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INSTITUTIONAL EQUITY RESEARCH

Page | 1 | PHILLIPCAPITAL INDIA RESEARCH

Magma Fincorp (MGMA IN)

Rising like a phoenix INDIA | NBFC | Initiating Coverage

4 September 2017

New branch structure to drive sustainable improvement in asset quality With an aim to improve customer service, productivity/cost efficiency, and its underwriting process, the company overhauled its branch structure in December 2015. Under its new structure, portfolio originated is seeing significantly lower delinquencies vs. 10%+ in the old book. New portfolio originated after December 2015 was around 55% as of June 2017, and is likely to be more than 80% of the total AUM by March 2018. With improved processes and risk‐management systems, we expect MGMA’s GNPA ratio to moderate to 5.9%/5.4% (90dpd) in FY19/20 from 7% (120dpd) in Q1FY18. Improved branch quality and favourable macro environment to drive growth While AUM growth is likely to remain sub‐5% in FY18 due to restriction on new business in few branches (C/D category), growth will accelerate to 15%/25% in FY19/20 with majority branches coming under A/B categories. The management is hopeful of bringing more than 80% of its branches under A/B categories (symbolising superior asset quality) from current ~60% (led by improving collections, especially in the tractor segment). Almost half of C/D category branches are in these bottom categories due to higher GNPA in tractors. Aided by good monsoon in 2016‐17, CER (collection efficiency ratio) for tractors is improving – Q1 CER was at a multi‐year high of 90%+ vs. ~85‐87% in Q1 historically. As balance sheet expands, opex ratio to turn healthier After almost two years of contraction, MGMA’s balance sheet is likely to start expanding from Q3, as it has largely tackled its asset‐quality challenges. With this, operating leverage will drive an improvement in its opex ratio (as % of AUM) to 3.6% by FY19 and 3.4% by FY20 from 3.9% in FY18. Moreover, MGMA has invested in technology and process improvements aimed at enhancing productivity and reducing operating costs – for example, its frontline staff carries tablets and Bluetooth printers for a quick turnaround and to generate information in real‐time. Rural recovery to drive sharp improvement in profitability While demonetisation in November 2016 and the farm‐loan waiver have had an interim impact on MGMA’s asset quality, things have settled down now. With 80% branch network in rural‐ and semi‐urban regions, MGMA’s fortune is directly linked to the rural economy, where two consecutive good monsoons have boosted cash flows. A rise in agricultural production, higher yields, and rising crop prices in FY17 have started to aid rural cash flows, also evident from MGMA’s rising collection efficiency. With 15% higher allocation to MNREGA in FY19 and an additional 10% in FY20, the outlook for companies operating in rural areas is promising. We expect MGMA’s RoAs to improve to 2.5%/2.8% in FY19/20 from 1.4%/0.1% in FY16/17. Valuation and recommendation Historically, MGMA has traded at a 50‐60% discount to its peers (MMFS, CIFC, SHTF) due to sub‐optimal profitability ratios. While the discount has narrowed in the last 6‐9 months – aided by improvement in asset quality and a likely sharp turnaround in profitability – it remains high at 40%. With its new organisational structure, buoyancy in the rural economy should drive balance‐sheet expansion and sharp improvement in opex and credit‐cost ratios. We expect RoA to improve to 2.5%/2.8% in FY19/20 from an average RoA of 1.3% in FY12‐16; RoE to increase to 15%/17% from 11%. We initiate coverage with a BUY rating and a target of Rs 250 (2.2x FY19 book value), implying an upside of 44%.

