied valuation of the FY24 PB. What if one were to value the mortgage and non-mortgage businesses
other business is 8.5x FY24
separately? In this hypothetical example, we assume that the optimal leverage at
PB
which the mortgage business would run would be 6x. Giving it a multiple of 3x (vs
2x for HDFC given Bajaj’s stronger growth), the implied valuation of the non-
mortgage business is 8.5x FY24 BVPS.

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Figure 162

Calculating the implied multiple of the non-mortgage business if the mortgage business is valued
at 3x FY24 PB
FY24, Rs bn Mortgage Others Consolidated
Loan book 943 1,751 2,693
Leverage 6.0 3.7 4.3
Networth 157 470 627
PB multiple 3.0 8.5 6.9
Value (Rs bn) 471 3,988 4,459
Source: CLSA

Bajaj trades at a similar Comparing Bajaj to global BNPL players

MCap/revenue multiple as Bajaj trades at a valuation similar to that of Afterpay on a MCap/revenue basis
that of Afterpay (FY23) despite lower revenue growth. Also, as mentioned earlier in the note, if one
were to compare Bajaj with fintechs, one must consider only the relevant segments
(sales finance, personal loans and rural finance) and then compare the segments
with fintechs. Giving a fintech multiple to the entire book or the entire revenue of
Bajaj would be erroneous, in our view.

Figure 163

Bajaj trades at a similar multiple to Afterpay on an FY23 basis

Company Revenue (USD m) Mcap/Revenue (x)
Mcap FY21 FY22 FY23 FY24 FY21 FY22 FY23 FY24
Klarna 45,600 1,229 37.1
Afterpay 21,024 647 1,076 1,658 2,228 32.5 19.5 12.7 9.4
Affirm 36,000 870 1,275 1,867 2,708 41.4 28.2 19.3 13.3
BAF 59,037 3,558 4,158 5,104 6,158 16.6 14.2 11.6 9.6
Source: BBG, CLSA; Note: Bajaj estimates are ours; Affirm and Afterpay estimates from BBG; Revenue for Afterpay and Affirm for the financial year ending June
2021

Bajaj raised equity capital Rs144bn to Rs1.5trn – the beauty of value creation via capital raises
thrice in the past 5-6 years To fund its strong AUM growth, Bajaj has raised equity capital often – in the past
5-6 years, it has raised a cumulative Rs144bn. When a company raises equity at a
PB multiple greater than 1x, the transaction is accretive to book value per share
(BVPS). Given that Bajaj has always traded at premium multiples over the years, the
BVPS accretion with each capital raise has been significant. Per our calculations
below, without the last three capital raises, the FY20 BVPS would have been Rs347
vs the actual BVPS of Rs540, ie, 36% lower. Assuming the same PB multiple for the
stock, the market cap of the company would have also been 36% lower. This 36%
translated to a market cap of Rs1.5trn. Essentially, Rs144bn raised over the past 5-
6 years is worth Rs1.5trn in value today, per today’s market price.

Figure 164

Details of equity capital raises in the past few years

Rs mn FY16 FY18 FY20
Equity capital raised 14,000 45,000 85,000
Price 428 1,690 3,900
No. of shares issued (mn) 32.7 26.6 21.8
BVPS 139 276 540
Net worth assuming no capital raise in that year 60,266 113,577 239,150
No. of shares assuming no capital raise in that year 503 550 578
BVPS assuming no capital raise in that year 120 206 414
BVPS accretion due to each capital raise 16% 34% 31%
FY20 BVPS assuming no capital raise 347
FY20 BVPS accretion (cumulative) 56%
Source: Company, CLSA

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The question to ponder on now is – If growth will be 20-25% YoY rather than 35%+
YoY, will Bajaj need to raise capital any time in the medium term (current
loans/equity = 4.3x)? And if it does not need to raise capital, then would BVPS
accretion over the next five years be as strong as it was in the previous five?

