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WINDS of CHANGE, GIVING WINGS TO FLY!

Changing direction by taking a giant leap forward and upward!

* Poonawala Fincorp (PFL) is an NBFC which focuses on consumer and small business finance via products like personal loans, loans to professionals, business loans, SME loans, LAP, pre-owned car finance, medical equipment loans and auto lease. It operates across 21 states with a lean branch network and standalone AUM of ~INR132b as of Sep’22. This NBFC is the erstwhile Magma Fincorp wherein consequent to a capital raise of ~INR35b in May’21, the Poonawalla Group acquired a controlling stake in the NBFC.

* Credit rating upgrades ease cost of borrowings: With new promoters on board, PFL’s access to liabilities rose multifold and it was able to achieve credit rating upgrades that resulted in a significant decline in the cost of borrowings (down ~190bp over last 12 months) with better and more diversified liability mix. This enabled PFL to refocus on better credit-quality customers and realign its product suite to generate superior risk-adjusted returns

* Robust asset quality with benign credit cost…: Post-acquisition, PFL’s management has strengthened its foundation notably by investing in technology (aiding infrastructure/processes), distribution and talent. Over the last 18 months, PFL front loaded provisioning (annualized ~32% in 4QFY21) and took aggressive write-offs in legacy stressed pool of loans. We expect asset quality to remain robust and credit costs to stay benign at ~1% going ahead, due to its strong risk management and focus on credit-tested customers

* …to steer a smooth take-off: At its current size (one-fifth to one-tenth of peers in similar segments), a huge opportunity beckons in its target product segments and with a healthy capital position we believe PFL has a strong and long runway for growth ahead. We model an AUM/PAT CAGR of 37%/~65% over FY22-FY25E, respectively. We also model an RoA/RoE of 4.8%/~12% in FY25E. PFL will have more levers from its fee income and operating cost ratios to deliver a further improvement in RoE driven by an improvement in gearing.

* Initiate coverage with a BUY and a TP of INR350 (premised on 2.3x FY25 BV). Key downside risks: a) Inability to execute on its articulated strategy despite a new management team and investments in technology and processes and b) aggressive competitive landscape leading to pressure on spreads/margins and/or deterioration in asset quality

Digitial-first at its core; Focus on DDP model will aid scalability

* PFL has rapidly transformed into a ‘Digital-first’ organization whereby it has reconciled the physical and the digital initiatives to widen its footprint without having to increase the branch distribution, employee count or operating costs proportionately. PFL will eventually transform its distribution model from a DSAdriven model to one of direct sourcing.

* The company has partnered with various fin-techs and consumer-techs such as Cars24, PaisaBazaar and KrazyBee. Seamless tech integration has made PFL the partner of choice. Direct, Digital and Partnership (DDP) contribution in organic disbursements stood at 47% (v/s 17% in 4QFY22). This has led to lower customer acquisition costs (CAC), reduced TAT and customer delight.

Realignment largely complete; expect 37% AUM CAGR over FY22-FY25

* Post-acquisition, the Poonawala group has strengthened its leadership team across functions. This was accompanied by reorientation of the customer mix,realignment of the product suite and implementation of stringent credit policies across existing and newer businesses.

* The company implemented a Unified Loan Origination System (LOS), Loan Management System (LMS) and Customer Relationship Management (CRM) platform. PFL leveraged upon its expertise at erstwhile Poonawalla Finance to deepen its data analytics and enhance the customer value proposition as well as cross-sell function. It is now in a sweet-spot to deliver sustainable AUM growth and profitability. We estimate an AUM CAGR of 37% over FY22-FY25E.

Upgrade in credit ratings; significant improvement in liability franchise

* There were several improvements that transpired after the new management took control around May’21 – including but not limited to – sharpening the underwriting framework, front-ending of write-offs by implementing a stringent write-off policy and leveraging analytics for policy optimization. Collections were further strengthened to exercise a tight control over asset quality. All these interventions along with a strong promoter led to an improvement in credit rating to AA+ (up two notches). CARE recently upgraded both PFL and PHFL to AAA.

* Improvement in credit ratings allowed PFL to get most bank loans re-priced at lower rates and enabled the company tap diversified sources of borrowings (including debt capital markets) leading to a marked improvement in liability franchise. PFL now has one of the lowest cost of borrowings in the NBFC cohort

Conservative portfolio guardrails to enable best-in-class asset quality

* Robust underwriting processes and a change in the company’s customer universe have led to a strong asset quality. Following the acquisition, PFL’s customer profile transformed to a formal income group (from informal earlier). More than 80% of the customers have a CIBIL score >730, implying stability.

* We expect recoveries from the legacy written-off portfolio to continue in 2HFY23 and even in early FY24. Unlike some of its peers, PFL is a pure-play retail franchise. We project NNPA to remain below 1% and model credit costs to be at ~0.5/1.2% (including recoveries) during FY24/FY25E.

A ‘valued’ NBFC franchise in the making; initiate with a BUY rating

* Consumer and small business finance – the segments targeted by PFL – have a huge market opportunity. While we expect the early green shoots of a transformed company to become visible within the next three-to-six months, PFL has laid down a robust foundation for sustainable profitability through initiatives that will lead to lower operating costs (as a % of AUM), higher business volumes and robust asset quality.

* We model an AUM/PAT CAGR of 37%/~65% over FY22-FY25E, respectively. We also model an RoA/RoE of 4.8%/~12% in FY25E. PFL will have more levers from its fee income and operating cost ratios to deliver a further improvement in its RoE profile when it reaches steady-state.

* Initiate coverage with a BUY and a TP of INR350 (premised on 2.3x FY25 BVPS).

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