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Pick up in lending business; non-lending to act as catalyst driving valuation

About the stock: JM Financial (JM) is a diversified financial group engaged in various businesses providing a host of services including mortgage lending (wholesale and retail), distress asset management (ARC), investment banking, wealth management & securities (AWS) and AMC. On a consolidated basis, JM reported revenue at | 3343 crore and PAT at | 597 crore. The outstanding advance book was at | 15653 crore while ARC AUM was at | 13558 crore.

Key triggers

• With a pick-up in retail sales coupled with a gradual increase in property prices, a recovery is seen in the wholesale book with 6% QoQ reported in Q4FY23. Going ahead, a strong sales cycle could impact the growth momentum but an uptick in construction activity is expected to result in a healthy uptick of 15-20% YoY growth in the wholesale book

• Focus on building the retail segment (affordable home loans, LAP) with technology driven service and delivery coupled with investment in building physical distribution capabilities is expected to enable robust momentum ahead (93% QoQ, 55% YoY)

• JM’s ARC strategy is expected to continue focusing on acquisition and resolution of stressed assets with higher proportion of incremental business based on fee income. With one time provision and anticipated recovery of ~| 1200-1300 crore in FY24E, the probability of elevated provisioning seems bleak. In addition, JM ARC is also focused on diversification with the acquisition of a substantial proportion of retail asset with IRR of 16-18%

• The investment banking business has been a focus area for JM and engages in catering to institutional, corporate, government and ultra high networth clients. A slowdown in IPOs and corporate activity has resulted in de-growth in topline in FY23. However, the equity and debt pipeline remains strong and is, thus, expected to pick up in FY24E. The strategy to expand the breadth of the client base to is seen aiding traction in revenue thereby delivering RoE in mid-teens. Plans to integrate the IB business with the PMS and wealth business is seen lowering the cyclicality in the business

• With continued investment undertaken through hiring, improvement in digital and technology capabilities, focus is increasing in AWS (MF, wealth management). Thus, cost to income is expected to remain higher. However, the same is expected to normalise with topline traction kicking in. Thus, we expect faster growth in topline of AWS while traction in earnings is expected to follow with a lag as operating efficiency kicks in

Valuation & Outlook

Despite challenges during Covid, JM delivered a gradual recovery in performance with improvement in both business growth and asset quality. Though some business segments continue to remain cyclical, the performance excluding one-offs (provision in ARC business, investment in AWS business) remains encouraging. Further, we believe the overall performance will improve given 1) pick-up in lending business with AUM growth expected in the 15-18% range; 2) improvement in recoveries in ARC business with minimum probability of substantial provisioning ahead; 3) recovery in investment banking revenue with focus continuing on wealth and asset management pie. Thus, we expect revenue to grow at ~14% CAGR in FY24-25E to | 4327 crore while the earnings trajectory is seen staying healthy at 18.3% CAGR to | 837 crore in the same period. Demerger of the business after it attains adequate scale stays a catalyst for unlocking value. However, we have not factored this in our valuation.

Given the diversified business segment, we value JM using SOTP valuation and valuing business segments individually, we arrive at a target price of | 95 (10.7x FY25E consolidated EPS) and assign BUY rating to the stock. We expect a gradual pick-up in business momentum and earnings trajectory with the same getting reflected in valuation.

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