Using a residual income model to arrive at our TP

We value the stock based on a residual income model with key assumptions as
follows:

Figure 165

We model ~23% RoE for the next 17 years and 20% terminal RoE
Rsbn 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 Termin
al
Risk free rate 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3%
Risk premium 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%
Beta 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05 1.05
Required CoE 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0%

Net worth 626 750 900 1,081 1,299 1,560 1,874 2,249 2,698 3,234 3,874 4,637 5,546 6,629 7,917 6,544
ROEs 23.2% 23.4% 23.6% 23.7% 23.7% 23.7% 23.7% 23.6% 23.5% 23.4% 23.3% 23.2% 23.1% 23.0% 22.9% 20.0%
PAT 132 161 194 234 282 338 406 486 581 693 827 986 1,175 1,398 1,663 1,446
growth 26% 22% 21% 21% 20% 20% 20% 20% 19% 19% 19% 19% 19% 19% 19%

Required return 68 83 99 119 143 172 206 248 297 357 427 512 612 732 875 869
Residual income 64 78 95 115 139 166 200 238 283 336 400 474 562 666 789 577
Discounted RI 57 62 68 73 79 84 90 96 102 108 115 121 128 136 144 1,569
Source: CLSA

FY38 PAT = 1HFY22 AUM To put these numbers in perspective, the RI model implicitly factors in 20% Cagr in
PAT over the next 15 years. Consequently, PAT would grow 16x over the next 15
FY38 AUM > 1HFY22 loan years to reach Rs1.7trn by FY38. This means that FY38 PAT would be equal to
book of SBI + ICICIB
current AUM. Assuming steady RoA of 4.6% over this time period, this implies that
Bajaj would be as big as what HDFC currently is by FY28, as big as HDFC Bank +
Kotak Mahindra Bank currently is by FY33 and bigger than what State Bank of India
+ ICICI Bank is by FY38.

Figure 166 Figure 167

RI model implies 20% PAT Cagr over FY23-38 What Bajaj’s loan book will be assuming RoA is maintained at FY23
levels of 4.6%

Source: CLSA Source: Companies, CLSA; Text in red highlights the current loan book size of
that bank/HFC

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Figure 168

Arrive at a TP of Rs6000 implying 5.8x FY24CL PB

Rs bn Value Contribution to Avg. ROE Avg. COE
value assumption assumption
FY24 Net worth 626 17.4%
PV of RI over FY25-30CL 456 12.7% 23.6% 12.03%
PV of RI over FY31-38CL 950 26.4% 23.2% 12.03%
Terminal value 1,569 43.6% 20.0% 12.03%
Total value of the firm 3,601 100.0%
Total number of shares 602

Value per share 5,986

Target price (rounded off) 6,000
Current market price 7,100
Upside -15%
Implied PB- FY24 5.8
Implied PE - FY24 27.2
Terminal growth assumption 5.0%

Assumptions
Risk free rate 6.25%
Risk premium 5.50%
Beta 1.05
Required Cost of Equity 12.0%
Source: CLSA

Why we haven’t given a ‘fintech’ optionality value to Bajaj

The aim of the business transformation project is to improve cross-sell, thereby
aiding loan growth, as well as to reduce costs. As discussed above, our assumptions
include 20% PAT Cagr over the long term. The 20% long-term PAT Cagr, on this
large base, is an outcome of Bajaj’s ‘fintech’ foray. Hence, giving an additional
optionality value for the fintech piece would be double-counting.

What long-term growth do current valuations price in?

We use our RI model to tweak the PAT growth assumptions to arrive at the current
market price. Based on that, Bajaj will have to grow at a 23% Cagr over FY23-38,
followed by a 5% terminal growth rate, to justify its current market price of
~Rs7,300.

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Key risks – where can we go wrong

Management has demonstrated its ability to identify new segments
One of the key differentiating factors of Bajaj vs other NBFCs is the sheer breadth
of the product suite. Over the past decade, management has identified new product
segments for growth. If the next decade too presents such opportunities, then the
company could grow far higher than our estimates.

Digital transformation could lead to stronger fee income generation

At ~1.7% of average AUM, Bajaj’s fee income ratio is best among NBFCs and ranks
high when compared to banks too. We have not factored in any improvement in the
fee margin hereon. However, if the payments business in the long-term turns out
to be more lucrative than it is today, the company would be able to deliver
meaningfully higher fee income, which would be RoA/RoE accretive.

