Religare Investment Call

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1 BUY CMP (Rs) Target Price (Rs) Potential Upside Sensex Nifty Key Stock data BSE Code NSE Code Bloomberg Shares o/s, Cr (FV 2) Market Cap (Rs Cr) 3M Avg Volume 52 week H/L Shareholding Pattern (%) Promoter FII DII Others Sep Year relative price performance Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec % 31,213 9, MAGMA MGMA IN , , /85.5 Dec-16 Mar-17 Jan Feb-17 Mar-17 Apr May-17 Jun-17 Right steps towards a better future performance Kolkata-based (Magma) is a well-diversified NBFC with presence in utility vehicles/cars, construction equipment, commercial vehicles, used assets, tractors, SME loan and mortgage. Portfolio mix is largely skewed towards Commercial Finance (~50%) followed by Tractors (~20%), SME (~10%) and Mortgage (~20%) among the key business divisions. Investment rationale Magma's product portfolio has been realigned towards higher margin products with more focus on mortgages, SME, used assets and tractors while reducing its weightage on CV/CEs. Consequently, share of the former segments is likely to go up in the coming years. This would result in better NIM's, which is expected to improve to ~7.4% for FY19E against ~7% in FY17. This will be supported by lower cost of funds and improved product mix. The company recently sold its hard bucket NPLs to clean up the balance sheet. The bad loan sale amounted to Rs 680 cr (Rs 580 cr vehicle finance loans and Rs 100 cr mortgages loans) or ~4% of FY17 AUM. Post the sale, the average age of its residual NPL pool stands at about 8 months. Consequently, G/NNPAs have come down from 8.8/6.7% to 6.7/5.6% YoY. Further, management expects higher upgrades and recoveries going forward and targets NNPAs to come down in the next couple of years. Magma's efforts in FY16-17 were on improving its delinquency scenario, especially in CV, CE & Tractor segments. The specific emphasis on better collections has helped the company to lower its delinquencies. Magma is currently adopting 120 DPD NPL recognition and the management has guided to migrate to 90 DPD NPL recognition in FY18. The rising GNPA (post the 90 DPD migration) will however be restricted by improving loan book, better recovery & upgradation due to improving rural income. Outlook & Valuation Over the past few years, Magma has been reeling under asset quality pressure, which overshadowed the otherwise improvement in its operating performance. The recent cleaning up of balance sheet has led to lower G/NNPAs in FY17 at 6.7/5.6%. It will also reduce the asset quality pressure as the company migrates to 90 DPD NPL recognition in FY18 and enhance its ability to grow its balance sheet as and when economic activity picks up. Further on the operational front, Magma's changing portfolio mix towards high margin products will lead to NIM expansion. All the current key segments for Magma, such as CV, auto and mortgage, have strong, long-term growth potential in India, though some of them may be going through short-term cyclical challenges. Growth potential in loan book and asset quality stabilization due to improving rural economy outlook will keep prospects favourable for the company. With a steady growth profile and improving asset quality we expect the stock to re-rate. We initiate with a BUY on the stock with a target price of Rs 163 (1.5x FY19E P/BV). Magma NSE Financial Summary Particulars, Rs cr FY15 FY16 FY17 FY18E FY19E Net Interest Income 1, , , , ,410.7 Research Analyst Siji A Philip siji.philip@religare.com PPOP PAT EPS (Rs) ROAE (%) ROAA (%) ABVPS (Rs) P/BV (x) June 9, 2017