BUY CMP Rs 174 TARGET Rs 250 (44%) COMPANY DATA O/S SHARES (MN) 237MARKET CAP (Rs BN) 41MARKET CAP (US$ BN) 0.652 ‐ WK HI/LO (Rs) 185 / 87LIQUIDITY 3M (USDMN) 1PAR VALUE (Rs) 2 SHARE HOLDING PATTERN, % Jun 17 Mar 17 Dec 16PROMOTERS : 27.8 27.8 27.0FII / NRI : 48.4 48.6 61.1FI / MF : 1.4 0.8 0.7NON PRO : 3.3 3.3 2.6PUBLIC & OTHERS : 19.1 19.7 8.5 PRICE PERFORMANCE, %

1MTH 3MTH 1YRABS 1.6 44.6 71.7REL TO BSE 3.6 40.3 59.1 PRICE VERSUS SENSEX

Source: Phillip Capital India Research KEY FINANCIALS Rs mn FY18E FY19E FY20ENet Income 13,063 14,631 17,128% growth 3 12 17Net Profit 2,313 3,722 4,941% growth 1,716.3 60.9 32.7EPS (Rs) 9.6 15.5 20.5PER (x) 18.1 11.2 8.5Book value (Rs) 100.0 113.7 132.0P/BV (Rs) 1.7 1.5 1.3Adj. book value (Rs) 61.4 85.0 102.0P/ABV (Rs) 2.8 2.0 1.7

Source: PhillipCapital India Research estimates Pradeep Agrawal (+ 9122 6246 4113) Manish Agarwalla (+ 9122 6246 4125)

0

50

100

150

200

250

Apr‐16 Oct‐16 Apr‐17Magma FincorpBSE Sensex


MAGMA FINCORP INITIATING COVERAGE

Branch structure changes to streamline asset quality In December 2015, MGMA dismantled its earlier vertical‐based branch structure and launched a new leaner and technology‐enabled structure with a focus on customer service, superior underwriting, and faster turnaround time. It tightened its risk‐management practices in the last one year, even as it introduced various measures and processes including: • Branch and dealer grading from April 2017: Under this, all its 297 branches and

all eight products at each branch are classified under A, B, C, or D, based on the actual portfolio performance of the branches. KRAs of all branch employees and dealers linked to a particular branch are aligned to its grading. For example, if a branch is graded A, it will be more focused on sales and less on collections. If a branch is graded D, its KRAs would be skewed towards collections with the lowest weightage for sales.

• Continuous Portfolio Monitoring Index (CPMI) as an early warning signal: MGMA has developed an index called CPMI that uses past portfolio‐based terminal losses as a key indicator for providing early warning signs about asset quality. This index measures the quality of the portfolio originated in the last 9‐ 12 months measured by the number of contracts that are more than two instalments due. If the quality of the new portfolio generated is not within a specified tolerance level, the branch is downgraded. The adoption of triggers (branch and product level) helps to fight early signs of portfolio stress.

• Credit‐scoring model: This supports credit underwriting by strengthening the branches’ credit decision.

• NPA management team: It has created specially and specifically focused groups on high‐ticket cases, reposition of assets, and early disposal of repossessed assets. This should lead to faster recovery in NPA accounts.

• Introduction of business CEOs for each vertical: These CEOs are responsible for the profits of their respective businesses – this ensures greater ownership and accountability with a sharp focus on asset quality.

Name Designation Responsibility Kaushik Banerjee President & CEO Asset Finance Manish Jaiswal MD & CEO Housing Finance & SME Business Rajive Kumaraswami MD & CEO Magma HDI General Insurance New branch structure introduced in December 2015

Source: Company, PhillipCapital India

• Merger of sales and 0‐90 collections teams to provide a one‐point contact with customers. Increasing customer touch points to 3,300 field officers from 1,500 • Reduced FOS service radius from 75kms to 30kms• Delegating decision making to branch managers• Incentives aligned to drive direct business / cross sell / customer service

People

• Simplified credit screens• Implemented immediate risk hind‐sighting• L2D process simplified and enabled in tablets Branch

Process

• High level of technology adoption by field officers and supervisors, improving efficiency and productivity• 'Daily journey plan' and 'visit calendar' enabled in tablets

Technology

• FOS tagged to 8,000 channels for service and business• Rigor of daily market activity implemented• IRR grids, doc charges, payout structures, and escalation matrices revised

Customer

If the quality of the new portfolio generated is not within a specified tolerance level, the branch is downgraded