Strong growth could continue longer than we estimate

Our residual income model factors in a 20% PAT Cagr over FY23-38 followed by
terminal growth of 5%. However, if one were to factor in 20% PAT Cagr over FY23-
48 (ie, for 25 years), the TP would be close to Rs13,000.

Empirical evidence suggests we will go wrong

Over the past several years, the company has proved many naysayers wrong. At
several points in time, there were investors and analysts who felt that the company
was too large to grow at 30% YoY, but it did. All analysts who had a ‘sell’ call on the
stock, at whatever point in time, have gone wrong.

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Annexure
Company history
Bajaj Finance has been in business for the past three decades. It started as a captive
auto financier for Bajaj Auto and later diversified into other segments. Today, the
company is present in multiple product segments across retail and corporate
lending and is among the largest non-banking financial companies (NBFCs) in India
with assets under management (AUM) of Rs1.7trn.

Figure 169

Bajaj Finance started Bajaj Finance - history

operations as Bajaj Auto
Finance in 1987

Source: CLSA

Key management personnel

Here is a summary of the key management personnel of the company:

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Figure 170

Key Management Personnel

Name Designation Date of joining Total experience in Previous employment details
Bajaj financial services
Mr. Rajeev Jain MD & CEO Sep 07 27 Deputy CEO of Consumer Finance business,
AIG; previously with American Express and GE
Mr. Anup Saha Deputy CEO May 18 19 ICICI Bank, GE Capital
Mr. Atul Jain CEO (Bajaj HFC) Mar 02 27
Mr. Sandeep Jain CFO Aug 08 16 Bajaj Auto
Mr. Deepak Bagati President - Debt Jul 08 18 HDFC Bank, Yes Bank, ONICRA, Mahindra &
Management Mahindra, Modi Xerox
Mr. Ashish Panchal President - Rural, Jan 11 21 Barclays, Citibank, Standard Chartered
insurance and
liabilities
Mr. MM Muralidharan Treasurer 1998 23 Seamless Steel & Alloys, ACC Babcock
Mr. Fakhari Sarjan CRO Nov 18 26 Barclays, Deutsche Bank, ABN AMRO, HSBC,
ANZ Grindlays & Asian Paints
Source: Bajaj, CLSA

Stock-based compensation offered to senior management

Bajaj offers employee stock options (ESOPs) to its senior management. Given below
are details of the ESOPs offered to the Managing Director:

Figure 171

Details of ESOPs granted to the Managing Director in the past few years
FY17 FY18 FY19 FY20 FY21
No. of options granted ('000) 206 152 121 141 246
Grant Price (Rs) 765 1,348 1,920 3,003 1,939
Source: Company, CLSA

Diversified Board of Directors with majority independent directors

Bajaj’s Board of Directors comprises 12 members, of which 7 are Independent
Directors.

Figure 172

Composition of the Board of Directors

Name of the Director Category
Mr. Rahul Bajaj Chairman Emeritus
Mr. Sanjiv Bajaj Chairman
Mr. Rajeev Jain Managing Director
Mr. Madhur Bajaj Non-Executive
Mr. Rajiv Bajaj Non-Executive
Mr. Dipak Poddar Independent
Mr. Ranjan Sanghi Independent
Mr. D J Balaji Rao Independent
Dr. Gita Piramal Independent
Dr. Naushad Forbes Independent
Ms. Anami N Roy Independent
Mr. Pramit Jhaveri Independent
Source: Bajaj, CLSA

Shareholding pattern
The promoters own 56% of the outstanding shares of the company. Their
shareholding has been largely constant over the past five years. Among institutional
investors, Bajaj has a larger ownership by Foreign Institutional Investors (FII, 24%)
as compared to domestic investors (mutual funds and insurance companies, 8%).