2 Investment rationale Diversified loan book with retail focus Exposure in Commercial Finance down to 38% in FY17 While traditionally Magma's business focused on CV/car financing, diversification (both organic and inorganic) over the past few years has helped the company expand into other areas of vehicle finance, and importantly, non-vehicle finance. Currently, the company runs a well-diversified loan book with Commercial (~50% including UV/Cars, CVs, CE, Used Assets), Tractors (~20%), SME (~10%) and Mortgage (~20%) among the key business divisions. Magma charted out through the inorganic route to add key businesses to its product portfolio. In 2013, Magma acquired GE Capital's housing finance and Home equity portfolio. The acquisition provided Magma with AUM of Rs 1,350 cr. It also tied up with HDI-Gerling for general insurance business in The business commenced operations in Q2FY13. As a result of the conscious diversification, Magma's Commercial Finance exposure has come down from 69% of loan book in FY14 to 38% in FY17. Portfolio Mix FY17 Segment wise AUM FY14-FY17 (%) Mortgage, 18.8 SME, 11.7 Tractors, 19.7 UV/Cars, 25.3 Used Assets, 1 CV, 6.5 CE, 6.6 UV/Cars CV CE Used Assets Tractors SME Mortgage UV/Cars CV CE Used Assets FY14 FY15 FY16 FY17 Tractors SME Mortgage Portfolio realigned towards high ROA products Loan Book diversified but skewed towards Commercial Financing Magma realigned its product portfolio towards higher margin products and started focusing on mortgages, SME, used assets and tractors while reducing its exposure on CV/CEs. Higher margin product contribution is expected to increase to >70% in FY19E from ~58% in FY16. Consequently, NIMs will improve to ~7.4% for FY19E against ~7.1% in FY17. This will be supported by lower cost of funds and improved product mix. Particulars Commercial Finance Agri Finance SME Finance Mortgage Finance Ticket Size (Rs lac) ~4-5 ~3-4 <22 ~10-14 Loan to Value Ratio 70-75% 65-70% NA LAP 35-45%;HL 55-65% Tenure (months) Rural focus will help capture growing areas At 284 branches, Magma has less than half the footprint of its peers in the vehicle finance industry viz. Shriram Transport, Cholamandalam, etc., indicating sufficient room for growth from geographical expansion. Company has focused on the 'rurban' customers i.e rural and semi-urban areas, with over 80% of branches situated in these areas. Consequently, Magma is more leveraged to sustained high growth rates in the rural segment. In addition, Magma has a higher exposure to the under-penetrated eastern states (19%) of India, unlike market leaders which focus on the South and West.

3 Regionwise breakup Rural Urban focus East, 19% Urban, 19% North, 35% Rural, 32% Focus on 'rurban' customers South, 21% West, 25% Semi -urban, 49% North West South East Rural Semi-urban Urban Restructuring strategy undertaken to rationalize cost structure paying dividends Cost structure rationalised In the past, Magma's cost structure was on the higher side compared to its peers. Notably, such a high cost structure was driven by high employee cost and high direct selling agents (DSA) payouts, which together accounted for ~70% of its operating costs. In the last couple of years, as a part of its restructuring strategy, Magma restructured its cost structure. It modified its operational architecture, rationalised employee incentives and initiated process improvements through technology. It merged the sales and collections verticals versus its earlier approach of segregated verticals. Rationalisationing employee cost structure C-I ratio down to 48.7% in FY17 Tackling the high employee costs, it made one/two layers of mid/senior level employees redundant. Earlier its employees had an expansive coverage of ~100kms radius, which came down to ~30kms, bringing employees closer to its clients. Employee packages were realigned to reflect the change in the organizational architecture. Incentive caps were reduced with a simultaneous increase in threshold targets for the incentives. Branch managers were measured on profitability rather than business volumes. Hiring from talukas was preferred due to lower employee and travelling costs. Migration to online platform Focus on online platform and defined credit parameters Magma's entire loan appraisal cycle has migrated to the online platform, which enables the feet on street to keep the dealer updated with the loan approval status. Credit parameters are now better defined in the loan system in contrast to the earlier approach of a more subjective approach by the company salespersons. Technology-based tracking of Magma's feet on street ensures that all its empanelled channels get a uniform service. Hind-sighting analysis has been introduced to reduce employee misreporting of customer quality. Post its pilot run of the strategy in Maharashtra, which met with reasonable success, Magma undertook pan India implementation. This has resulted in improvement in Cost- Income ratio from 60.1% in FY14 to 48.7% in FY17. The cost restructuring successfully addressed the twin drivers of high operating costs. Improved employee efficiency eventually lowered Magma's industry highest employee costs and Higher direct origination lowered Magma's industry highest DSA payouts, with improving channel experience giving an opportunity to eventually lower the remaining payouts.