Results are encouraging so far – meeting desired objectives

Fresh delinquencies to remain under control Under its new branch structure, the portfolio originated is seeing lower delinquencies (vs. book originated under old structure). This is a testimonial to the new structure’s success. While GNPA ratio of the old book is 10%+, in the new book, it is significantly lower. As per historical trends, NPAs peak roughly at about two years from the date of origination. This suggests that NPAs in its book originated up to March 2015 have already peaked, and are not likely to show any more spikes. With legacy NPAs amounting to Rs 6.8bn (>2 years in vehicle finance and >6 months in mortgage) already sold in Q4FY17 (the remaining NPA in old book is in relatively lower buckets), the chances of recovery from this book remain quite high. Moreover, with the rising share of the new book in its overall portfolio, slippage ratio will continue to moderate. New portfolio originated after December 2015 was around 55% as of June 2017, and is likely to be more than 80% of the total AUM by March 2018. Aggressive growth in tractors/UV led to a GNPA spike, but… Over FY11‐13, MGMA shifted its focus from CV/CE (as the largely urban‐centric economic downturn began impacting asset quality in this segment) to other product segments (tractors, used assets, SME, UV, and cars). Ex‐CV/CE AUM CAGR over FY11‐13 was 60% led by used assets (121%), tractors (62%), UV/ cars (34%), and SME (32%). Led by aggressive growth, MGMA gained market share in tractors and UV/cars over FY11‐13. However, as the economic slowdown extended, two consecutive monsoon failures in FY15/16 added to its woes. Its GNPA ratio, which was at 0% in FY12 (MGMA followed 100% write off of 180+ DPD assets until 31st March 2012) increased to 1.6% / 3.6% in FY13/14 and worsened to 8.1% / 10.5% (without RBI dispensation) in FY16/Q3FY17.

• Better customer service • Better and faster credit decision• Improved productivity and cost efficiency • Better channel management • Better local accountability and ownership • More direct business and higher yields

Objectives

• Able to achieve a company‐wide turnaround time of just three hours for field investigations• Overall turnaround time across products has reduced by 15‐20% • Direct business share increase to 24% from 18% in FY15• Service radius decreased to 30 kms from 75 kms earlier

Results so far

While GNPA ratio of the old book is 10%+, in the new book it is significantly lower

With the rising share of the new book in its overall portfolio, slippage ratio will continue to moderate

From 0% in FY12, its GNPA ratio increased to 3.6% in FY14 and further to 10.5% in Q3FY17



GDP at constant prices: Base year 2004‐05 (% yoy).. GVA at constant basic prices: Base year 2011‐12 (% yoy)

Source: Company, PhillipCapital India Research, RBI Two consecutive weak monsoons of FY15‐16 (% of LPA).. …led to lower food grain production in those years

Source: Company, PhillipCapital India Research, RBI, IMD

Sales growth (% yoy) UV / cars Tractors CV

Source: Company, PhillipCapital India Research, RBI

‐2

0

2

4

6

8

10

12

14

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Total Agriculture Industry Services

‐2

0

2

4

6

8

10

12

FY13 FY14 FY15 FY16 FY17

Total Agriculture Industry Services

100.99

92.08

105.25

87.3685.46

96.85 96

75

80

85

90

95

100

105

110

FY12 FY13 FY14 FY15 FY16 FY17 FY18E

‐10

‐5

0

5

10

15

175

195

215

235

255

275

295Foodgrain Production mn tonnes yoy growth (RHS)

(40)

(20)

‐

20

40

60

80

FY11

FY12

FY13

FY14

FY15

FY16

FY17

Magma Industry

(40)

(20)

‐

20

40

60

80

100

120

140

FY11

FY12

FY13

FY14

FY15

FY16

FY17

Magma Industry

(80)

(60)

(40)

(20)

‐

20

40

60

FY11

FY12

FY13

FY14

FY15

FY16

FY17

Magma Industry



GNPA @ 120dpd (%) GNPA peaked in Q3FY17 (Rs mn)

