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Stress provisioning upfronted; new management’s vision 2025 unveiled

Magma Fincorp (Magma), in the quarter of transitioning to new promoter and management, reported consolidated loss of Rs6.5bn despite steady operating profit of Rs1.9bn. The stance reflects prudent provisioning by the new management as it has accelerated write-offs of Rs2.74bn and created covid 2.0 contingency buffer of Rs6.2bn. ECL provisioning stands at 9.5% of AUM with net stage-3 at a mere 1.2% reflecting upfronting of a larger part of stress. New management has unveiled vision 2025 to become a leading and most trusted NBFC for consumer and business financing; the vision outlines core strategic pillars reflecting the direction of the company. We assign high probability of enhanced operating metrics and return profile in the medium term on the back of: 1) strong corporate group backing, 2) >68% CAR (post infusion), 3) improved credit rating outlook, and 4) business competitiveness. This niche franchise can command 2.0x post transaction book value, and we revise our target price to Rs173 (previously: Rs125). Maintain BUY. Management transition and new strategy execution remain key monitorables.

Stress provisioning upfronted before transitioning to new management:

Company has accelerated write-offs adopting a conservative policy effective Q4FY21 where write-off for asset-backed (car, CV, CE, used assets, etc.) loans was done to accounts getting 180+dpd, for SME unsecured loans at 90+dpd, and affordable home loans at 730+dpd. This led to a one-time write-off of Rs2.75bn. Stage-3 assets declined from 6.9% to 3.7% QoQ; however, the company has also prudently created additional covid 2.0 related buffer of Rs6.2bn. With this, it now carries cumulative provisions of Rs11.9bn – coverage of 4% on stage-1 assets, 28% on stage-2 assets, and 69% on stage-3 assets. Restructuring pool stands at 4.3% of consolidated AUM (4.5% of standalone AUM and 3.3% of housing finance loans) with provisioning coverage of 17%. Outstanding ECL provision at 9.5% of AUM and 1.2% net stage-3 assets suggest adequacy of buffer to counter covid-related challenges. It will also result in lower incremental credit cost. Consolidation of AUM continued with discontinuation of a few product segments reflected in 5% QoQ / 12% YoY decline in Q4FY21 to Rs142bn

New management’s 2025 vision: 

Company has unveiled the new management’s vision 2025: 1) to be one of the leading (amongst top-3) NBFCs for consumer and small/medium business finance and the most trusted financial service provider; 2) scale-up current AUM almost 3x with accelerated growth and calibrated underwriting approach; 3) bring about 200-250bps reduction in funding cost; 4) follow prudent provisioning and aggressive write-offs thereby managing net NPAs at sub-1%.

Core strategic pillars laying a focused direction:

* New management to drive new vision: Magma will be a professionally-run organisation under a new leadership team supported by the existing leadership. With equity raise of Rs34.6bn, Magma Fincorp is now a subsidiary of Rising Sun Holdings Private Limited (owned and controlled by Mr. Adar Poonawalla). Mr. Adar Poonawalla has been appointed as the new chairman and Mr. Abhay Bhutada as the managing director. The CEO, Mr. Vijay Deshwal, shall be joining by the first week of Jul’21. Also, appointment process is underway for 10-12 senior management positions including CXOs, product heads, subject matter experts for risk analytics, digitisation, etc. The process for rebranding of Magma Fincorp under Poonawalla brand is underway (RBI approval for name change has been received).

* Capital buffer and parentage to improve credit rating outlook: Equity infusion has led to sharp rise in tier-1 ratio to 66.8%, with leverage of mere 1.3x. Ben

* Product strategy to be realigned: Company will realign its product and geographic strategy towards select consumer and small/medium business segments with focus on healthy IRR, RaRoC and cross-sell opportunities. It will soon add personal loans, professional loans, SME LAP, non-affordable home loans to its existing product bouquet of used car financing, business loans, affordable loans and small ticket LAP. By Mar’22, it will further look to venture into co-branded credit card, consumer durables, EMI card, medical equipment, merchant cash advance, and insurance cross-sell.

* Rationalise network and drive operational efficiencies: Company will focus on rationalisation of its existing network of 297 branches through the lens of branch level profitability, distribution capabilities for revised product suite, and new location strategy. It will invest into building alliances with pan-India players to ensure reduced cost of acquisition, steady volumes and contextual lending. It will also enhance reliance on influencer network in all product segments. Focus will be on enhanced use of technology and digital payments to optimise distribution and collection efficiency.

* Scale up risk management, data analytics and digital capabilities. Company is looking to expand its tech capabilities through an additional technology centre in Pune, which will form the backbone for all the technology-related requirements and support for the company. It would also set up a strong analytics team, focused on delivering targeted value proposition to customers and generating cross-sell opportunities. It will invest heavily in building the direct acquisition channel via digital route to ensure that the customer ownership and connect is optimised. It will follow an integrated approach to customer service management with ‘Do It Yourself’ solutions to ensure customers have best in class experience. It will also roll out a state-of-the-art contact centre to support the digital acquisition channel and bring in conversion efficiencies.

Magma Housing – equity infusion to shore up net worth for accelerated growth: Magma Housing too reported a loss due to a one-time write-off of Rs58mn and additional buffer of Rs440mn. With this, Magma carries 2.8% provisioning coverage on stage-1/2 assets and 52% for stage-3 assets. Else, housing finance AUM grew more than 20% with disbursement IRR of 13.6% that supported stable operating profit of Rs500mn in Q4FY21 (Rs1.44bn in FY21). Magma Fincorp has infused Rs5bn of equity into Magma HFC, shoring up the net worth of the HFC to Rs10bn. Statutory approvals have been received for change of name to Poonawalla Housing Finance. After having grown at 30% CAGR over the past 3 years, capital infusion should accelerate the growth further with lower funding cost benefit and expansion of customer base.

Magma HDI fund raise to accelerate growth: Magma HDI has announced fund raise transaction of Rs5.25bn at a pre-money valuation of Rs12bn. This includes fresh capital of Rs2.5bn by ICICI Ventures, Morgan Stanley PE Asia and secondary sale of Rs2.75bn by Magma Fincorp group to ICICI Ventures, Morgan Stanley PE Asia, Cyza Chem Pvt (a Poonawalla group company), and two family offices.

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