Magma Fincorp (Q1 FY15)

• Disbursement growth strengthens further; asset growth set to improve

• NIM continues to expand; outlook remains strong

• Continuance of high opex growth and deterioration in asset quality was disappointing 

• Long term RoA/RoE trajectory unchanged; Retain BUY with 24-month target of Rs198

Disbursement growth strengthens further; asset growth set to improve

Magma’s consolidated disbursements accelerated to robust 33% yoy driven by substantial investment in technology and deeper penetration in rural markets over the past year. In terms of products, it continues to be driven by tractor financing, used asset financing (pre-dominantly CVs), SME loans and Mortgages. The share of these products combined in the quarterly disbursements rose to 56% while that of CV and CE financing combined declined to 18% in-line with the company’s strategy. While we expect the high growth in tractor and SME financing to moderate going ahead, overall disbursement growth in the year could still be in an impressive range of 23-27% yoy with sustained strong traction in mortgages and expected revival in Car/UV financing business. The AUM growth which was at 12% yoy in Q1 FY15 seems to have bottomed and should gradually improve to 14-15% by end of the year following the trend in disbursements. As industrial and consumption recovery is like to get stronger from FY16, we estimate Magma to record a disbursement and asset growth of 29% pa and 25% pa respectively over FY15-17. Given modest Tier-1 capital at 11.2% and currently depressed RoE of 10-12%, Magma will need to raise equity capital in the coming 12 months.

NIM continues to improve; outlook remains strong

Magma’s NIM for Q1 FY15 stood higher at 5.76% v/s 5.6% in Q1 FY14 despite a significant increase in Gross NPLs during the past 12 months. The margin expansion has been driven by shift in product mix and customer mix. The AUM share of CV and CE financing has fallen dramatically (from 36% to 28%) where average lending yields are 15-15.5% and 13-14% respectively, whereas the contribution of tractor and used assets financing has increased (from 23.5% to 28%) where average lending yields are much higher at 19-20% and 18-19% respectively. Company has also been successful in optimizing the customer mix in CV financing business by incrementally focusing on SRTOs and FTBs where yields are ~2% higher as compared to large fleet operators. Additionally during Q1 FY15, higher recognition of income (Rs390mn) on the securitized portfolio due to improved collections also aided margins. Magma expects NIMs to improve further in the medium term driven by sustained product mix shift, running down of low yielding loans disbursed 3-4 years back, better collections on the securitized portfolio and a gradual improvement in asset quality. 

Continuance of high opex growth and deterioration in asset quality was disappointing 

Continued investment in collection infrastructure (visible in 50% yoy growth in employee expenses) drove an elevated 25% growth in the opex. This has lead to persistent deterioration in the cost/income ratio over the past few quarters despite material expansion in NIMs. With overall collection efficiency not improving as expected in Q1 FY15 (was rather stable at 94-95%), the gross NPL ratio slipped significantly to 3.2% from 2.7% in the previous quarter. Taking confidence from intense recovery efforts underway and expected cyclical improvement in collections, Magma believes that worst is behind and asset quality would improve over coming quarters. Following this, credit cost is also likely to come-off from the current elevated level of annualized 110bps.

Long term RoA/RoE trajectory unchanged; Retain BUY with 24-month target of Rs198 

A lethal combination of improving asset growth, NIM expansion, decline in cost/income ratio and moderation in credit cost would drive a robust 43% CAGR in Magma’s earnings over FY14-17. RoA is projected to improve from the current sub-optimal level of 1.3% to healthy 2.1% by FY17. Thus, RoE would improve from 10% to 15% in the aforesaid time. We expect a sharp recovery in valuation from present 0.8x to 1.7x FY17 P/ABV over the next two years. Consequently, we believe that Magma can deliver more than 100% return in 24 months.