MSME Credit Expansion And Lower Funding Costs Will Support Long Term Earnings Resilience

Catalysts

About SBFC Finance

SBFC Finance is a non bank lender focused on secured MSME and gold loans to small business owners across underserved Indian markets.

What are the underlying business or industry changes driving this perspective?

• Expansion in the formal MSME credit market between INR 500,000 and INR 3 million, which has been compounding at more than 20 percent annually, positions SBFC to compound its AUM as it selectively tightens filters without sacrificing its 5 to 7 percent quarterly growth ambition, supporting sustained revenue growth.
• India's environment of low and less volatile inflation alongside structurally lower real interest rates is driving down SBFC's incremental cost of borrowing while loan yields remain stable, which may protect spreads and gradually lift net interest margins and earnings.
• High capital adequacy of more than 34 percent and current debt equity of below 2 times give SBFC room to lever up its balance sheet prudently. This may translate stable 4.5 percent plus ROA into structurally higher ROE and profit growth without equity dilution in the near term.
• Ongoing operating leverage from a maturing branch network and disciplined branch additions is reducing OpEx to AUM. Combined with stable disbursal capacity of around INR 300 crores a month, this may drive faster growth in pre provision operating profit than in AUM and enhance net margins.
• Sharpened underwriting through higher minimum ticket sizes, stricter CIBIL cut offs and closer monitoring of customer leverage is likely to cap credit cost after a near term uptick, allowing a larger share of high yielding secured MSME income to drop to the bottom line and support earnings resilience.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming SBFC Finance's revenue will grow by 26.8% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 42.6% today to 42.3% in 3 years time.
• Analysts expect earnings to reach ₹7.9 billion (and earnings per share of ₹7.26) by about December 2028, up from ₹3.9 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 29.3x on those 2028 earnings, down from 29.4x today. This future PE is greater than the current PE for the IN Consumer Finance industry at 24.0x.
• Analysts expect the number of shares outstanding to grow by 1.37% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 16.02%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Sustained stress in specific geographies such as Karnataka, where political and regulatory interventions have already disrupted an otherwise healthy portfolio, could keep delinquency flows elevated for several quarters. This could drive higher credit costs and put pressure on earnings and net margins over time.
• Rising leverage on the customer side, amid renewed aggressive growth in unsecured lending by other financiers, may translate into overlevered MSME borrowers in SBFC Finance's target segment. This could weaken repayment behavior, increase GNPA and one plus buckets, and weigh on revenue growth and credit costs.
• Structural political and climate risks, which management notes are now more prominent than in the past, could trigger sudden repayment moratoriums, localized economic disruption or collateral value impairment. This could lead to higher provisioning requirements and lower return on equity and profitability.
• A prolonged tough credit environment in the lower ticket MSME segment, where stress is already visible, may force SBFC Finance to keep tightening underwriting and pulling back from sub INR 700,000 loans. This could cap AUM expansion and slow revenue and earnings growth below current expectations.
• If industry wide competition and regulatory constraints continue to limit pricing power while SBFC Finance's credit costs settle structurally higher than the current 1.29 percent level, the combination of narrower incremental spread improvement and elevated provisions could prevent ROA from remaining above 4.5 percent and stall further gains in net margins and ROE.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of ₹130.75 for SBFC Finance based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹150.0, and the most bearish reporting a price target of just ₹110.0.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be ₹18.8 billion, earnings will come to ₹7.9 billion, and it would be trading on a PE ratio of 29.3x, assuming you use a discount rate of 16.0%.
  
• Given the current share price of ₹105.14, the analyst price target of ₹130.75 is 19.6% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.