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Robust Pharma performance; Stable quarter for FS business

* Piramal Enterprises (PIEL) reported consolidated PAT of INR5.3b (up 8% YoY), despite consolidated revenues coming in flat YoY. However, it was aided by interest expenses, which declined ~11% YoY – on the back of meaningful decline in debt on the balance sheet and progressively lower cost of borrowings.

* In 1QFY22, Financial Services (FS) was characterized by a continuing and intended run-down in the wholesale lending book (down 5% QoQ). Also, muted disbursements in Retail led to ~3% QoQ decline. The total FS lending book was down 4% QoQ / 17% YoY to INR428b.

* In sharp contrast to the asset quality deterioration (especially in the wholesale book) reported by some of the larger HFCs, FS asset quality remained largely stable. GS3% increased ~20bp QoQ on decline in the total loan book, even as absolute GS3 declined ~3% QoQ.

* PIEL delivered robust growth of 30% YoY in the Pharma segment, led by the Complex Hospital Generics (CHG) and India Consumer Products (ICP) businesses. The Contract Development and Manufacturing Organization (CDMO) business also saw healthy momentum on the back of favorable demand in the API / Sterile Fill-Finish space.

* With the completion of the Dewan Housing Finance (DHFL) acquisition around the corner, incremental disbursements in FY22 would be driven largely by the Home Loans business and the cross-selling of PIEL’s organic products to DHFL’s large customer base. We forecast a ~13% loan book CAGR over FY21–24E. The company has ECL provisions of 5.8% of total AUM, which is healthy and adequate, in our view.

* The management shared some finer details around the contours of the DHFL integration and on its ongoing preparations to leverage the DHFL branch/customer network. We await the completion of the acquisition before incorporating this in our estimates. Maintain Buy, with TP of INR3,100/share (June 2023E SOTP-based).

Broader timelines and contours of DHFL acquisition

* Since the NCLT approved the resolution plan in Jun’21, it has appointed a monitoring committee comprising a Committee of Creditors (CoC) and members from the PIEL management team. Regulations require the implementation of the resolution plan within 90 days of the NCLT approval.

* Net accretion to the Piramal loan book from the DHFL acquisition would be INR302b. It would do net allocations between retail and wholesale only after the fair valuation/mark-down of DHFL loans.

* The structure and broader contours of the acquisition were part of the overall resolution plan, which was approved by CoC. Piramal Capital & Housing Finance (PCHFL) would be merged into DHFL. Subsequently, DHFL would become a 100% subsidiary of PIEL, and equity shares of DHFL would get de-listed. The PCHFL–DHFL combined entity would issue INR195.5b worth of 10-yr NCDs (at 6.75% p.a.) to existing creditors of DHFL. Also, the endeavor would be to change the name of the DHFL entity to align it with the Piramal brand.

* Of the INR147b cash consideration for the DHFL acquisition, there is INR100– 105b cash available on the DHFL B/S, and Piramal would infuse INR42–47b into DHFL on the very first day of completion of the acquisition.

* Post the DHFL transaction, the leverage of the FS business would increase from 1.6x to 2.5x. The management guided that with targeted growth in the retail loan book over the next 12–15 months, leverage could potentially increase further to 3.5x.

Scale-up in existing retail team; preparing to leverage DHFL branch/customer network

* Retail AUM is expected to grow 5x; it expects to be among the top five HFCs in India post the completion of the DHFL acquisition. Retail AUM would contribute 50% to the loan mix over the near term and 65–70% over the medium to longer term.

* With the DHFL acquisition, it would get access to a large network of 300+ branches across the DHFL + PIEL platform and ~4900 employees. Its endeavor over the next 3–4 years would be to expand its presence to 1,000 centers (not necessarily branches) across T2/T3/T4 cities in India. It would leverage the DHFL platform to cross-sell to its existing sizeable life-to-date customer base of ~1m.

* It would begin cross-selling the rest of the non-home loan products from the very first quarter post the integration. The existing retail team is already working on cross-selling strategies, particularly for unsecured loans with shorter durations.

