TCS Group - Capital and Co-CEO Concerns Notwithstanding, Still Delivering

Alongside pressure on fintech stocks globally, TCS's share price has been buffeted in recent weeks after the surprise announcement of a new co-CEO. This followed news that TCS is doing the groundwork for a possible capital raise, with the timing as yet unknown. These concerns notwithstanding, the recent 3Q21 numbers starkly highlighted the still-excellent underlying business fundamentals. This was evidenced in particular in record customer acquisition and surging F&C income. We now think TCS is on track to top 22 mln total active customers in Russia by end-2023. This feeds into stronger revenue forecasts as TCS's ecosystem develops and continually adds new elements (such as mortgages, private banking and enhanced merchant solutions), which, despite higher costs (in part due to MLTIP expansion), pushes up our 2022-23 earnings forecasts 5-7% per year, with ROE remaining solidly above 30% in 2022-23. We think that the stock, trading at around a 14.5 2023E P/E, looks good value following the market's recent jitters, even given the concerns about the new management structure. We refresh our SOTP valuation, rolling forward our valuation to 2023, and raise our target price by 20% to $122 per GDR, keeping our BUY recommendation. > 3Q21 - what we learned. Record 3Q21 earnings showed what robust shape the overall business is in. The most encouraging elements were fee and commission income (up 16% Q-o-Q and 91% y-o-y), led by better than expected acquiring and SME revenues, as well as customer acquisition, with 1.3 mln new active customers added in the quarter (now totaling 12.8 mln). Risk costs remained very low, helped by a changing loan mix, with credit cards falling to less than 50% of total loans for the first time. Less positive, but also not surprising, funding costs finally started to rise, and 14% Q-o-Q staff cost growth meant that overall cost growth just outpaced operating income growth in the quarter.> Acquiring machine still firing on all cylinders. With Tinkoff Black adding on average over 1 mln active customers a quarter this year and guided to continue this pace through next year, TCS looks on track to add almost 10 mln new active customers by end-2023, taking the total to 22.1 mln, which would still only account for around a quarter of total active retail banking customers in Russia. As the domestic ecosystem expands its scope, and user engagement increases (with average products per customer edging up to 1.7 by end-2023), the operating leverage benefits should fuel 20-25% earnings growth in 2022-23, with ROE remaining solidly above 30%. > Co-CEOs - we're not sold, but time will tell. The stock has sold off following the surprise announcement of a new co-CEO, Pavel Fedorov. We do not see this as a prelude for long-time CEO Oliver Hughes's role changing much or being diminished, which is good, and both Hughes and TCS founder Oleg Tinkov have long known Fedorov. As TCS becomes an increasingly important player in Russia, as evidenced by its SIFI status, and starts out on the delicate path of liaising with Russian and international regulators and potential key partners, having a top management figure at the helm dealing with these issues seems like a priority. Time will tell on this, but the move certainly came as a surprise to us and the market, and it is now about delivering.> Lack of clarity on capital raise. The other issue that has muddied the waters is the announcement of a possible capital raise of up to 5% (so about $1 bln) at some point within the next three years to support strong domestic growth amid tightening regulation on unsecured lending and the initial steps in international expansion. Given the relatively small size of this issue, we do not think it needed to be pre-announced in this way, particularly given the wide window in which it could take place, as this creates unnecessary uncertainty about the timing. While there are a lot of moving parts, we think that TCS can grow the loan book by 35-40% in 2022 while maintaining a RAS CET1 level of around 10%, assuming dividends are not reinstated in 2022, and that is what we model for now (38% gross loan growth in 2022, 10.3% N1.1 at end-2022). > MLTIP expansion a sign of the times. Further potential share dilution will come in the form of the revamped and expanded management LTIP program. The size - up to 1.5% of the current share capital to be issued per year (so potentially up to about $275 mln based on the current market cap) - looks large, and includes the new contracts for the co-CEOs. This figure is, however, a ceiling, so much will depend on the pace at which the program is opened up to more employees, and it is also a matter of changing the balance between cash and share compensation. Moreover, around a quarter of possible share issuance will be less-dilutive stock options and warrants for new employees. Costs are, however, likely to be front-loaded, putting pressure on staff costs in 2022 (we forecast 36% y-o-y). Ultimately, the key is whether TCS can continue to generate positive operating leverage over the next few years, which we think is still likely but may be a push in 2022. However, this move is a reflection of intense competition for talent in Russia (and globally) now, as well as a symptom of TCS's business growth. The latter has been recognized in the bank's promotion to SIFI status by the CBR. This shows how far TCS has come since its 2013 IPO, at which time it was Russia's 61st largest bank with less than R100 bln in assets, while now TCS has the No 3 retail franchise by customers with a balance sheet 10 times larger, and it has achieved that without a single branch.