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Completion of the DHFL acquisition a positive; transitioning from a ‘trust me’ to a ‘show me’ story in Retail

* Piramal Enterprises (PIEL) reported completion of DHFL’s acquisition after it paid INR342.5b to the latter’s creditors. This included an upfront cash component of INR147b and deferred component of INR195.5b paid via 10- year NCDs raised at 6.75% p.a. Principal on NCDs will be repaid at 5% p.a. for the first five years and 15% p.a. thereafter for the next five years.

* As per the resolution plan, there was an additional carve out consideration of INR38.1b from the available cash on Dewan Housing Finance’s (DHFL) Balance Sheet, leading to a total recovery of INR380.6b for its creditors and deposit holders.

* DHFL also has a Life Insurance JV with Pramerica. As shared by the management earlier, it will be a two-step acquisition. Piramal Capital & Housing Finance (PCHFL), the HFC and the wholly-owned subsidiary of PEL, will first merge with DHFL and subsequently the combined merged entity would be renamed as PCHFL.

* Post-merger, the Retail loan book will be 5x of PIEL’s current Retail loans and the retail-to-wholesale mix will be 40:60 (MOSL estimate). The management said it will improve this mix to 50:50 in the near-term (within one-year) and 67:33 over the mid-to-longer term. We have covered details on the significant improvement in distribution footprint, customer franchise, and liability profile in Exhibit 5.

* While Phase I (consolidation) was a ‘trust me’ story, Phase II and III in PIEL’s transformation agenda has to be a ‘show me’ story, where PCHFL will have to scale up DHFL’s mortgage franchise and leverage the platform to effectively cross-sell its other organic Retail products to the customer pool.

* With the completion of the DHFL acquisition, incremental disbursements in FY22 would be driven largely by the Home Loan business and cross-selling of PIEL’s organic productsto DHFL’s ~1m life-to-date customer base. Though there are still some moving variables, we have incorporated the consolidation of DHFL’sloan book in PCHFL in our estimates. Post this, we forecast ~28% loan book CAGR over FY21-24E and ~13% CAGR over FY22-24E. It has ECL provisions of 5.8% on its total AUM, which is healthy and adequate. We maintain our Buy rating with a TP of INR3,150/share (Jun’23E SoTP-based).

Deep diligence undertaken on DHFL’s retail portfolio

* PIEL has addressed the credit/fraud risk while undertaking due diligence on DHFL’s Retail portfolio. In addition to financial and performance diligence conducted on the entire loan book, it has also conduced physical diligence on a sample set of ~2,620 customers by physical visits/verification and also by establishing the title in the property/mortgage documents.

* The management has ruled out possibilities of multiple loans from different institutions on the same property by creating a charge on the mortgaged property: generating an asset reference number for all live loan accounts.

* The due diligence team prepared proprietary models to predict default risk over the next 12 months in the DHFL portfolio and to quantify potential credit losses. These credit risk models also segmented the DHFL portfolio into ‘high’, ‘medium’, and ‘low’ risk.

* The accuracy of the model was put to test during the second COVID wave, and incremental NPA formation was from the ‘high risk’ segment, predicted by credit risk models.

* The output of these proprietary credit risk models has been adequately factored in the consideration paid for DHFL, ruling out possibilities of any major negative surprise on asset quality in the acquired Retail loan pool of DHFL. Acquired wholesale loans, in our view, would be marked down to ~INR30b.

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.

* DHFL’s deposit license was canceled by RBI in the aftermath of the events in the company, and as such this acquisition does not come along with a deposit taking license. PCHFL will have to separately apply for a deposit licence to the RBI, which will evaluate it independently and decide.

* 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 Financial Services business to deliver ~2.3% RoA/10% RoE over the medium term (post building in the DHFL acquisition). We have maintained our target multiple of 1.8x for the Financial Services business. Using SoTP, we arrive at TP of INR3,150/share (Jun’23E based). We maintain our BUY rating.

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