* PIEL introduced used car financing in 4QFY21. It already has two platforms / fintech tie-ups in this segment and would add two more soon. It is also doing on-field physical tie-ups with dealerships. 2W and education finance loan products would be introduced in the coming quarters. It would continue to partner with more fintech and consumer tech firms.

Corporate book run-down continues; no new restructuring in 1QFY22

* The intended rundown in the wholesale lending book (down 5% QoQ) to INR376b continued in 1QFY22 as well.

* Unlike certain other large HFCs, it did not see deterioration in wholesale asset quality. FS asset quality remained broadly stable, with GS3% increasing ~20bp QoQ due to decline in total loan book – even as absolute GS3 declined ~3% QoQ. Total ECL provisions on the balance sheet remained steady at 5.8% of total AUM.

* PIEL has not restructured any new loans in 4QFY21 and 1QFY22. The two restructured loans include (a) one in Real Estate with exposure of INR1.58b, wherein construction has resumed (it expects the project to be completed by Dec'2021), and (b) one is Mytrah Energy with exposure of INR10.62b, wherein all the lenders did the restructuring.

Pharma – CHG revival; steady performance in CDMO segment

* PIEL’s Pharma sales grew 31% YoY in 4QFY21, led by 43%/73% YoY growth in CHG/ICP revenue (34%/13% of sales). The CDMO segment (53% of sales) grew by 17% YoY. The EBITDA margin expanded 200bp YoY to 12.5% on the back of higher operating leverage, particularly in the CHG/ICP segment. While the proportion of CDMO has been lower for the quarter, it is expected to increase on the back of a robust order book and seasonality associated with this business.

* Around 30 projects in the CDMO segment are at the integrated level. Interestingly, ~30 molecules are in the Phase III clinical stage, providing enough scope for a ramp-up to the commercial phase post a successful clinical outcome. It has seen good recovery in the CHG segment despite the ongoing COVID-19 impact. PIEL launched four products during the quarter and improved distribution efficiency, driving the profitability of the ICP segment.

Highlights from management commentary

* Piramal guided for 20% YoY revenue growth and an EBITDA margin of 22% for FY22. The benefit from the Hemmo Pharma acquisition would be fully reflected from 2QFY22.

* The higher off-take by CDMO customers in the latter part of the financial year is driving the quarterly seasonality in the CDMO business.

* No material slippage or write-offs were reported in the FS loan book in 1QFY22. Two hotel exposures moved into Stage 2. The value of the loan exposure that moved into Stage 3 would be fully recovered.

* DHFL still has the deposit license, but the RBI has asked it not to accept any deposits. The RBI has asked PIEL to separately apply for a deposit license.

* Pharma would be de-merged and listed separately. Thereafter, underneath the PIEL listed entity, it would have Piramal Finvest (NBFC) and the merged DHFL entity. It is still trying to work out what would be the best structure for the FS business from a regulatory standpoint.

Valuation and view

Over the past two years, PIEL has a) strengthened its balance sheet by running down its wholesale loan book, b) reduced the Top 10 exposures, c) brought equity capital into the company through multiple means, d) improved the texture of its borrowings by reducing CPs, and e) fortified itself against contingencies, with ECL provisions at 5.8% of AUM.

Mortgage has the potential for multi-year strong growth. This would be complemented by PIEL’s organic multi-asset retail platform, which has been built to be “digital” at the core, but “phygital” for the end customer. Over the next three years, we expect the company to make meaningful inroads into Retail. Product diversification within Retail would help the company deliver strong growth and lower concentration risk. We expect the FS business to deliver ~3% RoA / 9% RoE over the medium term (before building in the DHFL acquisition).

Within Pharma, a) The outlook for the CDMO segment has improved, and PIEL is well-placed owing to its presence across the value chain; b) it is entering newer markets and winning tenders in the CHG segment; and c) it is increasing margins in the ICP segment. Based on these factors, we raise our EV/EBITDA multiple for the Pharma business to 19x (from 17x earlier) and P/BV multiple for the FS business to 1.8x (from 1.0x earlier). Using SoTP, we arrive at TP of INR3,100/share (June 2023E-based). Maintain BUY.

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