> How does stronger growth in customers impact our numbers? Stronger customer acquisition feeds into higher deposit growth (13-18% higher in 2022-23) and loan growth (10-18% higher). We think TCS will keep its foot on the pedal in terms of loan growth in 2022 (38% gross loan growth). The loan mix will continue to shift toward secured loans (including mortgages, which should be fully launched in late 2021) amid tighter regulation on unsecured loans, which will keep the pressure on NIM (down to about 12% in 2023) but be supportive for risk costs (cost of risk staying below 5.5%). Stronger than expected fee income trends support a 41% 2022E-23E CAGR, but we also push up costs, especially in 2022 (32% y-o-y). Our 2022 and 2023 net income forecasts of R76 bln and R94 bln are 5-7% above our previous forecasts (and 2-3% above the consensus), with ROE set to remain above 30%.> At a 2023E P/E of 19, our target price does not look stretched. We update our SOTP valuation and now value the banking business at a 25% premium to CEEMEA banks (rather than just relative to Kaspi.kz, as previously) to reflect TCS's materially stronger banking growth and profitability (implying a 14.7 12-month forward P/E) than the average for CEEMEA banks. We value the acquiring and payments/SME segment at a 10% discount to a wider group of payments peers (rather than just PagSeguro) given the inclusion of SME. Meanwhile, we continue to benchmark the invest-tech platform to Brazil's XP. As we are approaching the year-end, we also roll our valuation year forward by six months to 2023. From this, we derive a 12-month target price of $122 per GDR. At our new target price, TCS would trade at a P/E of 23.7 for 2022 and 19.0 for 2023. In our view, this does not look stretched when compared to a clutch of fintech peers, particularly given TCS's long track record of consistently strong execution and high profitability, even if we appreciate that the market has yet to be convinced by the new management setup. > Nubank will be a useful valuation peer. In terms of relative value, we think the IPO of Brazil's Nubank, which may happen by the year-end, could provide an interesting benchmark for TCS, given that it has developed a fairly similar platform and core product mix to TCS's, though Nubank is already well down the road in international expansion. Ultimately, the initial planned IPO valuation range of $46-51 bln (which, given current market conditions, may not be the final range) implies a similar "per active customer" valuation (around $1,400), but while Nubank has been a great customer acquisition and international expansion story, its ability to monetize within a highly competitive LatAm fintech and evolving regulatory environment remains unproven, in contrast to TCS's track record. Ultimately, this leaves us thinking that the $24 bln that TCS would be worth at our target price does not feel overstretched. > What are the main catalysts and risks? Most in focus over the next 12 months will be international expansion, and we wait to hear a more detailed plan of the strategy here. We are broadly in the pro camp - the global fintech battleground is heating up, Southeast Asia feels like a region still ripe for disruption and TCS is well-equipped to give it a good crack. Admittedly, things have not started ideally, with the failure to obtain a digital banking license in the Philippines, but this should be a relatively minor setback. Another area of focus is regulation. The CBR is clearly concerned about rapid consumer lending stoking inflation, as well as growth in risky segments of this market, and tighter regulation is possible, including new powers for the CBR to directly cap growth in certain market segments if desired. To its credit, TCS does not issue big-ticket, long-duration unsecured loans (its typical maximum duration is three years and the average ticket size is relatively small at around R250k), which the CBR has flagged as a particular problem area. TCS has long had to live with regulatory tightening, and further de-risking of the unsecured credit market as a whole should be good for both it and the broader unsecured lending market. Beyond this, continuing to deliver strong operating numbers will be key to assuaging the concerns outlined above, and we wait for the 2022 outlook in the new year.