Source: Company, PhillipCapital India Research

…asset quality is stabilising, and collection efficiency is rising Asset quality is showing signs of stabilisation in the last two quarters, after consistent deterioration between FY14 and Q3FY17. With good monsoon in FY17, rural cash flows have improved. This improvement did not translate into improvement in asset quality in FY17, as demonetisation in November 2016 (just after the monsoons) disrupted currency in circulation. However, as things have settled down, recovery rates have improved – collection efficiency ratio was higher at 102% / 97% in Q4FY17 / Q1FY18 vs. 99%/ 94% in Q4FY16 / Q1FY17. This improvement was largely driven by strong collections in tractors, which is a testimony to buoyancy in the rural economy. Moreover, good monsoon in the current year will provide a further boost to the rural economy. GNPA ratio stabilised as collection efficiency improves Credit cost to moderate (%)

Slippages ratio moderated even as balance‐sheet shrank GNPA ratio in line with peers


1.6%

3.6%

4.9%

8.1%

9.9%

6.7% 7.0%

0%

2%

4%

6%

8%

10%

12%

FY13 FY14 FY15 FY16 Q3FY17 Q4FY17 Q1FY18

2598

64368301

14640

18500

10800 10870

0

4000

8000

12000

16000

20000

FY13 FY14 FY15 FY16 Q3FY17 Q4FY17 Q1FY18

Rs6790mn NPA sale

1.63

3.6

4.9

8.05 6.7 7.098.2

95.795.2 95

96

97

93

94

95

96

97

98

99

0

2

4

6

8

10

FY13 FY14 FY15 FY16 FY17 Q1FY18E

GNPA% Collection Effeciency %(RHS)

0.71.1

1.3

2.0

3.5

2.0

1.51.2

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

2.6 2.6

4.0

3.5

10 9

‐7

‐11

‐15

‐10

‐5

0

5

10

15

0.0

1.0

2.0

3.0

4.0

5.0

FY14 FY15 FY16 FY17

Slippages ratio AUM %yoy (rhs) 10.5

8.07.0 6.8

4.7

0.0

2.0

4.0

6.0

8.0

10.0

12.0

MMFS STFC MAGMA SCUF CIFC



Branch quality improvements to lead growth About 40% of its branch network is in the less‐than‐desirable categories While AUM growth should accelerate to 15%/25% in FY19/20, it is likely to remain sub‐5% in FY18. This is because MGMA has restricted some of its branches (C and D categories) from conducting new business until their asset quality rises to a specific level. In April 2017, the management graded all its branches and products based on asset quality and found that around 40% branches were in C and D categories. It has assigned these branches lower weightage on disbursements and higher weightage on collections and recovery. Improving rural incomes enhancing collections; to drive progress in branch grading Almost half of the branches in C/D categories are there because of higher GNPA ratio in tractor segment. With rural India’s cash flows improving after two consecutive good monsoons (2016‐17), its collection efficiency ratio (CER) has been improving. CER for tractors was at a multi‐year high at 90%+ in Q1FY18 vs. ~86% in Q1FY17. Led by improving asset quality, the management is hopeful of bringing C/D‐category branches down to less than 20% of its total branch network by Q4FY18. Branch grading – short‐term pain, long‐term gain By Q4FY18, when it hopes 80% branches come under A/B categories where focus is more on business than recovery, growth will gain pace. While grading will impact business growth in FY18, it will put in place a self‐corrective mechanism for all its branches, ensuring sustainable and healthy balance‐sheet growth in the long term. Rising share of A/B category branches (%) ... ...to drive quality growth

Tractor contributes majorly to GNPA Collection efficiency in tractors at multi‐year highs*

Source: Company, PhillipCapital India Research; Note: Q3FY17 w/o RBI dispensation *Approximate numbers

4060

80

6040

20

0%

20%

40%

60%

80%

100%

Q1FY17 Q1FY18 Q4FY18E

A/B C/D

10.3

35.0

10.1 9.4

‐7.1‐11.5

4.0

14.7

25.2

‐20

‐10

0

10

20

30

40

0

50

100

150

200

250

300

FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

AUM AUM % yoy (RHS)

