Covid-19 can accentuate stress in the book
PEL has reported a healthy performance in its pharma segment with 13% YoY revenue growth in both verticals and ~26% margin in FY20 driven by its global pharma segment. We expect pharma segment to grow at a CAGR of 12.1% over FY20E-FY22E. The systemic credit cycle disruption has accentuated the perceived stress that could emanate in the financial services business of Piramal Enterprises (Piramal). This is especially pronounced in the context of an anticipated slowdown in the residential real estate sector with new sales coming down materially and consequently putting pressure on real estate prices in the top-tier cities where Piramal has exposure. Company made additional COVID provisioning of Rs19bn even as PCR on Stage 3 went up from 24% to 40% QoQ. High capital adequacy (~31%) and strong balance sheet (which became stronger after the capital raise) allows it to absorb any major stress that can potentially emanate from its wholesale exposures (real-estate/Corporate/Hospitality). Though it scores highly on the capital buffer and decently on liquidity, it would need to recalibrate its strategy given the stresses in real estate. Downgrade to ADD (from Buy) with an SoTP-based target price of Rs1,050.
* Exposures are fully secured with high security cover, but incremental stress cannot be ruled out: As highlighted in our initiation note (link), Piramal’s conservative underwriting, asset monitoring capabilities and ability to find resolutions in stressed projects gives us confidence that it can navigate the turbulence likely in real estate sector post-lockdown. Even allowing for a one-time restructuring of loans, we feel there could still be newer stress in the book; we therefore estimate FY21E credit cost at 3%.
* Borrowing costs will remain elevated even as incremental liquidity could become scarce: Risk aversion to wholesale real estate financiers will likely remain high even after the lockdown is lifted and things return to a semblance of normalcy by Sep/Oct’20. While Piramal was able to tap debt markets last quarter, newer borrowings even if available will potentially come at a higher cost now.
* Consumer lending, albeit delayed by Covid-19 dislocation, will likely be launched soon: Consumer lending business, which the company is expected to soon venture into, will have a material gestation period since the incumbents have wide presence at the points of sale. However, Piramal’s foray into consumer and SME finance using a digital analytics platform (in partnership with a leading telecom player) has the potential to be a real game changer in the post Covid-19 scenario. Economic dislocation can be a massive opportunity!
* Resilient pharma performance: PEL reported 10% YoY growth in the pharma segment in Q4FY20 driven by 11.4% growth in the global pharma segment. Some stockpiling of complex hospital generics due to COVID and initial batches from the two NCE product approvals (CDMO segment) have supported the growth. However, COVID severely affected the OTC segment that reported a decline of 8% in Q4FY20.
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