Buy IIFL Finance Ltd For Target Rs.415 by Motilal Oswal Financial Services Ltd
Earnings miss; asset quality weakness in unsecured and micro-LAP
* Healthy ~40% QoQ growth in gold loans; calc. NIM dips ~70bp QoQ
* IIFL Finance (IIFL)’s 3QFY25 PAT declined ~85% YoY to INR817m. NII declined 22% YoY and ~8% QoQ to ~INR12.4b (~7% miss). Other income stood at ~INR1.1b (PY: INR1.1b). This was lower than our estimates because of lower assignment income and lower gain on fair value changes.
* Opex grew 3% YoY to INR7.5b (in line) with the cost-income ratio at 56% (PY: 43%). PPoP declined ~38% YoY (~28% miss) to INR6b for the quarter.
* Credit costs rose to ~4.2% (PQ: ~3.6% and PY: ~2.1%) primarily because of higher stress in MFI and MSME segments. The company witnessed asset quality stress in its MFI, unsecured personal/business loans, and smallticket LAP during the quarter, which was reflective of weak macro trends
Consol. AUM declines ~8% YoY; Gold loan AUM rises ~40% QoQ
* Consol. AUM declined 8% YoY while it grew ~7% QoQ to INR714b. On-book loans grew ~5% YoY. Off-book formed ~30% of the AUM mix, including colending forming ~13% of the AUM mix.
* IIFL’s YoY AUM dip was led by Wholesale CRE book (-69%) and Microfinance (-14%). Home loans rose ~19% YoY, and MSME loans grew ~31% YoY.
* Gold loan AUM stood at ~INR150b and rose ~39% QoQ. The management shared that while the gold loan volume growth will remain strong; it is likely to scale up its gold loan AUM to INR220-230b by Mar’25. The company expects gold loan growth to come at the expense of yields but expects to recoup the yield in the following financial year.
MFI stress keeps credit costs elevated; credit cost guidance at 8.0-8.5%
* Management shared that MFI in the AUM mix will decline below ~10% within the next two years, and it aims to reduce its unsecured loan portfolio to below 15% of the total portfolio.
* The microfinance sector is facing challenging conditions amid concerns over over-leveraging. However, inflows into the zero bucket have been gradually declining since late Nov’24 and Dec’24, with improvements sustaining in Jan’25 as well. The company guided MFI credit costs at 8.0-8.5% in FY25.
* We estimate consolidated AUM to grow ~1% YoY in FY25 and ~20% YoY in FY26, resulting in consol. AUM CAGR of ~13% over FY24-27E
NIM contracts ~70bp QoQ due to a ~70bp QoQ decline in yields
* Consolidated yields and CoB declined ~70bp and 25bp QoQ to ~12.9% and ~9.5%, respectively. Calculated NIM contracted ~70bp QoQ.
* The gold loan portfolio yields remained under pressure as IIFL was working to regain customers.
Minor deterioration in asset quality; credit costs elevated
* GS3 rose ~2bp QoQ to ~2.42%, while NS3 declined ~5bp QoQ to ~1%, driven by a ~330bp increase in S3 PCR to 59%. The company posted a deterioration in its MFI asset quality, with MFI GS3 increasing to 5.1% (PQ: 3.4%).
* The stock trades at 0.9x FY27E P/BV and ~6x P/E for a PAT CAGR of ~13% over FY24-FY27E. We estimate RoA/RoE to decline to 0.8%/2% in FY25 but recover to 3.4%/17% in FY27. We have a BUY rating on the stock and a TP of INR415 (based on SoTP valuation; refer to the table below).
* Credit costs rose to ~4.2% (PQ: ~3.6% and PY: ~2.1%), primarily because of the stress in the MFI and MSME segments.
* We expect consolidated credit costs to increase to ~3.1% in FY25 and then gradually decline to ~2.2%/2.0% in FY26/FY27.
Update on IT raids across offices of IIFL and group companies
* There were Income Tax (IT) raids on all the office premises of IIFL and its group companies and also at the residence of a few key employees, including Mr. Nirmal Jain.
* IT raids were conducted under Section 132. Under this, the IT team checked documents and took data and statements from various employees. The IT team was trying to investigate undisclosed income and unreported profits.
* The company cooperated with the IT team and shared all data and statements that were asked for. IIFL continues to uphold the highest standards of governance.
* The IT raid started on 28th Jan’25 and concluded on 3rd Feb’25. The IT team will make an appraisal report (which can take three months), which will then go to the assessing officer. Subsequently, IIFL will be required to reply to the observations/demands made in the appraisal report.
Highlights from the management commentary
* Within the MSME segment, secured loans are expected to grow at a faster pace. The company has already discontinued personal loans offered through partnerships.
* Home loans and gold loans will each constitute 1/3rd of the total portfolio, while MSME loans will account for 20-25%, with a composition of 70% secured and 30% unsecured loans.
Valuation and view
* IIFL reported a weak quarter, marked by elevated credit costs and a slight deterioration in asset quality due to a cyclical slowdown in the economy. While consolidated AUM declined YoY, the company resumed strong growth in its gold loan portfolio, which grew by ~40% QoQ.
* IIFL’s management shared that with the embargo on the gold lending business now lifted, the company is well-positioned for the next phase of high-quality growth in secured products like gold loans and LAP.
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