Fusion Micro Finance

Second largest microfinance NBFC

Well diversified national footprint, strong growth and stable asset quality to drive performance, but high credit risk customer base and evolving microfinance regulation are challenges

Fusion Micro Finance is a second largest microfinance Non-Banking Finance Company (NBFC) in terms of gross loan portfolio (GLP) providing financial services to unserved and underserved women in rural and peri-rural areas across India. It is one of the youngest companies in terms of getting an NBFC- Micro Finance Institution (MFI) licence among the top NBFC-MFIs in India in terms of AUM. As of June 2022, total AUM of the company was Rs 7389.02 crore.

The company has prioritized organic geographic diversification since inception in 2010, with a focus on strategic management of state concentration risk by expanding into underpenetrated rural areas that offer significant growth opportunities. The company has built a significant footprint across India with network of 966 branches and 9,262 permanent employees spread across 377 districts in 19 states and union territories in India serving 2.90 million active borrowers end June 2022.

The significant footprint of active borrowers and branch network puts the company in a vantage position to further penetrate and deepen its presence in areas in with established branch infrastructure but remaining relatively untapped and also to expand into new regions that have significant growth potential.

The company has been able to maintain low levels of AUM concentration per state despite growth over the years and no single state contributed to more than 20.00% of total AUM. The proportion of AUM in five largest states in terms of AUM concentration has further decreased from Rs 612.49 crore or 94.61% of total AUM end March 2016 to Rs 4885.42 crore or 66.12% of total AUM end June 2022.

The share of AUM from customers in rural areas represented 91.37% of total AUM. The focus customer segment is women in rural areas with an annual household income of up to Rs 3 lakh. The business runs on a joint liability group-lending model, wherein a small number of women form a group (typically comprising five to seven members) and guarantee one another’s loans.

The key product offerings are income-generating loans that provide capital for women entrepreneurs in rural areas to fund businesses operating in the agriculture-allied and agriculture, manufacturing and production, trade and retail, and services sectors. Subject to certain eligibility criteria, the company also offers existing customers top-up loans to manage interim working capital requirements for existing businesses as well as emergency loans to fund urgent financial needs arising as a result of unforeseen events. In addition, existing customers are also offered cross-sell loans that are utilized for livelihood and productivity enhancing purposes as well as MSME loans to eligible enterprises.

The company has been able to optimize cost of funds, liquidity requirements and capital management over the years. It benefit from a large and diversified mix of 56 lenders comprising a range of public banks, private banks, foreign banks and financial institutions. The average effective cost of borrowings has declined to 10.10% in Q1FY2023 from 12.33% in FY2020. The company has a dedicated asset liability management (ALM) committee that regularly reviews and monitors the maturity schedule for all financial liabilities in accordance with ALM policies and guidelines. The long-term credit ratings have improved from a rating of “BBB” by CARE as of March 2017 to a rating of “A-” by CRISIL, CARE and ICRA end June 2022.

Technology is an integral part of overall business strategy. Through early adoption of cloud computing software and emphasis on best-in-class security practices, the company has established a foundation in enabling automation and digitalization of several processes across business functions including customer onboarding, customer service, loan disbursements, internal audit and risk management. All of customers have been onboarded digitally and cashless disbursements amounted to 96.26% in Q1FY2023. The technology initiatives have and will continue to be instrumental in optimizing operational efficiency, enhancing customer experience and minimizing costs.

Devesh Sachdev is Managing Director and Chief Executive Officer of the company with 26 years of experience in the banking and financial services industry.

The company aims to deepen, strengthen and expand geographic presence. It would continue to invest in technology to enhance operational efficiency and optimize costs. The product offering is proposed to be enhanced leveraging network, domain expertise and data to enhance product offering.

The Offer and the Objects

The initial public offer (IPO) consists a fresh issue of Rs 600 crore to issue 1.714 crore equity shares of face value of Rs 10 each at lower price band of Rs 350 per share and 1.630 crore equity shares at the upper band of Rs 368 per share.

The offer for sale (OFS) comprises of 1.369 crore equity shares to raise Rs 479.34 crore at lower price band Rs 503.99 crore at upper price band. Among the promoters, Honey Rose Investment has offered for sale 14 lakh equity shares, Creation Investments Fusion, LLC 14 lakh equity shares, Devesh Sachdev 6.5 lakh equity shares and Mini Sachdev 1 lakh equity shares.

The promoter and promoter group shareholding would decline to 68.18% post IPO from 85.57% pre-IPO.

The issue is to be made through the book-building process and will open on 02 November 2022 and will close on 04 November 2022.

The company proposes to utilize the net proceeds towards augmenting its capital base. In addition, it expects to receive the benefits of listing of the Equity Shares on the Stock Exchanges and enhancement of Company’s brand name amongst existing and potential customers and creation of a public market for equity shares in India.

Strengths

The company has built a well diversified and extensive pan-India presence. The number of active borrowers grew at a CAGR of 33.63% and number of branches grew at a CAGR of 31.92% between March 2016 and June 2022.

The AUM grew at a strong CAGR of 37% from Rs 3606.52 crore end March 2020 to Rs 6785.97 crore end March 2022, and increased to Rs 7389.02 crore end June 2022.

The company has achieved a consistent reduction in cost to income ratio from 63.35% for FY2019 to 44.27% for FY2022 through benefits of operating leverage in business and digitization.

As a result of expansion efforts, no single state contributed to more than 20.00% of total AUM, and proportion of AUM in five largest states in terms of AUM concentration has further decreased from Rs 94.61% of total AUM end March 2016 to 66.12% of total AUM end June 2022.

