JSE analyst competition: Access Financial Services Limited
Richard Gordon of NCB Capital Markets Limited emerged winner in the last round of the Jamaica Stock Exchange (JSE) market research competition for analysts, with scores of 43 of a potential 60 points for the written text, and 34 out of 40 for the oral presentation. The winner was decided on July 15 after assessment by the JSE panel of judges, which is chaired by Professor Claremont Kirton, head of the Department of Economics, University of the West Indies.
Richard's analysis is below.
Access Financial Services Limited (AFS) began operations in 2000. It provides micro, small and medium-size business loans and personal loans; hire purchase facilities and remittance, cambio and bill-payment services.
In line with the stated strategy of its initial public offering, AFS has expanded its loan portfolio and branch network - now 11 from eight - with the funds raised.
AFS operates a five-memberboard,headedbyChairman Brian Goldson.
CEO and founder Marcus James is also a member.
Goldson has prior board experience as a director of GraceKennedy Limited where he spearheaded expansion in the company's money, transfer business across the Caribbean. Board members have strong academic backgrounds and are well experienced, having sat on several boards and held senior positions within the financial industry.
Two of the five members are non, executive independent directors. However, global best practices for corporate governance recommends that at least 75 per cent of the board be independent.
Microfinance is the provision of financial services to low-income or self-employed individuals who lack access to traditional banking credit.
Commercial microfinance institutions, or MFIs, extend microcredit to individuals who would not be able to access credit through established financial institutions.
Globally, the provision of microfinancing has historically been the domain of non-profit organisations and governments through national development banks. Commercial finance is vibrant in many countries in southeast Europe and Asia and is considered a significant contributor to growth.
Similarly, in Jamaica, microfinance has historically been provided primarily by not-for-profits such as Cope and the National Development Foundation of Jamaica, and state-owned entities such as the Development Bank of Jamaica (DBJ), through a network of approved financial institutions, and with the assistance of multilateral lending agencies. Commercial microfinance business within the formal banking system was also pursued by Workers' Bank, a registered commercial bank, until its demise in the 1990s. Commercial microfinancing, which is a subsegment of the financial services industry, has witnessed credible growth in recent years.
There are several factors that support continued growth in Jamaica over the medium term.
The Government's reaffirmed commitment to provide assistance to the sector which is seen as a major avenue to boost economic activity and a source of unemployment for through small and medium-size entities or SMEs.
Jamaica's large informal sector, which is estimated to account for 35-40 per cent of GDP, pro-vides a ready market for MFIs (http://www.imf.org/external/pubs/ft/wp/2006/wp06235.pdf).
Lower interest rates consequent to the Jamaica Debt Exchange should reduce cost of capital for MFIs and foster further growth in small and medium-size businesses.
As a niche market, the sector has potential for above-average growth, but is also susceptible to greater risks associated with subprime borrowers.
With improved risk management, growth should remain buoyant despite the economic downturn, as individuals' needs and appetite for borrowing increase.
AFS' business model is to fill the void in the loans market by providing loans to individuals and businesses that cannot meet the requirements of larger traditional financial institutions which require collateral and have more stringent procedures in place. Traditional financial institutions have a limited presence in commercial microfinance because of their perceived higher risk, and the small loan sizes cannot offset transaction costs.
AFS provides collateral-free personal loans and business loans to those who meet a more relaxed set of criteria.
Management has also sought to diversify revenues through complementary services which allow it to leverage its expanded branch network.
The company offers cambio and bill-payment services through a partnership with GraceKennedy Remittance Services and acts as an agent for its Western Union business. This supplements its main revenue stream with stable income and reduces the volatility of its revenues.
Applying the Porters Five Model, the following was determined for the microfinance industry in Jamaica:
Threats of Substitutes: Low
Several companies operate in microfinancing. The industry is dominated by Jamaica National Building Society, which leads in terms of number and value of loans disbursed. AFS ranks second in number of loans disbursed, and third in loan value.
Several regulated financial institutions also extend loans to SMEs. However, these are more likely to be extended to entities that do not fall in the informal sector.
Bargaining Power of Buyers: Low
Given the size of the informal sector, there is a large pool of potential borrowers. These persons depend on short-term loans for personal needs or for profit via small-business ventures. Further, with limited access to regulated institutions, microfinancing companies represent one of the few options for loans for low-income earners. Therefore, these institutions can charge higher interest rates relative to other institutions.
Bargaining Power of Suppliers: High
Providers of capital would be the main suppliers in the industry. Capital is usually obtained from banks or government agencies such as the DBJ. Given the small size of most MFIs, established financial institutions have significant pricing power.
While government agencies offer funding at low fixed rates, they can dictate the terms on which funds are loaned to MFI customers.
