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Hold Piramal Enterprises Ltd For Target Rs.2,797

Near term notable triggers priced in; optional value co-exists with risks

Piramal Enterprises’ (PEL) Q1FY22 performance surprised positively on stable stress pool (stage-2/3 and restructuring pool) despite challenging environment. No further credit provisioning was required (for fifth consecutive quarter) after creating buffer in Q4FY20. The strategy of rationalising wholesale exposure (down 4% QoQ) and ramping up secured mass retail lending continued.

This aided in-line consolidated net profit of Rs5.38bn in Q1FY22 (up 8% YoY) and stable revenue of Rs29bn. Performance in pharma segment was strong with 31.2% YoY revenue growth (albeit on a weak base). Stock has doubled in past six months with several notable triggers: 1) Robust performance of pharma business, 2) successful consolidation of wholesale mortgage book reducing concentration risk; 3) stress exposures being addressed appropriately containing stage-3 pool and credit cost at better than expected levels; 3) transitioning into diversified NBFCs with build-up of organic retail portfolio; and 4) successful bidding for DHFL with regulatory approvals in place.

Improving visibility towards building a diversified book (through DHFL acquisitions), coupled with stable stress in wholesale segment, has triggered re-rating of financial services business. We expect this business to now command 1.5x FY23 book. We expect pharma segment to register earnings CAGR of 16.6% over FY21-FY23E. Pharma business will command 16x EV/EBIDTA and 4.5 EV/sales. This along with value of its stake in Shriram group and unallocated equity value gives us SoTP based fair value of Rs2,797 (earlier: Rs2,230). We downgrade the stock to HOLD from Buy.

Hereon, what can drive up valuation further: i) Optional value of utilisation of unallocated equity into new business, inorganic opportunities or return to shareholders, ii) demerger of financial services and pharma business, and iii) business transformation opening up new possibilities. However, at the same time, risks persist with respect to: i) Deferment in integration of DHFL, ii) integration uncertainties and challenges including higher mark-downs etc and iii) effectively leveraging acquired network to cross-sell existing retail products.

* Strong performance across the board: PEL reported 31.2% revenue growth in Q1FY22 driven by 42.6% YoY growth in CHG segment, which was led by healthy demand for sevoflurane in the US. We expect the growth trajectory to sustain with falling covid cases in developed markets raising demand in elective surgeries. Growth of 17.1% in CDMO was driven by strong orderbook and rising demand. OTC reported a sharp jump of 74.0% YoY with improving consumer sentiment, new product launches and high demand for its covid products (sanitisers, masks, etc.). We remain positive on the growth potential and expect pharma segment’s revenue CAGR to be 16.6% over FY21-FY23E.

* Collections not disrupted much for its set of developers: Performance of PEL’s developer clients was not disrupted much with respect to collections in Q1FY22: 1) Developer sales were down, in-line with industry trends; however, it bounced back in Jun’21; 2) developers now have healthy sales pipeline and competencies to digitally market / sell products; 3) construction activity at ~90% of levels witnessed prior to covid 2nd wave; 4) no major impact on developer collections due to strong sales witnessed in H2FY21 as well as aided by slab-wise collections on improving the stage of construction. Though there isn’t much risk to collections, sales momentum gaining traction will be critical.

* Stage-3 assets steady at 4.3%; no further provisioning requirement: Stage-3 (% of AUM) broadly remained stable at 4.3% (4.1% in FY21) even in this challenging quarter with no major fresh slippages or write-offs during the quarter. It optically looks higher QoQ due to decline in wholesale book. Gross slippages nonannalised were around 0.3% and on a net basis, mere 0.1%. Couple of hotel assets with payment deferment got into stage-2 assets but they too are fully collateralised. In Q3FY21, PEL invoked OTR for loans worth Rs17bn (3.8% of loan book), post that no additional accounts were restructured in Q4FY21/Q1FY22.

The company continues to maintain provisions at 5.8% of the loan book (Rs27.5bn; down Rs470mn in Q1FY22) to manage any contingencies arising from covid second wave. PEL is confident provisions of 6.3% on wholesale portfolio is adequate, and there was no creation of any further buffer (fifth successive quarter of no provisioning post the one created in Q4FY20). The company carries provisions of Rs17.6bn against standard assets (stage 1 & 2 loans) – at 3.8%. We are building in credit cost of 1%/0.8% for FY22E and FY23E.

* Rationalising wholesale exposure continues: PEL is continuing to rationalise the wholesale loan book - compared to one account earlier, now there are no exposures >15% of net worth of financial services business. In fact, the wholesale book was down 4% QoQ to Rs376bn and similarly, top 10 exposures were down to Rs128bn (from Rs133bn in FY21). Top 10 exposures were reduced by Rs55bn since FY19. We expect organic growth to be led by retail scale-up and wholesale book to remain in consolidation mode.

* Retail transformation underway: The group’s core objective is to transform into a well-diversified lending entity with share of retail rising to 50%. This will primarily be driven by organic build-up of retail lending, completion of DHFL acquisition, rationalising wholesale lending and making it more granular. It continued with organic build-up of retail increased product suite from two to seven products in FY21 (will add four more in FY22), expanding to 40 locations and increasing headcount to 1,000. The company is partnering with fintechs and consumer tech firms to build scalable cloud infrastructure and create big data and proprietary information assets.

Digital infrastructure and manpower excellence will be based out of Bengaluru. Retail lending monthly disbursements were impacted by covid disruption in June and were back to Rs990mn. Average yield on fresh disbursement is 11.9%. Collection efficiency in retail portfolio improved to 96% in Jun’21 after witnessing some decline in Apr/May-2021. In Jul’21, collection efficiency has further bounced back to 98% and bounce rates have normalised as well.

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