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Diversified product suite strengthens execution

Risk-reward favorable for a ~25% AUM CAGR and RoE of ~20-21%

* IIFL Finance (IIFL) has a presence across home loans, loans against property (LAP), gold loans, microfinance loans, and unsecured business and personal loans. The two factors that will help IIFL sustain its strong AUM growth over the medium term are: 1) the aggressive expansion of its physical distribution and digital capabilities, and 2) its first-mover advantage in co-lending with banks, complemented by an effective direct assignment strategy.

* The company’s NIM (as % of total AUM) is likely to improve to ~8.0% in FY24E from 6.2% in FY19, aided by an improvement in the product mix and a decline in the cost of borrowings (CoB). We expect IIFL to sustain NIM at the current level in FY25/FY26, with a potential upside from any credit rating upgrade.

* The opex-to-average AUM ratio was high at ~3.9% in FY23, as IIFL invested aggressively in branch expansion for its home loan, gold loan, and MFI businesses, which gave it a strong distribution edge. We expect IIFL to slow the branch expansion and expect higher branch productivity to result in an improved opex-to-average AUM ratio of ~3.5% by FY26.

* Gold loans and home loans, which contribute ~65% to the AUM mix, exhibit robust asset quality and low credit costs. They help IIFL mitigate the relatively higher vulnerability of MFI and digital loans. We estimate credit costs to remain range-bound at 2.2%-2.3% over FY25-26.

* The asset-light model leveraging co-lending/direct assignments, and a diversified product suite will enable a strong AUM CAGR of ~25% over FY23-FY26E. With current valuations at 1.8x/1.5x FY25E/FY26E P/BV, we believe risk-reward is favorable for a franchise that can deliver a PAT CAGR of ~27% over FY23-26E and RoA/RoE of ~4.1%/22% by FY26E. We reiterate our BUY rating with a TP of INR800 (based on SOTP valuation).

Home loans and LAP: Using technology advantage for scale-up

* IIFL Home Finance Co.’s (HFC) operational model is its differentiator, including the way it leverages its technology and digital capabilities to deliver a lower turnaround time (TAT) and a superior experience to customers. It operates under a hub-and-spoke model and has a centralized credit, legal and technical team.

* The company has also pivoted to a more granular LAP product, in which the competition from banks is much lower and there is no irrational pressure on pricing. This allows IIFL to maintain healthy yields on its LAP product.

Gold loans: Distribution and co-lending boosting AUM growth

* IIFL is now the second-largest gold loan NBFC in India in terms of AUM and the third-largest in terms of on-book loans. It has 2,700+ gold loan branches in 25 states/UTs. The northern and western regions account for ~34% and 26% (cumulatively ~60%) of its gold AUM, respectively.

* Two important strengths in the gold lending business are: 1) physical distribution, and 2) brand awareness and trust. It has also established a strong visibility and brand recall through multiple brand positioning initiatives. This has enabled IIFL to achieve ~70% repeat customers (similar to most of its peers) in gold loans.

* Leveraging co-lending for gold loans has been a masterstroke for IIFL. The spread of around 8-9pp on co-lending in gold loans is similar to that in the traditional model, but co-lending has allowed IIFL to deliver much higher growth in gold AUM growth than peers. For IIFL, we model a CAGR of ~25% in gold loan AUM over FY23-26 (vs. ~12% for MUTH and ~10% for MGFL). We are confident in IIFL’s ability to deliver sustained gold AUM growth through branch additions, improvements in existing branch productivity, and leveraging co-lending.

MFI: No impact from Punjab; improvement in flood-impacted Tamil Nadu

* Punjab and Haryana cumulatively contribute less than 0.5% of AUM for IIFL Samasta; hence, disruptions in Punjab/Haryana have not notably affected its microfinance business. Tamil Nadu is one of the top-3 states of IIFL Samasta and the floods there resulted in high delinquencies in 3QFY24. However, things have improved and delinquencies/PAR book have been declining.

* The company also voluntarily reduced its lending yields by ~50bp in 3QFY24. It has made a conscious decision to tighten credit underwriting in MFI by not giving loans to customers, who have four or five loans from other MFI lenders or already have a high fixed obligation to income ratio (FOIR). IIFL has taken a cautious approach to growing its MFI business and overall rejection rates have also gone up substantially.

* We expect IIFL Samasta to deliver an AUM CAGR of ~31% over FY23-26 through a focus on operational efficiency, technology, and diversified loan offerings.

Digital loans: Making pivots to a better customer mix and business loans

* The digital loan segment continues to see forward flows from lower-ticket personal loans, which were done in partnership with fintechs in FY23. IIFL has already taken corrective actions and has scaled down and discontinued many of its fintech partners. Incrementally, it is doing personal loans only as a cross-sell product to its existing non-personal loan customers.

* In addition, it has increased its focus on supply chain financing and invoice discounting, which are typically shorter-duration products. These products have lower yields, but they are less risky and have lower through-cycle credit costs.

* In digital loans, IIFL plans to focus on customer lifecycle management and targets to increase the products per customer (PPC) to 2+ (currently at 1.5-1.6). We expect digital loans to remain at ~5-6% of the AUM mix over FY24-26.

Valuation and view: Set for 25% AUM CAGR and 20%+ RoE

* IIFL's track record of successful execution is evident in its ability to pre-empt business cycles and prioritize sustainable and scalable asset portfolios. It has embraced technology and expanded digital capabilities in home loans, gold loans, and digital loans.

* Co-lending is capital-efficient and RoE-accretive, and mitigates risk. The company trades at 1.5x FY26E P/BV and can deliver RoE of 20%+ in the medium term. We believe there will be value-unlocking events over the next two to three years since it plans to demerge HFC and MFI subsidiaries and list them separately. We reiterate our BUY rating with a TP of INR800 (based on SOTP valuation).

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