Formerly seen as the golden child of microfinance, SKS Microfinance has recently suffered from a plight of bad press. In July 2010, SKS became the first Indian microfinance institution to go public. The deal was oversubscribed by 13 times at the top of its price band. Since this time, several events have called into question its future success such as the unexpected firing of its CEO, a rash of suicides by loan holders, and pending government regulations. Throughout this time, SKS’ stock has seen large price swings. Given this situation, it seemed appropriate to reevaluate that company’s stock price.
A number of factors support SKS’ high stock price. First, SKS is the clear market leader within India and established a model that is easily scalable. Second, the Indian market has only begun to be tapped. Currently, microfinance demand is estimated at US$51.4 million with only US$4.3 million supplied, representing huge market potential. Third, SKS’ operating expenses, while low internationally, are high in the Indian environment and could be reduced to increase margins.
Yet, several investment concerns are also present. First and foremost, SKS’ initial valuation was widely considered high. This overly optimistic valuation means that SKS’ extraordinary growth will have to continue to support its high price. If growth slows or does not meet expectation, the price will fall. Second, the company already has a high leverage ratio and could be incentivized to over leverage to meet its growth expectations. Lastly, SKS’ management has made some questionable decisions raising concerns about its capabilities and bringing negative publicity to the organization.
SKS’ operations may be impacted by two important risks. First, leadership risk is significant. Vikram Akula is the face of the organization, but should something happen to him it is unclear if the organization could maintain its fast paced growth. Second, regulatory risk is an immediate and pressing issue. Access to priority sector lending is a key funding source, which may be made off limits to for-profit institutions such as SKS. Any forced reduction in interest rates would also be damaging.
In valuing the company, comparative analyses were used, specifically price to book value (P/BV) and price to earnings ratio (P/E). In both instances, the ratios appeared high even with SKS’ phenomenal past success and future prospects. Looking first at P/BV, this ratio is used to compare a stock’s market value to the book value of equity. Utilizing FY2010 financial information, the P/BV was 6.27 and 7.53 post-dilution on October 15, 2010. Several analysts felt that this high ratio was inconsistent with SKS’ return on equity and that it should be in line with private sector banks (P/BV of 2.5 – 4x). P/E is used to compare a stock’s market value to the per-share earnings. With the same financial information, the P/E was 34.53 and 41.45 post-dilution. Looking at Compartamos (the only other public MFI) with a P/E of 26, these multiples appear unrealistic, especially considering Compartamos’ ROE is nearly double SKS’.
An updated stock price of Rs. 855.82 was calculated, representing a 24% decrease from the current stock price. This valuation was calculated with a P/BV of 4.75, which is in line with private banks with a slight increase to represent SKS’ potential growth, and a P/E of 26, which is Compartamos’ current ratio. While this valuation may be disappointing for current stock holders, it too may be high given SKS’ uncertain future.
For a full analysis, please refer to the “SKS: Poor Prospects ” report attached.
SKS: Poor Prospects