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Making efforts to strengthen retail and rundown legacy wholesale

We hosted the senior management team of Piramal Enterprises (PIEL), represented by Mr. Jairam Sridharan, MD, PCHFL, for investor meetings in Mumbai. Here are the key highlights from investor engagements:

* PIEL is committed to reducing its legacy AUM from ~INR130b as of Jun’24 to ~INR60-70b by Mar’25 and expects (not guidance) that a ~25% haircut could be required to run down the residual stressed legacy book.

* As in the past, the rundown will not impair the company’s net worth thanks to pockets of value in Shriram Life/General investments, AIF recoveries and tax-related gains.

* Unsecured digital loans are still a difficult but unavoidable channel (necessary evil) for lenders primarily focused on customer acquisition.

* The behavior and credit requirements of customers acquired digitally are different from those of customers acquired through physical channels.

* Retail (at industry level) has been benign for the last two years, and growth/asset quality metrics could deteriorate by FY25 end.

* PIEL is making efforts to further strengthen its retail franchise; however, the reduction in opex ratios and improvements in the RoA profile will be only linear and gradual (no quick fixes).

Despite moderation in digital unsecured, Retail continues to strengthen

* Piramal Retail began its journey in 2021 with the acquisition of DHFL's loan book, which was valued on its balance sheet at INR170b-180b. Back then, PIEL had deliberately shifted from being a mono-line lender to a multiproduct lender, offering a diverse range of financial services.

* As of Jun’24, its retail loan book stood at over INR500b. The target product mix in the retail division would include 40-45% housing loans, 20-25% loan against property (LAP), and 5% in used car loans and gold loans. Unsecured loans would make up 25% of the retail loan portfolio (including business loans, salaried personal loans and digital loans).

* The target mix between secured loans and unsecured loans will be 75% and 25%, respectively. PIEL’s strong leadership team in Retail, composed of veterans from mortgage finance and vehicle finance, helped guide the business toward success.

* Retail business (because of its gestation period requiring investments in branches and manpower) reported losses in its first two years and achieved a break-even in Jun’23. It has been improving its RoA profile and aspires to improve its retail RoA to ~2.5% by FY27. This is based on the assumption of a decline in opex cost ratios and normalized steady-state credit costs of 1.75%-2.0%.

Remains steadfast to run down legacy AUM without impairing its net worth

* PIEL’s wholesale lending business is undergoing significant changes. The legacy wholesale loan book will continue to decline as the company focuses on "Wholesale 2.0," which yields 13.5-14.0% with operating expenses between 1.0- 1.5% and credit costs of around 2%. The company plans to downsize its legacy wholesale portfolio to INR60-70b by the end of FY25.

* To downsize its stressed legacy book, PIEL has taken a ~25% haircut on its stressed outstanding pool over the past 24-30 months. It expects that net worth will not be impaired as it attempts to further run down the residual legacy AUM to ~INR60-70b (from ~INR130b as of Jun’24). Net worth accretion is anticipated to come from the newer retail and Wholesale 2.0 segments.

Branch expansions to moderate with focus on improving productivity

* Following the DHFL acquisition, PIEL has expanded its branch network significantly, from 300 to 500 branches. It added 225 branches after the DHFL acquisition. It plans to moderate the branch expansion and may add ~100 more over the next several quarters.

* Operational efficiency has improved, with the operating expense ratio (as % of AUM) declining by ~150bp over the past five quarters. By FY25 end, PIEL expects the opex-to-average AUM ratio to stabilize between 3.5% and 4.0%. All new branches initially offer only home loans and LAP, with other retail products gradually introduced over the course of time.

Presence in digital personal loans necessary for customer acquisition

* PIEL’s salaried personal loan segment has an average ticket size of INR410k, with a disbursement yield of 17.7%. Borrowers in this segment have an average CIBIL score of ~770.

* An interesting, yet worrying, statistic shared by the management was that, at the industry level, more than 10% of customers seeking unsecured credit have over 10 open credit lines, adding complexity to risk assessments.

* In terms of distribution channels, PIEL has emphasized physical channels over digital ones, using a credit bureau score juxtaposed with a leverage score to filter out high-risk customers. However, the digital channel is still critical for future growth, especially in the context of customer acquisition, even though it incurs high costs. While PIEL still does monthly disbursements of INR300-400m in small-ticket digital unsecured loans, the management admitted that it was a tough business segment and it continues to exercise caution in this segment.

Open to acquisitions in few pockets of lending but not at expensive valuations

* PIEL is open to M&A opportunities in the gold and MFI segments. However, the company has no current interest in expanding into new car financing, prime housing loans, two-wheelers (2W), or medium/heavy commercial vehicles. It may consider small commercial vehicles in the future.

* PIEL already has a presence in the micro-LAP segment, which is reported as part of LAP in the loan mix.

* PIEL could explore new product lines such as loans against shares (LAS) and mutual funds (MF) in the future. Additionally, it might consider entering the payments business (without large capital-intensive investments), with a focus on creating fee-income-generating products like co-branded credit cards. These initiatives reflect the company's long-term ambition to diversify its income streams and create a capital-light model for some segments.

Valuation and view

* Our earnings estimates for FY25 and FY26 only factor in exceptional gains from PIEL’s AIF exposures and no tax incidence in the foreseeable future. Because of the uncertainty and unpredictability around the timing of the monetization of its stake in Shriram Life and General Insurance, we have not factored it in our estimates. It does, however, provide streams of one-off gains, which can help offset the credit costs required to dispose of the stressed legacy AUM.

* We do not see catalysts for any meaningful improvement in the core earnings trajectory of the company. We expect PIEL to deliver ~1.7% RoA and ~6% RoE in FY26. We value the lending business at 0.6x FY26E P/BV (unchanged). Retain Neutral with a revised TP of INR1,000 (premised on Mar’26 SOTP).

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