Barriers to Entry: Low
With no real barriers to entry within the industry, new firms can easily enter the market, erode margins, and reduce profitability. One of the newest entrants was Nation Growth Micro Finance, in 2008, whose aim is to provide small loans at more competitive rates.
Rivalry Among Competitors: Low
With two companies dominating the retail micro-lending market, they have the potential to earn above- average returns without price wars to gain market share. This suggests good profit potential over the short to medium term.
Robust performance over the last four years with net-interest margin rising steadily.
Expanded capital base post-IPO can support additional lending and absorb losses.
Absence of a stringent regulatory framework gives the company freedom and flexibility in making business decisions.
Expanded branch network gives the company a relatively wide distribution channel.
The business model is exposed to higher credit risk given that it focuses primarily on subprime borrowers.
Unregulated and in the absence of strong internal controls and risk- management practices, AFS could be exposed to higher levels of default and other risks.
Further its reach through brand awareness and niche-marketing strategies.
Room for strategic expansion of reach through additional branches in major rural cities.
Increasedincentives and continued support by the Government should foster continued growth for the loans sector.
More stringent policies regarding the underwriting of loans by financial institutions could keep demand high for loans from MFIs.
The downturn in the economy could lead to deterioration in loan quality as borrowers default on loans.
Potential for greater regulatory oversight goingforward, particularly given the Government's commitment to streamline unregulated financial organisations under the International Monetary Fund agreement.
As the industry matures, increased competition from new entrants can lead to reduced profits.
Commercial banks using their branch network to target high quality SME borrowers as they search for alternative sources of income.
AFS provides loans to both SMEs and individuals but focuses primarily on personal loans. Of its six loan products, just two are business loans.
Personal loans account for 78 per cent of its loan portfolio. Loans distributed through microfinancing companies over the last three years have increased by 8.7 per cent to J$3.49 billion, according to the Economic and Social Survey Jamaica 2009.
AFS began distributing loans to micro and small enterprises, or MSEs, in 2008, immediately making an impact - disbursing 5,306 loans (J$297.7m) compared to 3,765 ($164.1m) in 2008. However, the average loan size is small, with total loans accounting for 8.5 per cent of the market.
Since AFS is not a deposit-taking entity and is in the business of lending, a steady and growing stream of capital is central to its business.
AFS funds its operations by borrowing from established financial institutions and also receives funds for onlending from government agencies. In May 2010, the Government made available $750 million in loans through companies such as Jamaica National, Nation Growth, and Access Financial Services.
AFS also raised funds from its IPO, as well as internal funding from the repayment of principal and interest from the loans it makes.
Between 2006 and 2009, profits have grown at a compounded annual growth rate of 63 per cent to $32.8 million for the year ending December 2009. Earnings almost doubled post- IPO, and subsequent listing on the JSE Junior Stock Exchange in 2009.
Rapid growth in its loan portfolio has been the primary driver of earnings growth. AFS' loan portfolio has almost quadrupled to $346.5 million from $87.3 million in 2005.
The acquisition of the money-services business in 2007 has also contributed to the strong performance.
Interest income from loans has grown at a brisk pace, quadrupling to $220.2 million in 2009. In addition to growth in loans, the yield on the portfolio has risen steadily.
The improvement in yields reflects the improved collections and the fact that most loans are due over the very short term. A breakdown of the company's loans past due shows where there has been a sharp reduction in loans between three-12 months over 2008, while the one-three month range shows an increase over 2008.
Total assets increased from $162.2 million in 2006 to $608.4 million as at December 2009, driven by the expansion in its loan portfolio.
Expansion in the balance sheet was also facilitated by the $93 million raised in the IPO in 2009, net of fees and expenses.
Equity was also boosted through retained earnings to $273.7 million in 2009, which resulted in a reduction in its leverage ratio.
Liquidity ratios have declined since 2006 but still remain at fairly healthy levels. The 2006 numbers (see key ratios graphic) reflected a nine- month period due to the changing of year end to December. The company's receivables ratio has fallen since 2007, reflecting a longer conversion time, also supported by the increase in 'days sales outstanding'.
Earnings quality, which refers to the sustainability of earnings, is reflected in the balance sheet accruals ratio. The accruals ratio has trended downwards over the period from 59.9 per cent in 2007, to 39.8 per cent in 2009, reflecting fairly good quality earnings.
While AFS' financials displayed several positive trends, the company's efficiency ratio increased steadily over the period due to higher staff costs and 'other' operating expenses. Management will need to improve on efficiencies to prevent erosion of margins.
Return on equity at December 2009 stood at 37.1 per cent. Having fluctuated over the years, this represents a significant improvement over the 20.3 per cent recorded in 2006. A five-point DuPont analysis gives a better assessment of the impact of taxes on the company's earnings (see graphic).