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Figure 173

Shareholding pattern as of Sep-21

Source: Company, CLSA

Well-placed on Environmental, Social & Governance (ESG) aspects

On the environmental side, the company is committed to environmental
preservation by going digital. In fact, it offers 10bp higher interest rate on its digital
fixed deposits as compared to regular deposits. On the social aspect, the company
has grown its rural lending business faster than the other segments. It plans to open
50 financial inclusion branches in rural and backward areas in FY22. On the
governance aspect, here are some key features:

∑ The Board of Directors has a majority of Independent Directors (7/12)

∑ Independent Directors meet senior management twice a year

∑ Separate meeting of independent directors without presence of non-

independent directors or executive management

∑ Quarterly meeting of Chief Risk Officers of Bajaj and Bajaj HFC with their
respective Boards without the presence of the Managing Director

∑ Bajaj has constituted an executive ESG committee led by Deputy-CEO

which consists of heads of finance, legal, compliance, operations,
information technology, risk, human resource, secretarial functions and a
senior representative of the company for implementing and monitoring
ESG-related aspects

∑ Disclosures to investors in the quarterly presentation are far superior to

that of peers

∑ No concerning related-party transactions

Hence, we rate Bajaj at a corporate governance score higher than the country
average.

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 Taking a breather Bajaj Finance - SELL

Valuation details
We use a residual income model to value the firm. We find an equity charge using
a 12.0% cost of equity built up from a 6.25% risk-free rate and 5.5% risk premium,
as used across our India coverage, and an adjusted beta of 1.05, based off a blend
of observed betas over different historical periods. We set a terminal growth rate
of 5% based on macro factors such as India's higher GDP growth and factoring in
strong growth outlook, and a modestly lower terminal ROE at 20%, to account for
compression on the assumption that competition increases. The resulting target
price implies 5.8x Mar-24CL PB.

Investment risks
1) Management has demonstrated its ability to identify new segments, thus the
company could grow far higher than our estimates

2) Digital transformation could lead to stronger fee income generation

3) Strong growth could sustain longer than we estimate

4) The ongoing pandemic of Covid-19 and its emerging variants could send country
into lockdown and impact the company's business or customers' ability to repay

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 Taking a breather Bajaj Finance - SELL

Detailed financials
Profit & Loss (Rsm)
Year to 31 March 2018A 2019A 2020A 2021A 2022CL 2023CL 2024CL
Interest income 115,855 163,488 229,704 233,034 271,634 336,571 410,617
Interest expense (46,139) (66,236) (94,732) (94,140) (97,566) (120,465) (147,723)
Net interest income 69,716 97,252 134,972 138,894 174,068 216,107 262,894
Trading income - - - - - - -
FX gains/(losses) - - - - - - -
Fee/Commission income 11,589 21,384 34,034 33,647 40,102 46,053 51,035
Other operating income 124 130 118 150 135 161 194
Non-interest income 11,713 21,514 34,152 33,797 40,237 46,214 51,228
Total op income 81,429 118,766 169,124 172,691 214,305 262,321 314,122
Staff related expenses (14,336) (19,385) (25,491) (24,967) (34,204) (39,335) (45,235)
Property related expenses (5,335) (7,129) (10,564) (12,465) (18,074) (18,978) (21,824)
Other operating expenses (13,019) (15,447) (20,554) (15,651) (21,718) (24,788) (28,301)
Total operating expenses (32,690) (41,961) (56,608) (53,082) (73,996) (83,101) (95,360)
Preprovision OP 48,739 76,805 112,516 119,608 140,309 179,220 218,762
Specific provision for loans - - - - - - -
General provision for loans (10,305) (15,014) (39,295) (59,686) (43,427) (37,477) (40,090)
Other provisions 0 0 0 0 0 0 0
Loan-loss provisions (10,305) (15,014) (39,295) (59,686) (43,427) (37,477) (40,090)
Operating profit 38,434 61,792 73,221 59,923 96,882 141,743 178,672
Associate income - - - - - - -
Other exceptional items - - - - - - -
Other income/expense 0 0 0 0 0 0 0
Profit before tax 38,434 61,792 73,221 59,923 96,882 141,743 178,672
Taxation (13,471) (21,842) (20,584) (15,724) (25,189) (36,853) (46,455)
Profit after tax (before preference 24,964 39,950 52,638 44,198 71,692 104,890 132,217
dividends)
Preference dividends - - - - - - -
Profit for period 24,964 39,950 52,638 44,198 71,692 104,890 132,217
Minority interest 0 0 0 0 0 0 0
Net profit 24,964 39,950 52,638 44,198 71,692 104,890 132,217
Adjusted profit 24,964 39,950 52,638 44,198 71,692 104,890 132,217
EPS (Rs) 44.5 69.4 89.5 73.6 119.2 174.4 219.8
Adjusted EPS (Rs) 44.5 69.4 89.5 73.6 119.2 174.4 219.8
DPS (Rs) 4.0 6.0 10.0 10.0 17.9 26.2 33.0