4 C-AA and C-I Ratio (%) improvement Rationalising cost structure resulting in cost efficiencies FY13 FY14 FY15 FY16 FY17 FY18E FY19E 15.0 C-AA (%) C-I (%) - RHS Borrowing profile skewed towards wholesale funding entity, benefitting from lower interest rates Benefits of low interest rates on a wholesale funded book Magma is primarily a wholesale funded entity, with more than half of its borrowings being bank borrowings. In a benign interest rate scenario, wholesale funded NBFCs remain competitive versus banks on funding costs. Also, Magma enjoys strong credit rating on its debt despite its smaller size. The company's ratings are at par with those of its larger peers. This will also aid the company to raise funds at lower costs whenever the need arises. Other than the SME segment (~10% of loan book), most loans for Magma are fixed-rate loans, and hence the company could benefit from a downward movement in cost of funds. Liability profile (%) Borrowing mix skewed towards banks FY14 FY15 FY16 FY17 Banks Debt Capital Markets Tier I/II Capital & Others Stabilizing asset quality on balance sheet clean up and improving collection efficiency Magma has witnessed asset quality pressure over the past few years (G/NNPA spiked to 8.8/7% in FY16), even as operating performance improved led by its implementation of restructuring strategy across the country. Management's conscious decision to slow down AUM growth also helped improve operating performance to some extent. It also took up selling of a part of its bad loans as a one-time exercise to clean up its balance sheet. Consequently, FY17 G/NNPAS have come down to 6.7/5.6%.

5 Balance sheet clean up by selling hard bucket NPLs Sale of hard bucket NPLs ~ Rs 680 cr In Q4FY17, management concluded the sale of its bad loans in the hard bucket category (sub-standard for more than 2-years) as a part of one-time balance sheet clean up exercise. The bad loan sale amounted to Rs 680 cr (of which vehicle finance loans were Rs 580 cr and mortgages loans were Rs 100 cr). This was ~4% of AUMs as on December Post the sale, the average age of its left over NPL pool stands at ~8 months. The consideration received for the sale stood at Rs 160 cr (of which Rs 86 cr was in the form of security receipts) and the expected post tax loss is to the tune of ~Rs 140 cr. Shift to 90 DPD in FY18 Impact of 90 DPD shift to be well taken in FY18E With the spike in NPAs, company focused its efforts in FY16-17 on improving its delinquencies, especially in CV, CE & Tractor segments. Emphasis on better collections has helped the company to gradually lower its delinquencies. Magma has currently adopted 120 DPD NPL recognition and the management has guided to migrate to 90 DPD NPL recognition in FY18. The rising GNPA in FY18 however will be restricted by improving loan book, better recovery & upgradation due to improving rural income. Credit costs are expected to decline in FY19E to ~1.7% from ~2% in FY16. The falling credit cost and stabilizing asset quality will contribute towards rising RoA. Asset quality improving Hard bucket NPA sell off improves asset quality FY14 FY15 FY16 FY17 FY18E FY19E GNPA(%) NNPAs (%) Uptick in Operational Performance We expect the company's Net Interest Income (NII) to grow at a steady rate propelled by AUM growth and NIM improvement. Improved product mix, boost in rural income, cross selling opportunities, increasing customer reach and branch expansion will contribute to loan book growth. We expect ROAAs to sustain at 1.5% as a result of NIM expansion, declining operating expenses & credit costs.

6 Improving NIM on lower Cost of Funds ROAAs to remain stable at 1.5% FY13 FY14 FY15 FY16 FY17 FY18E FY19E YOA (%) - LHS COF(%) - LHS NIM (%) - RHS Peer Comparison Magma is amongst the cheapest NBFC stocks on forward multiples, as seen in the table below. It currently trades at a discount to larger vehicle finance stocks such as Shriram Transport on forward P/E and P/B multiples, respectively. The discount seems justified given current low returns. While Magma's business model is broadly comparable with some of the larger asset financing NBFCs focusing largely on rural and semi urban regions, its operating cost structure was significantly higher compared to its peers. This has now been addressed with the gradual efficiencies creeping in with the restructuring of its business model. We expect the discount to narrow going forward with continued strong growth and improving return profile. Company Name Market Cap (Rs cr) FY19E BV (Rs) CMP P/BV ROAE(%) FY19E ROAA(%) FY19E M&M Financial 18, Shriram Transport 22, , Cholamandalam 15, , Magma 3,

7 Company background Incorporated in 1978, Magma is a Kolkata-based RBI registered NBFC and is classified as a 'NonDeposit taking Systemically Important Asset Financing Company' by RBI. It is engaged in financing of utility vehicles/cars (25% share of AUM as on FY17), tractors (20%), used asset (11%), commercial vehicles (7%), SME (12%), construction equipment (7%) and mortgages (18%). The company is managing AUMs of Rs 16,101 cr (FY17) through a network of 284 branches. Magma is also involved in the financing of tractors manufactured by International Tractors Ltd through its 74% owned subsidiary, Magma ITL Finance Ltd. The group also operates a mortgage business separately through its wholly owned subsidiary, Magma Housing Finance since Feb The group has a presence in general insurance business in partnership with HDI through Magma HDI General Insurance Company Ltd since Oct Risks In the past, the company has diversified into unrelated areas such as purchase of windmills, etc. While diversification in related/ complementary segments is good for growth, unrelated diversification could be a risky proposition. Any mismatch in tenures of borrowed and disbursed funds may result in liquidity crisis and thereby impact company's ability to service its loans. Magma primarily lends in the Vehicle Financing sector. The auto industry is cyclical in nature and competition in the industry has also intensified. So slow down in this sector could impact AUM growth. Asset quality of the company has deteriorated in the past with G/NNPA of 8.8/7% in FY16. While the situation is stabilising gradually on asset clean up done recently, any further deterioration has to be closely eyed.