With financial leverage falling over the period and EBIT margin volatile, asset turnover has been the major impulse behind the increase in ROE, reflecting increased income from assets employed.
The first quarter ending March 31, 2010, saw AFS continuing its strong performance. Profit before tax jumped 92 per cent to $39.1 million (EPS: $0.14) compared to $20.3 million (EPS: $0.05) in Q1 2009.
Earnings per share was calculated based on a post-stock split volume of 274,509,840 shares.
Total interest income increased 49 per cent to $96.7 million, spurred by growth in interest income from loans. Interest expense fell 11.7 per cent as high-interest debt was paid down, leading to net interest income rising 58 per cent to $88.9 million.
Net feeandcommission income declined marginally to $1.2 million. However, the money services business continues to deliver positive results, with a 12 per cent increase to $9.4 million, despite lower foreign- exchange gains.
Total operating expenses rose 29.4 per cent to $60.9 million, reflecting higher staff costs (+31.9 per cent) and other operating expenses (+29.4 per cent) consequent to AFS' expanded branch network.
Management was conservative, with its provisions for losses as individuals and businesses find it difficult to repay their debt. Allowances for credit losses continue to increase in line with the expansion in the loan portfolio to $9 million.
The balance sheet contracted 7.2 per cent to $564.9 million since December 2009 due to the reduction in short-term securities used to repay loans. Loans payables fell by 28 per cent, pushing liabilities 21 per cent lowerto$265.6million. Shareholders equity increased 9.3 per cent to $299.2 million (book value per share: $1.90).
AFS has been illiquid since listing on October 30, 2009. Despite being oversubscribed, investors have been shying away from the stock evidenced by the low trading activity.
With 80 per cent of the shares closely held by senior management, the low free float has undoubtedly contributed to the subdued trading activity.
To improve stock liquidity, the board implemented a 10:1 stock split which saw the stock price falling proportionately from $33.51 to $3.35.
Prior to the stock split, the stock traded 33 times in six months. The price jumped 79 per cent soon after to $6 before retracing to $4.50 with still-low trading volumes.
Despite the strong first-quarter performance, investor interest remains low. The stock has performed in line with the junior market - then comprising two stacks, AFS and Blue Power - which appreciated 63 per cent up to the end of June.
Given the expectation of further disbursement of loans, it is anticipated that total interest income will increase by 43 per cent to roughly $425.4 million by the end of FY2010. Interest expense is expected to increase by 10 per cent to $41.9 million, pushing net interest income to $383.5 million.
Net fees and commissions are expected to increase to $6.76 million (+18 per cent), while money services fees are projected to reach $43.4 million, along with forex gains of $112.4 million.
Operating expenses are expected to rise to $270.6 million due to higher wages associated with the expanded branch network and increased provisions for credit losses.
Given the five-year tax break for junior listings, earnings should be in the region, $163.1 million (EPS: $0.59).
The Residual Income Model was used to determine an intrinsic value for AFS. Clean surplus accounting should give an accurate estimate of ending book value.
Applying the RIM over five years with a cost of equity of 21.15 per cent gives a value of $3.13.
The RIM analysis assumed a risk- free rate of 11.25 per cent using a two-year Jamaican bond, equity risk premium of 8.25 per cent, and a beta of 1.20.
Dividend Discount Model
The company plans to pay at least 20 per cent of earnings in dividends, which are expected to increase in line with earnings. A conservative five-year P/E of five times was applied to the EPS forecast to determine a terminal value.
Discounting this value, in addition to the interim dividend payments, gives a price of $4.53.
Both valuation models above seem fair despite the varying forward prices. However, a discounted cash-flow method is preferred given that AFS is in its growth phase, giving preference to the DDM price of $4.53.
Investors could also enjoy dividends of $0.12, based on projected EPS, which equates to an after-tax yield of four per cent.
Given the 136 per cent appreciation in the share price since its IPO listing, the stock is fully valued.
Low liquidity and free float of 20 per cent may restrict investors' ability to fully realise capital gains.
Despite the challenging local economy, AFS is expected to continue reporting above-average growth in earnings, supported by the tax break from becoming publicly listed. The tightening of credit policy by other institutions and the direct focus on growth in SMEs by the Government should keep the sector buoyant.
Over the medium term, profits will begin to revert to normal levels as more companies enter the high growth market which may possibly become regulated.
Over time, the sector will be driven by increased competition, improve niche marketing, and general improvement of economic conditions. The enhanced credit- risk management by commercial banks has meant more stringent criteria for obtaining loans and further need for alternative sources of funding by individuals.
In this regard, demand for loans from MFIs should remain high and continue to foster above-average growth in earnings over the short to medium term.