Profit & loss ratios

Year to 31 March 2018A 2019A 2020A 2021A 2022CL 2023CL 2024CL
Growth (%)
Net int inc growth (%) 42.2 39.5 38.8 2.9 25.3 24.2 21.7
Non-int inc growth (%) (9.7) 83.7 58.7 (1.0) 19.1 14.9 10.8
Operating inc growth (%) 31.3 45.9 42.4 2.1 24.1 22.4 19.7
Operating exp growth (%) 27.5 28.4 34.9 (6.2) 39.4 12.3 14.8
Loan provision expense growth 25.9 45.7 161.7 51.9 (27.2) (13.7) 7.0
Net profit growth (%) 35.9 60.0 31.8 (16.0) 62.2 46.3 26.1
EPS growth (% YoY) 31.1 55.9 29.0 (17.8) 62.0 46.3 26.1
Adj EPS growth (% YoY) 31.1 55.9 29.0 (17.8) 62.0 46.3 26.1
DPS growth (% YoY) 11.1 50.0 66.7 0.0 78.8 46.3 26.1
Margins (%)
Spread (%) (7.9) (7.9) (8.2) (7.2) (6.8) (6.8) (6.9)
Net interest margin (%) 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Returns (%)
ROA (%) 3.4 3.8 3.6 2.6 3.8 4.6 4.8
ROE (%) 20.1 22.5 20.2 12.9 18.2 22.4 23.2
Other key ratios (%)
Non-interest inc/op inc (x) 14.4 18.1 20.2 19.6 18.8 17.6 16.3
Cost/income (%) 40.1 35.3 33.5 30.7 34.5 31.7 30.4
Staff costs/op costs (%) 43.9 46.2 45.0 47.0 46.2 47.3 47.4
Provision exp/loans (%) 1.3 1.3 2.8 4.0 2.4 1.7 1.5
Earnings payout ratio (%) 9.0 8.7 11.2 13.6 15.0 15.0 15.0
Source: www.clsa.com

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 Taking a breather Bajaj Finance - SELL

Balance sheet (Rsm)

