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Retail gaining momentum, slippages continue in Wholesale; intermittent constraints in Pharma

PIEL reported a consolidated PAT of ~INR4.9b in 1QFY23 (PY: INR5.3                                        Revenue grew by ~22% YoY to INR35.5b in 1QFY23 (PY: INR29.1b).

? AUM in Financial Services (FS) grew 37% YoY to ~INR646b, while Retail loans grew over 4x to ~INR223b. The share of the Retail book rose to 37% (PY: 12%) primarily through the DHFL acquisition in Sep’21.

? Pharma sales rose 9% YoY to INR14.9b (inline) in 1QFY23, led by sustained momentum in the India Consumer Product (ICP) segment. The CDMO and Complex Hospital Generics (CHGs) business experienced temporary challenges in 1QFY23, impacting performance to some extent.

? PCHFL will now have to scale up DHFL’s Mortgage franchise and leverage the platform to cross-sell other Retail products to its customer pool. PIEL recently launched its Microfinance (MF) business and will soon start offering salaried Personal loans (PL).

? It has increased ECL provisions to 6.2% (PQ: 5.7%) to account for slippages of two large Wholesale accounts into Stage 2. It will be prudent to take a deep dive into the Wholesale loan book, recognize any stressed loans, and make adequate provisioning before it starts trading as a pure-play NBFC. We estimate ~17% loan book CAGR over FY22-24, incorporating consolidation in the Wholesale book over the next one year. We maintain our Buy rating with a revised TP of INR2,200 (FY24E SoTP-based).

Minor deterioration in asset quality driven by Wholesale slippages

* GS3 rose by ~30bp QoQ to 3.7% of AUM. NS3 increased to 1.8% (PQ: 1.6%).

* A non-RE account slipped from S2 to S3 and had a ticket size of INR1-1.5b.

* Two large accounts that slipped into S2 were: a) A Real Estate company in South India, which is facing an inquiry from the Enforcement Directorate (ED). PIEL has classified it under Stage 2 even though it is still a standard account. b) Exposure to a Hotel, which has started to perform well, but because of a mismatch in cash flows it has been classified under Stage 2.

* Recoveries from the FOCI book are enabling it to use some of the same against incremental provisioning requirements.

Introduction of newer segments to improve the Retail product mix

* PIEL launched its Microfinance business in May'22. The management said the stable loan mix will have Housing/MSME/Unsecured lending products contributing 50:25:25.

* It is aware that execution in multiple product lines won’t be easy. Only when a new product segment clears its experimental hurdle will it look to hire industry veterans to drive those segments.

* Disbursement yields improved to 12.6% in 1QFY23 from 11.3% in 1QFY22, driven by a shift in product mix within disbursements.

* Average CoB fell by ~130bp YoY and ~40bp QoQ to 8.8% on account of its ability to borrow funds at a lower cost after the DHFL acquisition and improved proportion of Retail in the loan mix.

Pharma: Near-term challenges in the CDMO and CHG segment; outlook remains intact

* Pharma sales grew 9% YoY in 1QFY23, led by a 17% growth in the ICP segment (14% of Pharma sales). The CDMO/CHG segment (52%/34% of sales) grew 8%/10% YoY in 1QFY23. PIEL launched seven products in the ICP segment in 1QFY23. With a strong focus on e-commerce and power brands, it is seeing superior execution in this segment.

* There has been a deferment in offtake by certain customers in the CDMO space, which impacted its 1QFY23 performance to some extent. Given the global challenge for Biotech funding, PIEL is seeing heightened activity from existing customers as well as new customers.

* There have been challenges in terms of procuring products from third-party CMOs, affecting YoY growth for the CHG segment in 1QFY23.

Highlights from the management commentary

Pharma

* In addition to the variation in the phasing of work in the CDMO segment, PIEL saw significant attrition, impacting business in 1QFY23.

* Management indicated USFDA approval for Desflurane would not happen in FY23.

* It is on track to demerge and list Piramal Pharma separately by 3QFY23, subject to various approvals. It has strengthened governance standards at Piramal Pharma by inducting three new board members.

Financial Services

* A non-RE account, with a ticket size of INR1-1.5b, slipped a notch to Stage 3.

* Company is open to M&A and it is adequately capitalized for evaluating any acquisition opportunities

* Given the rising interest rates, the spreads at which it used to borrow have been steadily falling due to granularity in the loan book and its performance.

Valuation and view

? Over the past two years, PIEL has: a) strengthened its Balance Sheet by running down its Wholesale loan book; b) the 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.

? Over the next three years, we expect the company to make meaningful inroads into Retail, led by mortgages and complemented by shorter tenure loans originated through digital partnerships. Product diversification within Retail will help PIEL deliver strong growth and reduce concentration risks. We expect the Financial Services business to deliver ~1.9% RoA and 9% RoE in the near term.

? We have maintained our target multiple at 1x P/BV for the Financial Services business. We have cut our FY23/FY24 Pharma EBITDA estimate by 7% to factor in: a) extended supply-chain challenges in the CDMO/CHG segment, b) higher raw material cost, and c) greater promotional costs in the ICP segment. We value the Pharma business at 17x EV/EBITDA ratio to arrive at our SoTP-based TP of INR2,200 (FY24E based). We maintain our Buy rating.

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