0%

20%

40%

60%

80%

100%

Q1FY17 Q3FY17 Q1FY18

UV/ Cars CV CE Used Assets Tractors SME Mortgage

75%

78%

81%

84%

87%

90%

93%

96%

Q1FY14‐16 Q1FY17 Q1FY18

40% of its total branch network was in C and D categories as on June 2017

Hopes to bring down C/D‐category branches to less than 20% of total by March 2018



Operating leverage to improve efficiency ratios Opex/AUM increased over FY15‐17 due to higher employees and shrinking AUM MGMA’s AUMs grew at a healthy CAGR of 20% in FY10‐13, with number of employees also seeing a similar pace at 17%. During this period, its efficiency ratios were almost in line with peers, with average opex/AUM ratio at 3.1%. However, anticipating a rebound in the economy, MGMA increased its employee base by 34% in FY14 alone (largely frontline staff), while its AUM growth came in at just 10%. AUM growth continued to slip over FY15‐17 (‐9% CAGR) while its employee base remained steady – this resulted in negative operating leverage with opex/AUM ratio increasing to 3.6% in FY17; average 3.5% over FY15‐17 from 3.1% over FY10‐13. Employee addition during slowdown… …led to poor operating efficiencies

Source: Company, PhillipCapital India Research Employee productivity to improve aided by higher technology and accountability MGMA has invested in technology and process improvements aimed at enhancing productivity and reducing operating costs. Its frontline staff carries tablets and Bluetooth printers for quick turnaround and to generate information in real‐time. The company is using data analytics for customised cross‐selling and to create a robust back‐end for faster and effective process implementation. As balance sheet expands, opex ratio to turn healthier Its balance sheet has been contracting since FY15; however, the management expects an expansion from Q3. We expect AUM to grow by 4% in FY18 and 15%/25% in FY19/20. Because of improving operating leverage and processes, we expect its opex ratio (as % of AUM) to improve to 3.6% by FY19 and 3.4% by FY20 from 3.9% in FY18. Operating leverage to drive opex ratio lower


1510

35

10 9

‐7‐11

5,150 5,700

7,300

9,760 9,7889,073 8,997

0

2,000

4,000

6,000

8,000

10,000

12,000

‐20

‐10

0

10

20

30

40

FY11 FY12 FY13 FY14 FY15 FY16 FY17

AUM growth Employees

20.1

19.4

17.5

19.1

20.8

19.10.3

0.30.2

0.4 0.30.3

0.0

0.1

0.1

0.2

0.2

0.3

0.3

0.4

0.4

15

16

17

18

19

20

21

22

FY12 FY13 FY14 FY15 FY16 FY17

Avg AUM/ Employee (Rsmn)

10

35

10 9

‐7‐11

4

15

25

2.6

3.3 3.33.7

3.43.6

3.93.6

3.4

0.0

1.0

2.0

3.0

4.0

5.0

‐20

‐10

0

10

20

30

40

FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19 FY20

AUM growth (LHS) Opex ratio (RHS)

