IGI Logo

Stress recognition with improved coverage restrains earnings

* Stress recognition and provision: Piramal Enterprises (PIEL) reported Q2FY23 loss of ~Rs15.36bn vs. Consensus/our PAT of Rs2.9bn/Rs3.7bn, primarily on account of much higher-than-expected credit costs of ~Rs32.6bn or 5.5% of average AUM. This was due to three factors: i) During Q2, PIEL classified ~Rs59bn of Stage-1 loans, pertaining to 18 wholesale accounts, to Stage-2. ii) Prudential write-offs of ~Rs3.6bn on accounts that were 100% provided for, with Stage-3 coverage ratio improving to 67% vs 54% in Q1FY23. iii) Fair value adjustment of ~Rs10bn on some credit investments. PIEL believes that now, with ~28% of the wholesale AUM under Stages 2 & 3, the asset classification cycle is largely completed.

* Retail disbursements display strong momentum: Retail disbursements continued to see robust momentum, overshooting the monthly-run rate target for Dec-22, given at the time of the DHFL acquisition. During the quarter, PIEL introduced salaried personal loans to cater to individuals in tier-2 & 3 towns. In Q2, disbursements grew by 62% QoQ, driven by housing (+78% QoQ), digital embedded finance (+68% QoQ) and MSME (+63% QoQ). Housing loans constituted ~38% of the disbursement mix, secured MSME loans were ~20%, while the unsecured segments were at 38%. Organic disbursements constituted ~73% of the total retail disbursements.

* Housing remains a dominant part of the retail portfolio: Overall AUM declined 1% QoQ/5% YoY to ~Rs638bn, with the retail loan book at ~Rs249bn (+12% QoQ). Wholesale AUM declined 8% QoQ and 12% YoY to Rs389bn. As per Management guidance, wholesale AUM can be expected to decline over the next few quarters, on account of normal attrition of the book coupled with overall higher competition from better-rated lenders. Retail AUM is currently 39% of the total AUM and is expected to advance towards the 50%-mark over the near term.

* Net interest margins reflect impact of stress recognition: Calculated NIM declined by 88bps sequentially, due to the interest reversal of ~Rs2.3bn on higher slippages. Excluding the interest reversals, NIMs were broadly flat.

* Operating expenses remain elevated: Heightened business momentum, continued investment in tech for retail growth, and de-merger related expense resulted in operating expenses increasing 23% QoQ. Opex-to-AUM increased to 3.45% (Q1FY23: 2.77%). As a result, PPOP declined 35.9% QoQ/grew 11.4% YoY to ~Rs4bn.

* Asset quality remains the focal point of earnings: Headline asset quality improved QoQ, with GS3 at 3.5% (Q1: 3.7%). Despite PIEL taking prudential write-off of Rs3.6bn, PCR on Stage-3 improved to 67% from 54% due to the elevated credit costs seen during the quarter. Stage-2 assets stood at 16% of the AUM in Q2 (Q1: 7%), while the PCR on these declined from 37% in Q1 to 30% in Q2. The proportion of Stage 2 & 3 assets rose, from 10.5% of AUM to 19.5% sequentially. Overall ECL stood at 8.6% (Q1: 6.2%). Management expects steadystate credit costs on the retail book, at 1.5-2% after 2-3 years.

* Wholesale portfolio decomposition: Decomposition of the wholesale portfolio into stages, based on ECL stress-based nomenclature, was the key highlight in Q2. While GS3 improved to 4.7 % (Q1: 4.9%), the combined share of Stages 2 and 3 in the wholesale portfolio rose, from 13.7% to 28.4% of the AUM QoQ. This was primarily due to ~Rs59bn of loans from 18 accounts moving into Stage-2. PCR on the combined Stages 2 and 3 stood at ~40%. The forward flow into Stage 2 was due to 1) recognition of stress at the group/parent level for companies; 2) possibility of a resolution seems possible in some of these loan accounts. Classifying such loans into Stage-2 provides the requisite flexibility in resolution which may necessitate some hair-cuts on exposures; and 3) adverse market-movements against borrowers. While the developers in question have not defaulted, cash-flow mismatches were visible in some cases. As per Management, just by looking at such accounts from a repayment behavior perspective, the loans would not have been classified as Stage-2. After front-loading this stress, Management expects the asset classification cycle to be largely completed, with focus now shifting to a more granular wholesale portfolio led by corporate mid-market loans (ATS: ~Rs0.5bn). However, Management did signal some caution, given the uncertain nature of the wholesale business, and with there being a risk of stress in coming quarters that Management is not yet apprised of. While some forward flows to Stage-3 are expected from the ~Rs59bn pool, substantial provisions are not expected given that the accounts are already well provided for. We had assumed stressed assets amounting to 30% of the legacy wholesale portfolio, with PCR of 60% on these by FY25E via internal accruals and recoveries from marked-down loans. As of Q2FY23, the retail POCI stood at Rs32bn, with PIEL having recovered a cumulative amount of ~Rs15bn from this book till date. During the quarter, gain from the POCI book was a little over ~Rs1bn.

* Earnings restatement and one-off re-measurement gains: All assets and liabilities pertaining to the demerged Pharma undertaking had been classified as non-cash assets held for transfer to Piramal Pharma / shareholders as on 1 April 2022 (being the appointed date). The difference between book value of assets and liabilities transferred was recognized as gains in the Profit & Loss account. Costs incidental / consequential to the arrangement incurred by the company were considered as exceptional items, being non-recurring in nature and netted off from extraordinary income. This extra-ordinary item is considered to be net-worth neutral. The unallocated equity of ~Rs48bn has been considered to be part of the lending business from Q2FY23. Prior quarter earnings were restated to reflect these extraordinary items, along with changes to other income/expense-line items.

* Changes in estimates: Considering the ‘work in progress’ nature of the enterprise, post the de-merger, we revise our net worth, AUM and P&L line item estimates. We utilize the erstwhile unallocated equity of ~Rs48bn to fuel the lending business. The retail disbursement estimates have been revised upwards, to reflect the strong organic/inorganic trend. We revise downwards our estimate of the wholesale book, from Rs400bn to Rs350bn, and expect it to be broadly stable over the forecast period. We revise our operating expense estimates upwards, to reflect the high Opex-to-AUM/Cost-to-income ratio (CIR) in H1FY23. The CIR is expected to trend down, towards 40% levels, in line with Management guidance. We revise our FY23 credit cost and asset classification across stages, based on the upfront recognition of stress in Q2FY23.

* Valuation and Risks: Considering the recognition of stress in the wholesale book, coupled with the up-fronting of provisions (with ECL provision at 8.6% of AUM and PCR of 40% on the wholesale Stage 2 & 3 loans), we retain our BUY rating on the stock, with Sep-23E target price of Rs1,200/share (earlier, Rs1,360), based on SOTP methodology, valuing: i) the financial services business using the Excess Return on Equity (ERE) method for a per-share value of Rs963, implying 1.0x of Sep-24E BVPS; ii) Investments in Shriram Finance based on our TP for Shriram Transport and Shriram City Union Finance, post holdco discount, at Rs135 per share; iii) Investments in the AIF and Insurance at allocated equity book value of Rs66 and Rs37 per share, respectively. Key risk: more forward-flows from the wholesale Stage-1 asset pool remain the key risk to our forecasts.

To Read Complete Report & Disclaimer Click Here

For More  Emkay Global Financial Services Ltd Disclaimer http://www.emkayglobal.com/Uploads/disclaimer.pdf & SEBI Registration number is INH000000354

Above views are of the author and not of the website kindly read disclaimer