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Building out the Retail franchise in the NBFC entity

Post demerger of the Pharma business, PIEL is now an NBFC with a simpler structure

* PIEL had fixed 1 st Sep’22 as the record date for the demerger of Piramal Pharma (PPL). Price discovery for the Financial Services business has already occurred, and PIEL now trades as a diversified NBFC registered with the RBI.

* Integration of DHFL has progressed well. The Retail lending business continues to gain traction, with an improvement in the disbursement run-rate. Multiple partnerships with FinTechs and Consumer-Techs have aided the momentum in the Embedded finance product segment.

* Asset quality (with slippages in the Wholesale book) has deteriorated over the last two quarters, with PIEL making provisions in corresponding accounts. The company currently carries ECL provisions of 6.2% of its total AUM and ~8.5% (MOFSLe) on its Wholesale AUM, with a PCR of 38%/~54% on S2/S3 loans. PIEL will utilize any recoveries from the POCI book, or any one-off gain from the contingent liabilities (~INR33b), to make requisite provisions on the stressed portion of its Wholesale loan book in FY23.

* We expect its Wholesale loan book to continue to moderate as the company looks to aggressively create provisions on stressed exposures, and then monetize them. Within Retail, we expect a disbursement/AUM CAGR of ~90%/~30% over FY22-25E. Consolidation in the Wholesale book and strong growth in the Retail book will result in the proportion of Retail loans increasing to ~55% of the loan mix by FY25E.

* We estimate a PAT CAGR of 37% over FY22-25, resulting in a FY25 RoA/RoE of 2.2%/~10%. Using the SoTP method (FY24E based), we value the Lending business at 1x BVPS, Shriram group investments at our TP for its subsidiaries, and Life Insurance and alternatives at 0.5x trailing EV and BV, respectively. PIEL has an excess net worth of ~INR48b, which we have valued at 1x. We maintain our Buy rating with a revised TP of INR1,320.

Embarking on a growth path and sustainable profitability

* The management will now be looking to scale up its loan book, which will entail a consolidation in the Wholesale book and strong growth in Retail. Even the Retail mix will improve, which may translate into a decline in borrowing costs (over time) and an upgrade in its credit rating.

* While PIEL will try to maintain a fine balance between growth, risk, and profitability, it has articulated targets that it aspires to achieve in the Financial Services business by FY27. These include: a) an improvement in the Retail loan mix to 60-70%, b) doubling of AUM, with a Retail disbursement CAGR of 40-50%, and c) an improvement its net debt-toequity ratio (leverage) to 3.5-4.5x. This will be achieved by running down its Wholesale exposures, diversifying the Retail mix, and expansion of the distribution network to 500-600 branches, with a presence in ~1,000 locations within the next five years.

Wholesale lending: Going granular with a focus on cash-flow backed lending

* The management is looking to pivot its business model in the Wholesale segment to focus on mid-market Residential projects in Tier I cities and the top 15-20 centers in Tier II/III cities. The company has discontinued financing highyield, structured mezzanine loans under the ‘HoldCo’ structure.

* Within Corporate Mid-Market Lending (CMML), the focus will largely be on smaller ticket corporate loans (non-Real Estate) at the OpCo-level.

* PIEL has a healthy deal pipeline and has appointed Mr. Yesh Nadkarni as CEO of its Wholesale lending business, who was earlier leading the Real Estate credit franchise at KKR.

Retail lending: Diversifying the Retail mix with its twin engine approach

* The management is targeting a well-diversified product mix in its Retail credit franchise. It has been undertaking various pilots and launching newer products where it is confident of scaling up.

* It launched its Microfinance business in May’22 under the ‘Phygital’ model, with a video and AI driven underwriting through a BC partner model. It is looking to activate ~100 Microfinance branches across four-to-five states in the near-tomedium term.

*We expect secured Housing and MSME loans to contribute 70-75% to the product mix. We forecast unsecured loans (originated via digital partnerships) like PL, BNPL, digital purchase finance, and small-ticket/short-tenor embedded finance products to constitute 10-15% of the loan mix

Asset quality: Stressed exposures would be provided for in the near-term

* Asset quality has deteriorated over the last two quarters, resulting in higher than expected provisions due to slippages in the Wholesale business. The management has made higher provisions on Mytrah Energy, which is likely to get resolved based on expected realization.

* Investor concerns, with regard to the level of stress in its Wholesale book, can be addressed if PIEL chooses to carve out its stressed Wholesale book as ‘defocused’ and makes accelerated provisions on this defocused pool of stressed loans. This will serve two goals, help: a) investors identify the quantum of stressed exposures in the Wholesale book, and b) PIEL quickly monetize these exposures as they will largely be provided for. For additional details on the Wholesale book, refer Exhibit 16 to 21.

* Recoveries from the POCI book (fairly valued ~INR33b as of Jun’22) will enable PIEL to make accelerated provisions and help keep aggregate credit costs lower than the guided levels of 2% in the near-term. Any differences in cash flow from recoveries in the POCI book (higher or lower than its fair value) will be accounted through the P&L. We model in a net credit cost of 1% each in FY24/FY25.

Liability profile will improve leading to a steady improvement in margin

* PIEL is relatively better positioned to navigate the rising interest rate regime as: a) ~60% of its assets are at a floating rate, and b) ~80% of its liabilities are at a fixed rate. This includes debentures of ~INR195b, which were raised for the DHFL acquisition at 6.75% p.a.

* Average borrowing cost has been declining. Given the rising proportion of Retail in the mix, there is a case for an upgrade to its credit rating within the next two years.

* We model a NIM of 5.6% in FY23 and expect it to improve by ~10bp each over FY24/FY25 led by an improvement in its liability profile.

Investment in the Shriram group – How can PIEL deploy the proceeds whenever it monetizes its stake in the merged entity?

* PIEL has already articulated that it will look to exit its investments in the Shriram group at an opportune time.

* The company has optimized the capital on its Balance Sheet through the DHFL acquisition. We believe that PIEL’s guidance of doubling AUM by FY27 assumes some inorganic acquisitions as well. Proceeds from the Shriram group stake sale may be utilized for acquisitions in Financial Services and growth capital, and if there is any excess capital it can even be returned to shareholders through a buyback or a special dividend.

Valuation and view

* Over the past two years, PIEL has: a) strengthened its Balance Sheet by running down its Wholesale loan book; b) ensured its Wholesale book is granular, with no exposure over 5% and only 10 exposures over 2% of Wholesale AUM; c) improved texture of its borrowings, driving lower cost of borrowings; and d) fortified itself against contingencies, with ECL provisions at 6.2% of AUM.

* PIEL will now have to scale up DHFL’s Mortgage franchise and leverage the platform to cross-sell other Retail products to its customer pool.

* It will be prudent to take a deep dive into the Wholesale loan book, recognize any stressed loans, and front-load the required provisioning. We expect a loan book CAGR of ~12% over FY22-25, incorporating consolidation in the Wholesale book over the next one-year. We maintain our Buy rating with a revised TP of INR1,320 (FY24E SoTP-based).

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