We expect AUM to grow by 4% in FY18 and 15%/25% in FY19/20



Peer comparison: Productivity and efficiency ratios _______MGMA_______ _________CIFC_________ ____Mahindra Finance____ _________SHTF_________ FY12 FY15 FY17 FY12 FY15 FY17 FY12 FY15 FY17 FY12 FY15 FY17Opex 3,031 6,852 6,204 4,368 7,483 10,133 5,920 10,068 14,509 7,277 11,232 12,749Employee 1,490 3,618 2,933 1,104 2,217 4,026 1,998 4,591 6,809 3,701 4,296 5,482Other opex 1,245 2,888 2,785 3,175 4,974 5,726 3,727 5,062 7,240 3,442 6,531 6,928Depriciation 296 346 485 89 292 381 196 415 460 135 405 339 Branches 200 232 284 375 534 703 607 1108 1182 502 741 918Employees 5,700 9,788 8,997 7806 13000 16000 9715 14197 17856 15057 16160 18885Average AUM 114,665 187,215 171,420 112,971 243,530 319,909 179,064 355,056 438,543 381,983 561,052 757,608 Efficiency ratio (%) Opex/ Aum (%) 2.6 3.7 3.6 3.9 3.1 3.2 3.3 2.8 3.3 1.9 2.0 1.7Employee cost/ Aum 1.3 1.9 1.7 1.0 0.9 1.3 1.1 1.3 1.6 1.0 0.8 0.7Other cost/ AUM 1.1 1.5 1.6 2.8 2.0 1.8 2.1 1.4 1.7 0.9 1.2 0.9 Branch productivity (Rsmn) AUM per branch 573 807 604 301 456 455 295 320 371 761 757 825Employee per branch 28.5 42.2 31.7 20.8 24.3 22.8 16.0 12.8 15.1 30.0 21.8 20.6Opex per Branch 15 30 22 12 14 14 10 9 12 14 15 14Employee cost/ branch 7.5 15.6 10.3 2.9 4.2 5.7 3.3 4.1 5.8 7.4 5.8 6.0Other opex per branch 7.7 13.9 11.5 8.7 9.9 8.7 6.5 4.9 6.5 7.1 9.4 7.9 Employee productivity (Rsmn) AUM/ Employee 20.12 19.13 19.05 14.47 18.73 19.99 18.43 25.01 24.56 25.4 34.7 40.1Opex per employee 0.53 0.70 0.69 0.56 0.58 0.63 0.61 0.71 0.81 0.5 0.7 0.7Emp cost/ employee 0.26 0.37 0.33 0.14 0.17 0.25 0.21 0.32 0.38 0.2 0.3 0.3Other opex/ employee 0.22 0.30 0.31 0.41 0.38 0.36 0.38 0.36 0.41 0.2 0.4 0.4

Source: Company, PhillipCapital India Research Deviation from peers’ average (%)

FY11 FY12 FY13 FY14 FY15 FY16 FY17

Efficiency ratio Opex/ Aum (%) ‐4 ‐13 20 25 39 24 33Employee cost/Aum 16 27 59 62 95 55 45Other cost/ AUM ‐24 ‐44 ‐9 0 0 ‐5 12 Branch productivity AUM per branch 43 27 1 24 58 49 10Employee per branch 63 28 16 74 115 89 63Opex per Branch 54 27 39 71 132 95 61Employee cost/ branch 69 64 63 107 232 147 77Other opex per branch 45 4 25 51 73 61 49 Employee productivity AUM/ Employee ‐45 4 ‐10 ‐27 ‐27 ‐21 ‐32Opex per employee ‐53 ‐3 16 ‐5 6 1 ‐2Employee cost per employee ‐36 32 45 19 46 24 6Other opex per employee ‐65 ‐36 ‐9 ‐23 ‐23 ‐21 ‐18




Reduction in costs to drive NIMs expansion Focus on high‐yield products has already improved yields Historically, MGMA was known to be a CV/CE player; 51% of its business in FY12 came from these two segments. However, taking cognizance of shrinking spreads amid rising competition in these segments (14% average yield) along with spread of less than 4%, MGMA gradually (over the last seven years) reduced its exposure to CV/CE to 13% in FY17. Simultaneously, it increased its exposure to high‐yielding segments such as SME loans, tractors, and used vehicles – where average yields are above 18%. As a result, the share of high‐yielding products increased to 43% in FY17 from just 23% in FY12. Due to the realignment in its portfolio mix, average portfolio yields saw a consistent improvement over the years – touched 16.1% in FY17 vs. 14.5% in FY12 and NIMs improved to 8.4% from 5.7%. Rise in share of high yielding products... ...led to higher yields and NIMs

