Initial Coverage: Fusion Micro Finance

Summary

Fusion Micro Finance Ltd is a non-banking financial company (NBFC) based in India that provides microfinance services to low-income individuals and small businesses. The company was founded in 1994 and currently operates in 18 states across India, serving more than 1 million clients through a network of over 400 branches. Fusion Micro Finance Ltd offers various financial products and services, including microloans, group loans, individual loans, and micro-enterprise loans, with a focus on promoting financial inclusion and entrepreneurship in underserved communities. The company's mission is to enable sustainable livelihoods for its clients by providing access to credit, financial literacy, and other support services. Fusion Micro Finance Ltd is committed to responsible and ethical business practices and has received various awards and recognition for its social impact and financial performance.

INDUSTRY RESEARCH:

• With effect from 1 April 2022, the RBI harmonized its MFI frameworks, which had a favorable influence on this sector. The MFI firms now compete on an even playing field with peer banks and SFBs thanks to these developments. The RBI also lifted interest rate ceilings, enabling NBFCMFIs to develop a risk-based pricing mechanism for these loans and raising the minimum family income required to qualify for microloans. The pool of potential customers has grown as a result. Additionally, the RBI has put a limit on total borrower debt, which will control the industry's asset quality. 
• In the MFI sector, NBFC-MFIs' market share increased by 331 basis points in 9MFY23, while banks' market share decreased by 430 basis points during the same time. Market share for NBFC-MFIs/Banks/SFBs/NBFCs/Others as of December 2022 was 38.5/35.7/16.3/8.5/1%, up from 31.8/39.8/17.5/9.8/1.1% as of March 2022 and 35.2/40/16.9/6.9/1% as of March 2022. Additionally, as of December 2022, NBFC-MFIs' annual Gross Loan Portfolio (GLP) growth rate was 41.1% as opposed to 24.7% in March 2022. Therefore, it is clear that these harmonized standards have benefited NBFC-MFI activity at the expense of bank business in this sector. 
• Except for Tamil Nadu, all of the main states have a penetration rate that is less than 50%, with Uttar Pradesh, Maharashtra, and Rajasthan having the lowest rates. Additionally, the Telangana High Court recently issued a judgment prohibiting State Governments from regulating NBFC-MFIs that are registered with the RBI, which is advantageous for these businesses in this sector. 

ABOUT COMPANY:

Fusion Micro Finance Ltd is a non-banking financial company (NBFC) based in India that provides microfinance services to low-income individuals and small businesses. The company was founded in 1994 and currently operates in 18 states across India, serving more than 1 million clients through a network of over 400 branches. Fusion Micro Finance Ltd offers various financial products and services, including microloans, group loans, individual loans, and micro-enterprise loans, with a focus on promoting financial inclusion and entrepreneurship in underserved communities. The company's mission is to enable sustainable livelihoods for its clients by providing access to credit, financial literacy, and other support services. Fusion Micro Finance Ltd is committed to responsible and ethical business practices and has received various awards and recognition for its social impact and financial performance.

BUSINESS MODEL:

• Healthy capitalization, supported by regular equity infusion and rich pedigree of investors

On November 2, 2022, Fusion opened its Initial Public Offering with fresh issuance of Rs 600 crore and an offer for sale of around Rs 500 crore. The fresh issuance along with internal accruals further strengthens the capitalization profile of the company. As of December 31, 2022, Fusion's net worth improved to Rs 2,205 crore with adjusted gearing at 3.7 times as compared to Rs 1,338 crore net worth and 5.1 times adjusted gearing in March 2022. Going by the past track record, Fusion has been able to raise the required equity capital and ensure that its overall capital position remains adequate. This would also substantiate maintenance of adjusted gearing at around 5 times and an overall capital adequacy ratio of 20% on a steady-state basis.  

• Improving profitability

The operating profitability of the company has shown improvement over the last 2 years. The company reported pre-provisioning profitability of 5.3% in fiscal 2021 and 5.7% in fiscal 2022. Resultantly, despite the credit costs elevating to 4.2% for fiscal 2021 and 5.3% for fiscal 2022, the company maintained its positive bottom line with a RoMA of 0.8% for fiscal 2021 and 0.3% for fiscal 2022. In 9M 2023, pre-provisioning profitability further improves to 7.4% (annualized). With the improvement in yield and collections along with a reduction in credit cost, net profit stood at Rs 273 crore and RoMA at 4.1% (annualized). With stabilizing collections and asset quality performance and, the ability to implement risk-based pricing under the revised guidelines for MFIs, the company’s operating profitability is expected to be strengthened further. Over the medium term, the company’s ability to maintain the quality of books created post-pandemic will remain a crucial factor from an earnings perspective.

• Sound risk management practices

Fusion has developed adequate risk management systems and practices over the last few years as it expands operations to new markets. This enabled the company to maintain its asset quality performance in existing regions; it also assists in the identification of newer regions. The company evaluates the potential area of operations on the Area Lucrative Index, which involves the assessment of parameters denoting the credit potential of the region. The company also has an extensive audit team of 329 members as of December 2022, with the number of branches being capped at two per auditor. The branches are graded twice a month on over 100 parameters, which helps the company detect any ongoing or potential issues.

In fiscal 2022, Fusion reported an AUM of Rs 6,786 crore and registered an on-year growth of 46%. The growth momentum has picked up from July 2021 onwards with an average disbursement of Rs 600 crore per month. During fiscal 2023, AUM further grew to Rs 8,654 crore as of December 31, 2022, with YTD growth of 27.5%.

