IGI Logo

Disclosures show significant stress; Senior leadership rejig

Company considers fresh equity raise

FUSION shared the outcome of its board meeting held on 21st Sep’24. Here are the key takeaways from the disclosures made by the company:

* Based on asset quality and collection trends so far in 2QFY25, FUSION may be required to make ECL provisions of around INR5b-5.5b in 2Q as compared to INR3.5b in 1Q. This translates into an annualized credit cost of ~19% in 2Q (vs. ~13% in 1Q).

* On 16th Sep’24, the company shared that it re-designated Mr. Tarun Mehndiratta (earlier the COO) as Head, Customer Loyalty Program and New Initiatives. FUSION appointed Mr. Sunil Mundra (whose last stint was with RBL Bank) as COO of its microfinance business.

* In order to strengthen its executive team, the company will initiate a search process for selecting a suitable candidate for the CEO role. It expects the selection process to be completed in the next few months. Mr. Devesh Sachdev, current MD & CEO, will remain in his role as MD for a period of time and then will be appointed as the Chairman of the board. This will ensure a smooth and orderly transition and continuity of the business.

* The board has asked the management to prepare a plan for a fresh equity capital raise of up to INR5.5b. FUSION had capital adequacy of ~26% as of Jun'24. Although the company does not immediately need equity capital, it will consider this equity raise to strengthen its balance sheet given the stress evident in the microfinance sector and the company’s loan book. The company noted that its promoters support the equity raise.

Higher-than-expected credit cost guidance in 2Q

* Our channel checks in microfinance during the quarter did suggest that 2Q (particularly Aug’24 and Sep’24) was panning out to be worse off compared to 1Q. Our channel checks earlier indicated a 300-400bp decline in the collection efficiencies in Aug-Sep’24.

* While we did expect 2Q to be a dismal quarter for microfinance lenders, FUSION’s credit cost guidance of ~INR5.0-5.5b in 2Q (19% annualized) is significantly higher than our earlier estimates. For FY25, we have now increased our credit cost estimate to ~11% (from ~6% earlier). This means that the credit cost during the current MFI credit cycle could be higher than it was at the peak of Covid.

* The stress evident in the MFI sector and FUSION’s loan book could be because of a combination of 1) customer over-leveraging, 2) high employee attrition, 3) payment default by customers who have taken multiple loans with multiple (fake) voter-ids and are not getting new loans, and 4) heavy rainfall and floods in certain parts of the country.

Senior executive leadership team rejig

* FUSION’s board and promoters are effecting key changes at the senior leadership level at Fusion MicroFinance. Earlier on 16th Sep’24, FUSION redesignated its existing COO and appointed Mr. Mundra as the new COO of its microfinance business.

* To strengthen its executive leadership team, the company will now appoint a new CEO within the next few months. To ensure a smooth transition and business continuity, the current MD & CEO, Mr. Sachdev will remain in his role as MD for a period of time and then be appointed as the Chairman of the board.

Given the asset quality stress, considering fresh equity capital raise

* FUSION reported capital adequacy of ~26% as of Jun’24. Given the asset quality stress evident in the MFI sector, the board has authorized the company to evaluate various modes of raising fresh equity capital of up to INR5.5b. The company also shared that its promoters support the proposal.

* One of the modes of raising equity capital could be via a rights issue if it decides to raise fresh equity below its current book value. Given that promoters support this equity raise, we believe that they will look to participate when the company decides to raise capital.

Read-through for the MFI Sector

* Effective Aug’24, most players in the MFI sector have implemented the guardrails imposed by the MFI SRO, MFIN, wherein it asked lenders not to lend to customers who have more than four lender relationships or whose total MFI loans outstanding exceeds INR200k. The implementation of MFIN guidelines will result in muted disbursements in 2Q, with AUM of the MFI lenders likely to remain either flat or decline QoQ.

* We do not see signs of asset quality stress peaking out in 2Q. Stress continues to build up and forward slippages have not been arrested yet. While we expect 2Q to be the worst quarter for most of the MFI players, we clearly see headwinds for the sector continuing for another 3-6 months.

Valuation and View

* Based on the disclosures made by FUSION, we have made significant changes to our estimates for the company. We estimate AUM growth of ~3% in FY25 (compared to ~22% earlier). For FY25, we have now increased our credit cost estimate to ~11% (from ~6% earlier). As a result, we now expect FUSION to report an insignificant PAT of ~INR10m in FY25. While we expect the intensity of credit cost to moderate (relatively) in 2HFY25, it will remain high.

* We see no signs of improvement in asset quality in the near term and remain watchful of stress unfolding over the next 2-3 quarters. In the near term, we will look forward to the appointment of the new CEO, but with no other upside catalyst, we maintain our Neutral rating on the stock with a revised TP of INR330 (earlier: INR440), based on 1.0x FY26E P/BV.

For More Motilal Oswal Securities Ltd Disclaimer http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html

SEBI Registration number is INH000000412