Year to 31 March 2018A 2019A 2020A 2021A 2022CL 2023CL 2024CL
Gross loans 800,001 1,137,115 1,427,989 1,483,313 1,809,642 2,207,763 2,693,471
Loan loss reserve 0 0 0 0 0 0 0
Net loans 800,001 1,137,115 1,427,989 1,483,313 1,809,642 2,207,763 2,693,471
Cash & equivalents 3,397 3,487 13,827 21,762 42,216 78,490 105,783
Placements with other banks - - - - - - -
Other interest earning assets - - - - - - -
Total interest earning assets 803,398 1,140,602 1,441,817 1,505,075 1,851,857 2,286,253 2,799,254
Net fixed assets 4,703 6,948 13,210 13,668 15,034 16,538 18,192
Intangible assets 0 0 0 0 0 0 0
Other assets 39,883 94,775 188,887 196,526 170,815 196,437 225,902
Total non-interest earning assets 44,585 101,723 202,097 210,194 185,849 212,975 244,094
Total assets 847,983 1,242,325 1,643,914 1,715,269 2,037,706 2,499,227 3,043,348
Current deposits - - - - - - -
Savings deposits - - - - - - -
Other deposits - - - - - - -
Customer deposits 0 0 0 0 0 0 0
Deposits from banks - - - - - - -
Other int-bearing liabs 665,573 1,015,879 1,298,064 1,316,454 1,574,388 1,942,831 2,370,254
Total int-bearing liabs 665,573 1,015,879 1,298,064 1,316,454 1,574,388 1,942,831 2,370,254
Other non-int-bearing liabs 23,932 29,476 22,573 35,647 39,211 43,133 47,446
Total liabilities 689,504 1,045,355 1,320,637 1,352,101 1,613,600 1,985,964 2,417,700
Share capital 1,150 1,154 1,200 1,203 1,203 1,203 1,203
Retained earnings - - - - - - -
Reserves 157,328 195,817 322,076 361,965 422,903 512,060 624,444
Treasury stock - - - - - - -
Shareholder funds 158,478 196,970 323,276 363,168 424,107 513,263 625,648
Minorities/other equity 0 0 0 0 0 0 0
Total equity 158,478 196,970 323,276 363,168 424,107 513,263 625,648
Total liabs & equity 847,983 1,242,325 1,643,914 1,715,269 2,037,706 2,499,227 3,043,348
Non-performing loans 11,638 18,035 23,626 27,304 37,591 43,373 51,870
Credit risk - - - - - - -
Operational risk - - - - - - -
Market risk - - - - - - -
Risk weighted assets 804,523 1,046,064 1,349,167 1,307,615 1,628,678 1,986,987 2,424,124
Average Risk weighted assets 712,860 925,293 1,197,616 1,328,391 1,468,146 1,807,832 2,205,555
Total tier 1 capital 148,368 170,257 286,977 328,385 389,324 478,480 590,865
Total capital 192,923 216,132 337,412 370,183 429,032 526,130 648,045
BVPS (Rs) 275.5 341.5 538.8 603.7 705.0 853.2 1,040.0

Balance sheet ratios

Year to 31 March 2018A 2019A 2020A 2021A 2022CL 2023CL 2024CL
Growth (%)
Loan growth (%) 41.8 42.1 25.6 3.9 22.0 22.0 22.0
Deposits growth (%) nm nm nm nm nm nm nm
Loans/deposits (%) 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Growth in total assets (% YoY) 36.9 46.5 32.3 4.3 18.8 22.6 21.8
Risk-wtd assets growth (%) 29.5 30.0 29.0 (3.1) 24.6 22.0 22.0
Asset quality
Provision expense/loans (%) 1.3 1.3 2.8 4.0 2.4 1.7 1.5
Gross NPLs/total loans (%) 1.5 1.6 1.7 1.8 2.1 2.0 1.9
Loan provisions/NPLs (%) 69.6 59.7 60.3 58.4 58.0 60.0 60.0
NPL growth/loan growth 44.1 130.4 121.2 401.8 171.2 69.9 89.1
Loan provision growth/loan provision 44.2 71.8 20.0 22.9 (134.7) (141.3) 280.9
expense growth
Capital Adequacy
Tier 1 CAR (%) 18.4 16.3 21.3 25.1 23.9 24.1 24.4
CAR (%) 42.4 36.9 46.3 53.4 50.2 50.6 51.1
RWA/total assets (%) 94.9 84.2 82.1 76.2 79.9 79.5 79.7
Equity/total assets (%) 18.7 15.9 19.7 21.2 20.8 20.5 20.6
Source: www.clsa.com

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 Taking a breather Bajaj Finance - SELL

DuPont analysis
Year to 31 March 2018A 2019A 2020A 2021A 2022CL 2023CL 2024CL
Net int income/assets (%) 9.5 9.3 9.4 8.3 9.3 9.5 9.5
Non-int income/assets (%) 1.6 2.1 2.4 2.0 2.1 2.0 1.8
Total op income/assets (%) 11.1 11.4 11.7 10.3 11.4 11.6 11.3
Op expenses/assets (%) 4.5 4.0 3.9 3.2 3.9 3.7 3.4
Op profit/assets (%) 15.6 15.4 15.6 13.4 15.4 15.2 14.8
Provision expenses/assets (%) (1.4) (1.4) (2.7) (3.6) (2.3) (1.7) (1.4)
Other items/assets (%) 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Tax expense/assets (%) (5.0) (4.9) (3.6) (2.6) (3.4) (3.5) (3.5)
ROA (%) 3.4 3.8 3.6 2.6 3.8 4.6 4.8
ROA incl other items/assets (%) 9.2 9.0 9.3 7.3 9.7 10.0 9.9
Leverage (x) 5.9 5.9 5.5 4.9 4.8 4.8 4.9
ROE (%) 20.1 22.5 20.2 12.9 18.2 22.4 23.2
Source: www.clsa.com