The company has a long history of serving rural markets with high growth potential in the microfinance segment, and has maintained a track record of financial performance and operational efficiency through consistently high rates of customer acquisition and retention and low-cost expansion into underpenetrated areas.

The company has built a deep rural franchise in the microfinance segment with 2.05 million or 70.77% of total customers, 696 branches or 72.05% of total branches, and Rs 6751.2 crore or 91.37% of total AUM, were from rural areas.

The company has implemented robust technology platforms that have significantly enhanced accessibility for, and addressed the borrowing challenges faced by, a rural customer base that is quite large and typically lives in remote locations.

The company has access to diversified sources of capital and effective asset liability management

The company has consistently maintained healthy capital adequacy ratios with CRAR of 21.13% and debt to equity ratio was 4.24 times end June 2022

CARE Advisory Research and Training has assigned a grading of “MFI 1”, which is the highest available grading on an eight point scale. An improving credit ratings and stable credit history provides a competitive advantage when borrowing funds for future growth and operations.

The strong underwriting processes and risk management policies, such as extensive customer assessment methodologies and monitoring systems, have resulted in healthy portfolio quality with gross NPAs at 3.67% and net NPAs at 1.35% end June 2022.

The company has followed a well-defined IT strategy since inception with clear targets in order to remain at the forefront of the dynamic and fast-evolving nature of business technology.

The company benefit from support of marquee investors, including Warburg Pincus LLC, a leading private equity firm focused on growth investing across several sectors, and Creation Investments Fusion, LLC, a leading alternative investment management company.

Weaknesses

The microfinance industry face various risks including competition, changes in customer behavior and demographic patterns, various central and state government decisions (including farm loan waivers), changes in interest rates and exchange rates and changes in regulations.

The microfinance industry in India faces unique risks due to the category of borrowers that it services, which are generally not associated with other forms of lending. The customers generally have limited sources of income, savings and credit histories.

The micro credit customers are often considered to be higher credit risk customers due to their increased exposure to fluctuations in cash flows and to adverse economic conditions.

The management of credit risk involves having appropriate credit policies, underwriting standards, approval processes, loan portfolio monitoring, collection and remedial management, provisioning policies and an overall architecture for managing credit risk.

The RBI regulations states that not more than two NBFC-MFIs may lend to the same borrower causing restriction on growth.

The laws and regulations governing the banking and financial services industry in India have become increasingly complex, with the regulations relating to MFIs still evolving. The requirement to comply with increasing regulations may continue to adversely affect business and the microfinance industry in general due likely requirements such as restructuring of activities, limits on interest rates charged to customer etc.

A large portion of collections from customers are in cash, exposing to certain operational risks.

The loans provided are unsecured loans and the company rely on non-traditional guarantee mechanisms rather than any tangible assets or collateral.

There exists a political and social risk such as negative publicity and public criticism of the microfinance industry. In addition, the microfinance sector may be susceptible to election cycles.

Competition from other MFIs, banks and financial institutions, as well as state-sponsored social programs, may adversely affect profitability and standing in the Indian microcredit lending industry.

NBFC-MFIs are subject to periodic inspections by the RBI.

Valuation

Fusion Micro Finance has posted strong revenue growth of 24% in FY2021, 29% in FY2022 and higher 32% surge in Q1FY2023. The Gross profit of the company has also jumped 44% in FY2021, 42% in FY2022 and 61% Q1FY2023. However, the PAT has declined 37% in FY2021 and 50% in FY2022 on account of higher credit cost. The PAT has jumped sharply by more than 17-times in Q1FY2023 with the dip in provisions.

The annualized EPS on post-issue equity works out to Rs 9.2 for TTM ended June 2022. At the price band of Rs 350 to Rs 368, P/E works out to 38.1-40.1 times of annualized EPS for TTM ended June 2022.

Post-issue, the book value (BV) will be Rs 201.8 at upper price band and adjusted BV (ABV) is Rs 192.6 (net of NNPA). The scrip is being offered at price to Adj BV multiple of 1.9x at the upper price band.

Among peer NBFC MFIs, CreditAccess Grameen is trading P/Adj BV (end June 2022) multiple of 3.4x, Spandana Sphoorty Financial at 1.5x and Satin Creditcare Network at 0.8x.

In terms of P/E, Fusion Micro Finance is offered at 40.1x of annualized EPS for TTM ended June 2022 at upper price band. Among peers, CreditAccess Grameen is trading at PE of 31.1x of annualized EPS for TTM ended June 2022.

Fusion Microfinance is the second largest NBFC-MFI in India in terms of gross loan portfolio at end June 2022. Fusion Microfinance reported 3rd fastest GLP growth of 36% between FY2019 and FY2022. Fusion Microfinance had the fourth fastest gross loan portfolio CAGR of 53.89% between FY2017 and FY2021 among the 10 largest NBFC-MFIs in India.

Fusion Microfinance tops among NBFC-MFIs in clients per branch and also in clients per employee. Among the top NBFC-MFIs, Fusion Microfinance has highest share of rural clients at 93%. Fusion Microfinance is ranked 4th among select NBFC-MFIs based on the presence in the number of states and 3rd based on the presence in number of districts. Fusion also has the lowest loan per customer among NBFC-MFIs showing better diversification and lower risk per customer.

Fusion Microfinance reported the 3rd highest NII growth of 38% between FY2019 and FY2022 among the peers. However, Fusion reported the 3rd lowest RoA and RoE among the top 10 NBFC-MFIs in FY2022. Fusion Microfinance had the 6th lowest GNPA ratio and 6th lowest average net NPA ratio amongst the top 10 NBFC-MFIs in FY2022.