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On solid path of profitable growth; resuming coverage with Buy

* Magma Fincorp reported a loss of Rs6.5bn in Q4 after taking a one-time write-off of Rs2.7bn and management overlay provision of Rs6.2bn (factoring in the second Covid wave). The company introduced 100% provisions and wrote off all accounts in the 90+ DPD in SME lending, 180+ DPD in Vehicle Finance and 730+ DPD bucket in Housing.

* In our view, after recent fund infusion and current quarter clean-up, Magma is well-placed on adequacy, promoter back-up and liquidity fronts. We are building in ~30% AUM CAGR for FY21-24E, backed by product diversity. With ease in cost of funds, we expect margin expansion to 875bps by FY23E from ~800bps in FY21.

* The company has already announced a change in management, under which Mr. Vijay Deshwal, Business head at ICICI Bank, will join as CEO from July’21. We believe the company is well-placed to attract new talent from across industries which would be the biggest trigger for overall growth.

* With change in guard, we do believe Magma 2.0 would be a journey of superior profitable growth, resulting in significant improvement in return ratios. We are resuming coverage of Magma Fincorp with Buy rating and TP of Rs175, corresponding to 2.1x P/ABV FY23E with RoE of 10.8% and RoA of 3.4%.

Surge in disbursements aided by sufficient adequacy and product diversity:

Management intends to triple AUM by FY25E, backed by sufficient liquidity and diversity in product offerings. Magma intends to discontinue business in used CV/CE and tractor financing space, which are relatively riskier businesses. Management intends to create sizeable presence in loans to professionals, PL, non-affordable housing loans and SME LAP. It also intends to introduce consumer durable financing, co-branded credit cards and digital lending products by the end of FY22E. With professional management taking guard, we are optimistic about growth numbers.

Cost of fund advantage to support margins and improve asset quality:

New promoters should lead to significant improvement in borrowing profile (shift toward capital markets), which in turn should support rejig in asset mix with the right mix of secured-unsecured loans – thus de-risking the loan book from Black Swan events. With ease in cost of funds, the company has dual advantages. Margin expansion being most obvious, the company can focus on quality of customers. And, this is possible at lower yields.

Outlook and valuations:

Magma, after fund infusion, is well-placed on adequacy, promoter back-up and liquidity. Probable rating upgrades, lower cost of funds and ability to inject equity by the promoter (without fear of forced dilution) are the key positives. We are resuming coverage with Buy rating and TP of Rs175, corresponding to 2.1x P/ABV FY23E with RoE of 10.8% and RoA of 3.4%.

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