ASA International was scheduled to release its FY19 results yesterday but, like some other London-based listings (and as per its announcement on 16 April), the company has elected to defer this disclosure to allow more time to assess the impact of Covid-19 on its business. This, together with an earlier decision to suspend the FY19 dividend and shelve 2020 guidance, point to a material impact.
As we demonstrate below, we think a significant level of bad news is already priced in to the shares. However, due to the substantial uncertainty regarding the business’s prospects, we suspend our rating pending further announcements from the company.
There are two principal ways in which Covid-19 will impact ASAI. One is a near-term issue while the other is more structural in nature.
Near-term challenge: loan delinquencies
In the current environment, we worry about the impact of coronavirus-blocking lockdowns on the quality of ASA International’s loan book. By choice, ASAI focuses on micro-business owners in emerging markets, and historically has been very successful in developing this niche. However, we think these clients are likely to be hit hard in an environment of social distancing and enforced business restrictions. The disappearance of cash inflows for these borrowers, and their limited financial resources, means they could struggle to pay back ASAI’s loans. Moreover, in close-knit communities facing collective hardship, we think the stigma associated with missing loan repayments (which has been a key protector of loan quality historically) is also likely to soften.
Indian demonetisation experience could be relevant
While it is difficult to estimate the potential scale of loan defaults, there is one recent episode that can perhaps shed some light on what to expect. The overnight demonetisation of INR500 and INR1000 banknotes in November 2016 caused significant hardship to many cash-based businesses in India. In its listing prospectus, ASAI noted that the proportion of its loans past due more than 30 days (PAR>30) increased to 19.6% at end-16 in its Indian loan portfolio, although this ratio had fallen back to 9.1% as at March-17. This deterioration in India was enough to lift the group PAR>30 ratio to 3.2% at end-16. However, by end-17 the group PAR>30 ratio had reverted to normal.
Figure 1: ASA International: Group PAR>30 ratios
Figure 2: ASA International: PAR>30 ratios at end-16
Note, 2016 data excludes India demonetisation impact. + = including India demonetisation impact. * = as at Mar-17
Source: Company filings, Tellimer Research.
Current situation appears more difficult
Arguably, the current environment is more challenging for ASAI. Much of India has been in lockdown since 13 April; this restriction is currently scheduled to end on 3 May, but it is still uncertain when full normality will resume. Moreover, unlike in the case of demonetisation, ASAI’s loan officers have likely faced reduced client interaction. Regular group borrower meetings, a key pillar of the ASAI way of doing business, will also have been disrupted. It is possible that some of the businesses to which ASAI has lent will be unable to bounce-back from this lockdown-induced shock. We note that the typical ASAl loan is not backed by physical collateral.
A more significant reason for why the current situation is more challenging than the India demonitisation episode is that the problem is replicated to a greater or lesser degree across all of ASAI’s markets of operation (in addition to Bangladesh and the Netherlands, where much of the company’s management and infrastructure is housed). Google mobility data for transit hubs (eg bus and train stations) in ASAI-relevant markets suggests lockdowns have been more effective (and hence potentially more disruptive for the company) in the Philippines, India, Sri Lanka, Rwanda and Uganda. Across all ASAI's markets, as shown in Figures 3 and 4, traffic volumes have fallen between 16% and 86% versus January/ February baseline levels.
Figure 3: Google mobility data in selected Asian markets
Source: Google mobility data, Tellimer Research
Figure 4: Google mobility data in selected African markets
Source: Google mobility data, Tellimer Research
Longer-term challenge: the relevance of ASAI’s high-touch business model
The second area where Covid-19 presents a challenge relates to the key characteristics of ASAI’s operations:
- High-touch client interaction (eg weekly meetings).
- Grouping borrowers together in local ‘clubs’.
- The prevalence of cash-based disbursement and repayments.
- A decentralised business model reliant on local physical infrastructure and personnel.
New entrants could encroach on ASAI's turf
Thus, while ASAI has a proven track record in relation to its locally based, high-touch, boots-on-the-ground business model, it also has a more infrastructure-heavy and capital-intensive structure than many new entrants. As such, ASAI could become vulnerable to potential business opportunities being captured by Fintech upstarts with lower-cost customer acquisition/ servicing strategies.
Figure 5: ASA International – key size metrics
Source: Company filings
Figure 6: ASA International – distinguishing features
Source: Company filings
Even if ultimately these encroaching businesses don’t succeed, they could damage ASAI’s historically attractive economics, and lessen its growth potential. We note that ASAI has recently meaningfully upped its technology investment and grown the size of its in-house technology team, and also deployed more technology in the field, which suggests management is well aware of this threat and is trying to respond.
How do both these factors impact the investment case? Higher loan delinquencies could erode ASAI’s capital base, while doubts about the business model could cap the upside for the shares.
Loan delinquencies/ capital erosion
To take an extreme example, if the proportion of loans becoming delinquent globally were to be in line with the India-demonetisation experience, and if these loans were never recovered (ie a 19.6% write-off of the loan book), this would cut ASAI’s equity/ assets ratio to 8.0%. In turn, these writedowns would lift the effective P/B ratio of the shares from their current 1.0x value (based on H1 19 data) to 2.5x. Delinquencies of this magnitude would likely also lead to certain of the company’s debt covenants being breached. Note that if the company were unable to generate tax credits against these write-offs, the potential capital erosion would be higher than shown in the table below.
|Loan writeoffs*||Equity/assets||P/B (H1 19)|
Source: Tellimer Research
We draw attention to ASAI’s strong credit risk management track record, such that the scenario presented above is far outside the historical experience of the business. In this context, however, we think it is relevant that ASAI had announced on 30 March that it was electing to suspend the dividend relating to FY19. This suggests to us that capital scarcity is a potential concern.
Another way to consider the impact of delinquencies is to estimate what level of capital erosion the company’s shares are currently pricing in. Using a model similar to that recently applied to our global banks coverage, the equity market appears to be pricing in a 39% erosion in the capital base, equivalent to 17.5% of loans being written off, and broadly consistent with an Indian demonetisation-style deterioration of the whole loan book.
Business model concerns
Our longer-term business model concerns could potentially impact the upside case for the shares. For example, to justify a GBP4.50 level for the shares, which was reached shortly after the 2017 IPO, our model demanded a 40% sustainable ROE and 8% terminal growth rate for the business. Halving both these metrics to model the potential impact of enhanced Fintech competition (and in the absence of any capital erosion or other forecast changes) would at that time have generated a GBP1.75 fair price for the shares.
Of course, the above framework is a very narrow lens with which to assess the business. Extensive fiscal support measures, many of which are directed at the lowest income segments of society, could help shield ASAI’s customer base from the worst consequences of this year’s global recession. Management may be able to successfully reposition the business to require less of a direct physical presence, and, in this context, some benefits to the long-term health of the business could potentially emerge from this crisis.
But we will look for substantial reassurance from management in relation to both these areas when the closed period finally ends (the timetable has not been defined, but disclosures should take place before end-June). Given the sensitivity of the investment case to higher loan delinquencies, for the time being we suspend our investment rating and Target Price on the shares.