In terms of geographic diversity, as of December 2022, the company has expanded its presence to 20 states, with the highest exposure to a single state being 20.8% (33% as on March 31, 2016, prior to demonetization) and the top five states being 67.7% (94% as on March 31, 2016). Alongside expansion in geographical presence, the robust growth encountered over the last few years is supported by adequate monitoring of operational parameters, such as a calibrated increase in ticket size and AUM exposure per branch, per district, and so on.

However, considering the rapid growth in the loan portfolio, significant expansion into new geographies, and limited loan cycle vintage, Fusion’s ability to sustain its risk management processes and demonstrate strong asset quality performance in new markets remains a key monitorable.

• The experienced senior management team

Fusion is promoted by Mr. Devesh Sachdev, who is an alumnus of Xavier School of Management, with over two decades of experience before he started Fusion in 2010. The second line of management comprises professionals with an average experience of over a decade in the fields of commercial and retail lending, audit, operations, people management, and IT. The board has adequate representation from investors and extends strategic support to the company.

• Diversified funding profile

Over the years, Fusion has adopted a calibrated approach toward diversifying the fundraising sources and minimizing the costs of borrowings with prudent asset liability management and effective liquidity management. As per the management, focusing on building a healthy balance sheet with a good mix of assets, liability, and equity and a positive net asset position has enabled the company to overcome various negative market conditions in the past. 

ABOUT MANAGEMENT:

The company has an experienced and professional management team as well as marquee investors at the helm. This helps the company in actively monitoring, evaluating, and refining its corporate governance practices throughout the organization. Fusion is promoted by Mr. Devesh Sachdev, who has over two decades of experience before he started Fusion in 2010. He is also the Chairperson of the governing board of the Microfinance Institutions Network. The second line of the management team comprises professionals with an average experience of over a decade in their respective fields. Several team members at the top management are with the company for more than 5 years.     

SHAREHOLDING PATTERN:

RISK:

• Risky nature of business: Microfinance is inherently risky business because of cash dealing and collateral-free nature. Clients have below-average credit risk profiles and lack access to formal credit. The borrowers of individual microfinance loans and micro & small enterprise loans are typically farmers, vegetable vendors, small machine and lathe owners, tea shops, provision stores, small fabrication units, waste paper recycling units, tailors, and power looms. They are an economically weaker class and face income volatility.
• Political risks due to the nature of loans: The loan book of Fusion is dominated by microfinance loans. Political instigation in some of the states asking people not to pay back their dues, as witnessed in the past, could result in higher NPAs. Further, microfinance businesses are also highly sensitive to natural calamities and social-economic events.
• High growth rate: Fusion is one of the fastest-growing NBFC-MFI and has grown at a CAGR of 51% in the last five years. Any economic slowdown or market share loss could impact the current growth rate of the company. Lower-than-expected AUM growth or build-up in the NPAs are the key risks to our thesis.
• Rising Interest rates: We witnessed a rising interest rate environment almost throughout FY23, and the cost of borrowings is rising for the NBFCs and on the asset side, the demand for the loan products is declining due to reduced affordability. This could impact the NIMs on account of the squeeze in the spread and ultimately on the profitability of the company.
• Change of regulations: NBFCs, including NBFC-MFIs, in India, are subject to strict regulation and supervision by the RBI. It requires several approvals, licenses, registrations, and permissions to operate the business. Any adverse change of regulation could have a negative impact on the business of the company

FINANCIALS:

The company has reported strong quarterly numbers in Q4FY23. The total interest income stood at Rs. 450 crores up 47/7% YoY/QoQ, whereas the interest expenses stood at Rs. 174 crores up 28/4% YoY/QoQ. Its yield on advances stood at 21% for the quarter as against 20.7% in Q3FY23 and 17.7% in Q4FY22, while its cost of borrowing stood at 10.4% (up 50/0bps YoY/QoQ). This healthy growth of interest income and controlled finance costs, coupled with robust growth in its loan portfolio, helped the company’s Net Interest Income to grow by 62/10% YoY/QoQ, and stand at Rs. 276 crores. Its NIM improved by 280/30bps YoY/QoQ and stood at 10.6% for the quarter. The management expects the yield to stabilize around 22% going forward. The Cost to Income ratio of the company improved to 36.2% for Q4FY23 vs 38.4% in Q3FY23 on account of stronger growth in its interest income compared to its finance and operating costs. The company reported 45/9% YoY/QoQ higher opex on account of continued physical expansion and digital initiatives to automate various.

CONCALL SUMMARY:

VALUATION:

In the last six years, the Asset Under management (AUM) of Fusion has grown at a CAGR of 43%, while during the same period, it has reported a healthy 28% CAGR in borrowers. Overall, FY23 has been a year full of milestones for the company. It has registered a 37% yearly growth in its AUM, reported its highest ever yearly PAT of Rs. 387 crores (up 1680% YoY), and organically added 0.8 million customers taking the total to 3.5 million spread across 20 states. Over the last four quarters, the company has continuously delivered RoA above 4% and RoE above 20% on account of robust margins and declining provisions. We expect the company to grow its AUM at 26% CAGR while NII and Net profit are expected to grow at 28% and 31% CAGR respectively over FY23-25E. ROAA is estimated to improve to 4.9% in FY25E from the current 4.6% in FY23. The asset quality should improve further from here on as collection starts stabilizing. The company is trading at 1.48x FY25E ABV, which is at a considerable discount to its peers. Looking at the growth opportunities we believe that the discount will gradually narrow. We feel that investors can buy the stock in the band of Rs. 500-510.

SOURCE:

-STOCX

-COMPANY'S WEBSITE