10 December 2021 [email protected] 77

 Important disclosures Bajaj Finance - SELL

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Companies mentioned
Bajaj Finance (BAF IN - RS7,452.50 - SELL)
Aavas Finance (N-R)
ABN Amro (N-R)
ACC Babcock (N-R)
Affirm Holdings Inc (N-R)
Afterpay (N-R)
Alphabet (N-R)
Amazon (N-R)
Amazon (N-R)
Amex (N-R)
ANZ Grindlay (N-R)
Asian Paints (APNT IS - RS3,178.7 - O-PF)
Axis Bank (AXSB IB - RS694.0 - BUY)
Bajaj Allianz GI (N-R)
Bajaj Auto (BJAUT IS - RS3,341.0 - U-PF)
Bajaj Auto Finance (N-R)
Bajaj Financial Securities (N-R)
Bajaj Finserv Limited (N-R)
Bajaj Group (N-R)
Bajaj Housing Finance (N-R)
Bank of Baroda (BOB IB - RS92.3 - BUY)
Barclays (N-R)
Boston Consulting Group (N-R)
Can Fin Homes (N-R)
Capital Float (N-R)
Chola Inv & Fin (CIFC IN - RS577.6 - BUY)
Citibank (N-R)
DBS Bank India (N-R)
DBS Singapore (N-R)
Deutsche Bank (N-R)
Facebook (N-R)
General Electric (N-R)
Google (N-R)
Havells India (HAVL IB - RS1,389.1 - O-PF)
HDFC (HDFC IB - RS2,841.8 - O-PF)
HDFC Bank (HDFCB IB - RS1,527.5 - BUY)
HDFC Life Insurance (HDFCLIFE IN - RS683.1 - O-PF)
Hero Fincorp (N-R)
ICICI Bank (ICICIBC IB - RS755.2 - BUY)
IL&FS (N-R)
IndusInd Bank (IIB IS - RS946.4 - BUY)
Jammu and Kashmir Bank (N-R)
Karvy (N-R)
Karvy Stock Broking (N-R)
Klarna Bank AB (N-R)
Kotak Bank (KMB IB - RS1,911.5 - O-PF)
L&T Financial Holding (N-R)
LIC Housing Finance (LICHF IB - RS394.1 - BUY)

10 December 2021 [email protected] 78

 Important disclosures Bajaj Finance - SELL

Mahindra (MM IB - RS851.0 - BUY)

Mahindra Finance (MMFS IN - RS165.1 - BUY)
MakeMyTrip (N-R)
Manappuram Finance (MGFL IN - RS174.9 - BUY)
Meta (N-R)
Modi Xerox (N-R)
Muthoot Finance (MUTH IN - RS1,507.0 - BUY)
ONICRA (N-R)
PayTM (N-R)
Phone Pe (N-R)
Pine Labs (N-R)
PNB Housing Finance (N-R)
Razorpay (N-R)
RBL Bank (RBK IN - RS199.1 - O-PF)
Seamless Steel (N-R)
Shriram City (N-R)
Shriram Transport (SHTF IS - RS1,494.0 - O-PF)
Square (N-R)
Standard Chartered (N-R)
State Bank of India (SBIN IB - RS488.6 - BUY)
Tanglin (N-R)
Yatra.com (N-R)
Yes Bank (N-R)
ZestMoney (N-R)
ZestMoney (N-R)
Zomato (ZOMATO IN - RS146.2 - BUY)

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own personal views about the securities and/or the issuers and that no part of my/our compensation was, is, or will
be directly or indirectly related to the specific recommendation or views contained in this research report.

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 Important disclosures Bajaj Finance - SELL

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 Important disclosures Bajaj Finance - SELL

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