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Should investors subscribe to Five-Star Business Finance IPO?

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Today is the opening of subscription for institutional investors Matrix Partners and Sequoia Capital’s offer for sale (OFS) of Rs. 1,960 crore by Five-Star Business Finance (Five Star) (November 9).

The company is valued at about Rs 13,800 crore at the upper end of the pricing range of Rs 474 per share. The company will be able to expand its operations with the aid of the OFS and capitalise on the credit crunch, underserved market, and other opportunities.

IPO Detail

The OFS of an NBFC (non-banking finance company) comes at a time when these organizations are displacing banks in the market for small business loans (by 41 percent).

The company benefited greatly from its long history and the promoters’ steadfast backing. Five Star is in a very high growth phase with an AUM (asset under management) of Rs 5,297 crore (end June 22). It is the fastest-growing NBFC among its peers according to its loan assets’ CAGR (compounded annual growth rate) of 65 percent between FY17 and FY21. The business has grown over the last five years, and despite the difficult business environment, the company has been able to maintain high levels of profitability. The highest among its peers, Five Star has produced a ROA (return on assets) of more than 7%.

Given these impressive figures, it is unclear how much additional headroom is available and why investors should take the IPO into account when there are so many other public NBFCs to choose from.

The large market opportunity (Rs 22 lakh crore market) and the relatively favorable value in comparison to the listed rivals are the two key reasons to think about this IPO.

According to CRISIL projections, the demand for small company loans is anticipated to increase at a CAGR of 22% over the next three years. Banks and other bigger NBFCs don’t have much competition because the typical ticket size is so tiny.

An ATS (average ticket size) of Rs. 3–5 lakh in towns. Because of the excellent capital adequacy (75.2 percent), it is well positioned for future expansion (only 15 percent MSMEs in India have access to formal credit in any form as per CRISIL).

The good valuation of the IPO gives us hope. Five Star is priced at 2.8 times expected book value for FY24, which is less than its listed competitors. Given the substantial market opportunity and strong return ratios in the private lending sector, this is enticing.

The limited scale of operation with a regional concentration, the somewhat experienced and concentrated product portfolio with high exposure to small and economically susceptible borrowers, and the lack of a strong parentage, however, partially offset these benefits.

5 star peer valuation
5 star peer valuation anually

MSME businesses dominates the advances book

Small loans for commercial reasons make up the majority of Five-loan Star’s portfolio (62.11%), along with loans for asset building (37.88%), which includes loans for house renovation, marriage, healthcare, and education.

The non-agro LIG (low income group) segment makes up the majority of the AUM (69 percent). Most of the loans are secured by residential property that is used for personal use (SORP – 95 percent).

Small-scale of operations with a regional concentration

Despite having an 85% geographic concentration in South India, the organization has been successful in expanding into new, underserved areas by using a calibrated expansion approach. Because of this, operations were highly efficient (steady branch expansion; AUM per branch in the range of Rs 15-17 crore).   

Five Star has a moderate resource profile (66 percent fixed-cost borrowings). The lowering of incremental cost (down 286 basis points in FY22 from FY19 levels) and the consistent superior yields led to an above-average return profile. The performance has been further supported by stable credit history coupled with a conservative approach to asset liability and liquidity management.

Improving asset quality with benign credit cost

Since FY20, when it was 1.37 percent, the reported gross non-performing asset (GNPA) ratio has decreased to 1.05 percent. However, Five Star’s asset quality is inherently risky due to its exposure to small borrowers in the MSME sector.
However, due to the strong infrastructure for collection (collection efficiency is over 98 percent) and efficient risk containment, the GNPA ratio is the best among peers. Credit cost is minimal (0.7%) and provision coverage ratio is sufficient (around 35 percent). 

About 1.4% of the loan book has been restructured (reduced by 12 percent YoY in FY22). Future asset quality will largely depend on how well these loans perform.


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