8 P&L Account Particulars, Rs cr FY15 FY16 FY17 FY18E FY19E Interest Earned Interest Expended Net Interest Income Other Income Total Income Total Operating Exp PPOP Provisions & Contingencies PBT Provision for Tax PAT 2, , , , , , , , , , , , , , , , , , , , Balance sheet Particulars, Rs cr FY15 FY16 FY17 FY18E FY19E SOURCES OF FUNDS Equity Share capital Reserves and surplus Shareholders' funds Total Borrowings Other Liabilities, provisions Total APPLICATION OF FUNDS Advances Investments Fixed assets Other Assets Total assets , , , , , , , , ,15 10, , , , , , , , , , , , , , , , , , , , , , , , , , , ,450.6

9 Key Financial ratios Particulars FY15 FY16 FY17 FY18E VALUATION RATIOS EPS Earnings Growth (%) BVPS (ex reval.) Adj. BVPS (ex reval. & 100% cover) RoAA (%) ROAE (%) P/E (x) P/ABV (x) P/PPOP (x) Dividend Yield (%) FY19E PROFITABILITY Yield on Advances (%) Cost of Funds (%) Core Spread (%) NIM (%) OPERATING EFFICIENCY Cost/Avg. Asset Ratio (%) Cost-Income Ratio (%) BALANCE SHEET STRUCTURE RATIOS Loan Growth (%) Borrowing Growth (%) Equity/Assets (%) Equity/Loans (%) Total Capital Adequacy Ratio (CAR) ASSET QUALITY Gross NPL (%) Net NPLs (%) Provision/Avg. AUM (%)

10 ROAA TREE Particulars FY15 FY16 FY17 FY18E FY19E Net Interest Income Non Interest Income Operating Cost Provisions Tax ROAA Leverage (x) ROAE

11 Before you use this research report, please ensure to go through thedisclosure inter-alia as required under Securities and Exchange Board of India (Research Analysts) Regulations, 2014 and Research Disclaimer at the following link : Specific analyst(s) specific disclosure(s) inter-alia as required under Securities and Exchange Board of India (Research Analysts) Regulations, 2014 is/are as under: Statements on ownership and material conflicts of interest, compensation Research Analyst (RA) [Please note that only in case of multiple RAs, if in the event answers differ inter-se between the RAs, then RA specific answer with respect to questions under F (a) to F(j) below, are given separately] S. No. Statement Answer Tick appropriate YES I/we or any of my/our relative has any financial interest in the subject company? [If answer is yes, nature of Interestis given below this table] I/we or any of my/our relatives, have actual/beneficial ownership of one per cent. or more securities of the subject company, at the end of the month immediately preceding the date of publication of the research report or date of the public appearance? I / we or any of my/our relative, has any other material conflict of interest at the time of publication of the research report or at the time of public appearance? I/we have received any compensation from the subject company in the past twelve months? I/we have managed or co-managed public offering of securities for the subject company in the past twelve months? I/we have received any compensation for brokerage services from the subject company in the past twelve months? I/we have received any compensation for products or services other than brokerage services from the subject company in the past twelve months? I/we have received any compensation or other benefits from the subject company or third party in connection with the research report? I/we have served as an officer, director or employee of the subject company? I/we have been engaged in market making activity for the subject company? Nature of Interest ( if answer to F (a) aboveis Yes :... Name(s)with Signature(s)of RA(s). [Please note that only in case of multiple RAs andif the answers differ inter-se between the RAs, then RA specific answer with respect to questions under F (a) to F(j) above, are given below] SS.No Name(s) of RA Signatures of RA Serial Question of question which the signing RA needs to make separate declaration / answer YES Copyright in this document vests exclusively with RSL. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose, without prior written permission from RSL. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. Disclaimer: