SBI Cards IPO – What should Investors do after Stellar Subscription and Tepid Listing?

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SBI Cards and Payment’s Rs 10,355 crore IPO–one of the largest IPOs in recent times–received an overwhelming response with an oversubscription of more than 26 times. However, it was a disappointing discounted listing debut on stock exchanges with the stock closing at Rs 683, almost 10 percent discount to its issue price of Rs 755 per share on the first trading day. A very high-risk aversion and bloodbath in equity markets following the spread of COVID-19 led to a lukewarm listing.

However, the stock’s listing performance need not be taken at face value. Page Industries, a consumer firm which got listed in 2007 at a discount to its issue price but then went on to deliver compounded annual return of over 30 percent in the past 12-13 years.

The current dislocation in equity markets may make investors ponder: should they place their bets on the listed parent SBI (holds a 70 percent stake in SBI Cards) and which has seen a sharp fall in market capitalization to Rs 2 lakh crore (as at end 16 March) as against newly listed SBI Cards with a market cap of Rs 64,000 crore?

Undoubtedly, SBI offers value at the current price of Rs 223. But the novelty factor along with SBI Cards’ strong market base, growth avenues, and extremely high-quality return ratios make it an equally attractive bet. More importantly, we have seen that value stocks have been underperforming since the past 2-3 years and growth stocks keep getting more pricey, which intends to make SBI Cards more valuable stock than SBI at this point in time.

Also Traders looking for listing gains were disappointed but long-term investors shouldn’t despair. SBI Cards’ business fundamentals continue to be very solid. The effects of the spreading COVID-19 have stalled travel and led to the shutdown of many such establishments such as malls which make up for a major chunk of credit card spending in today’s times. While the credit card industry will take a severe hit in the near term, the threat of COVID-19 does not dent SBI Cards’ future business opportunities. It will be very helpful to understand its long term business drivers, earnings potential and valuation.

SBI Cards – Strong and Classic Example of a Consumption Company

The credit card industry in India is forecasted to grow at a very healthy pace in the next 10 years driven by rising consumption spend along with the underpenetrated retail credit market, increasing e-commerce and online transactions, push for digital payments and improving payment infrastructure (point of sales).

SBI Cards’ is a market leader along with solid parentage will enable it to capture a rising share of this fast-growing industry.

With around 50 percent of its revenue is gained from consumer spending and another half from credit business, SBI Cards is a quintessential consumption company in the financial services space.

SBI Cards – High Earnings Growth Company

The nature of the credit card business is such that it can generate high return ratios for a long period of time. SBI Cards generates high quality and strong  RoA (return on assets) of over 4 percent as yields are high, cost of funds has been at a competitive level supported by regular funding from SBI and credit cost are benign. However promotional expenses on sales promotion and advertising have gone up due to increased competition, SBI Cards’ RoE (return on equity) hasn’t dipped below 25 percent in the past 6-7 years.

That said, any regulatory move to cap or reduce MDR (merchant discount rate) can significantly reduce SBI Card’s fee income and damage its earnings potential in the coming years. Though it is not possible to predict, we do not see this as an imminent risk.

Also, retail credit has been a best performing segment since FY09. The emergence of credit bureaus like CIBIL has played a key role in strong retail asset quality. Accordingly, we don’t see big asset quality challenges and slippages. Also, high yields provide a good cushion to it and can offset a small uptick in credit cost, if any.

Overall, we see SBI Cards providing super-normal returns to its investors with a compounded annual earnings growth rate of at least over 25 percent over 2 – 3 years.

The big question for investors: can valuations sustain in this market mayhem?

At the current market price of Rs 683, SBI Cards is trading at 32 times FY21 estimated earnings (P/E of 32). SBI Cards’ valuation looks lofty especially since market has corrected sharply in the last few days. However, there is more than one reason which makes us believe that its rich valuations can sustain.

Firstly, SBI Cards is likely to deliver earnings growth of over 20 percent in a market struggling to deliver single-digit earnings growth. Given superior return ratios (the RoE of around 30 percent), it can command higher valuations.

Second, SBI Cards is the only listed pure cards’ company. The credit card business of other big players (likes of HDFC Bank, Axis Bank, ICICI Bank) is bundled with the banking business and they cannot carve out the highly profitable segment separately. Hence, SBI Cards’ valuation is enhanced by the scarcity premium as it is one of its kind listed businesses.

One may also argue that SBI Cards is trading at a significant premium to almost all retail oriented high growth banks and NBFCs. But SBI Card’s valuation is more in line with consumption companies. Thinking intuitively, amid a major shutdown, people still have to spend on essentials and will prefer cashless transactions to maintain social distancing. Hence, investors must rightly view SBI Cards as a play on rising consumerism and less as a financial services company and accumulate its stock on price correction.

We have seen that consumer stocks may be expensive but despite that fact, have fallen much lesser compared to the overall market and financial stocks. SBI Cards too, being a consumption stock, may remain resilient in current market mayhem and will outperform in the long term.

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