Source: Company, Bloomberg, PhillipCapital India Research The management will continue to focus on higher‐yielding products; we see the share of these products increasing to ~45% by FY19 from 43% in FY17 – driving expansion in ABF yields. However, this expansion will be offset by higher share of mortgage – 21.5% in FY19 from 18.8% in FY17 – where yields are lower at 13.5%. While gross yields remain at similar levels, net yields will improve by 30bps in FY19, aided by lower interest reversal because of a drop in NPA levels. Because of focus on high‐yielding products and lower cost of funds NIMs should expand by 90bps over the next two years – to touch 9.3% by FY19. Favourable interest rate climate to lead to lower costs MGMA’ borrowing profile is largely dominated by banks (including working capital demand loans/ cash credit), which constitute 77% of the book, followed by bonds (17%), and commercial paper (6%). The share of bank borrowing has increased to 77% in FY17 from 69% in FY15, while debentures’ share declined to 17% in FY17 from 24% in FY14. Even as the weighted average cost of debentures has remained stable over the last three years at around 10.9% (led by two downgrades in the last four years), cost of bank borrowings has reduced to 10% in FY17 from 10.8% in FY15, driving a 67bps overall reduction in cost of borrowings over FY15‐17. With almost 70% of the total borrowings of maturities of one‐year and less, reprising of these borrowings is likely to drive a further reduction of 60bps in cost of borrowings in FY18.

25.6% 27.6% 27.6% 25.5% 24.9% 25.3%

33.8% 23.6% 17.8%13.3% 9.1% 6.5%

17.3%13.8%

11.8%9.8%

8.0% 6.6%

8.4%

9.8%11.3%

11.9%11.2% 11.4%

10.2%12.4%

16.0%17.8%

18.8% 19.7%

4.8%4.7% 5.6%

7.1%9.5% 11.7%

7.6% 9.4% 14.6% 18.5% 18.8%

0%

20%

40%

60%

80%

100%


UV/ Cars CV CE Used AssetsTractors SME Mortgage Gold

14.515.6 15.9

16.8 16.3 16.1

5.76.8 6.9

8.0 8.4 8.4

0

3

6

9

12

15

18


Yield on advances NIM

The share of high‐yielding products increased to 43% in FY17 from just 23% in FY12

Because of focus on high‐yielding products and lower cost of funds, NIMs should expand by 90bps over the next two years – to touch 9.3% by FY19



Sources of borrowing – instrument‐wise Interest rates trending down

Bank borrowings dominate MGMA’s borrowing profile – with weighted average cost of about 10%

___________FY15__ _______________ _______________FY16___________ ______________FY17___________

Proportion in total borrowings

Weighted average cost





Debentures 23.8 10.7 17.7 10.8 16.5 10.9Banks/ WC/ Cash credit 68.9 10.8 76.0 10.5 77.5 10.0Commercial paper 7.2 10.0 6.2 10.0 6.0 8.3Total 100.0 10.7 100.0 10.6 100 10.1 80%+ borrowings will re‐price at lower rates in FY18 Total borrowings (Rsbn) Maturity profile of borrowings (On book)

Wt Avg Cost(%)

Total Borrowing (Rsbn) Bank borrowing

Non Bank borrowing

Maturity beyond 5 years 10.8 5 1.4 3.5Maturing between 3 years to 5 years 10.8 8 4.7 3.2Maturing between 1 year to 3 years 10.9 18 14.3 4.1Maturing within 1 year 9.7 70 57.7 11.9Grand Total 10.07 101 78.1 22.7

Lower cost of funds to aid further NIM expansion A fall in the cost of funds will augment NIMs. MGMA’s cost of borrowing (reported) for FY17 was 9.8%, while incremental borrowing cost is 9%. With 70% borrowing in the less‐than one‐year maturity bucket, the re‐pricing of borrowings at a lower cost will drive about a 60bps reduction in the cost of funds. Further improvement in yields + lower cost of funds... …to drive NIMs expansion in FY18/19 (%)


23.8 17.7 16.5

68.9 76.0 77.5

7.2 6.2 6.0

0

20

40

60

80

100

120

FY15 FY16 FY17

DebenturesBank loans/ WC/ Cash creditCommercial paper

4

5

6

7

8

9

1010yr Bond yield (%) Repo rate (%)

16.216.1 16.1

16.2

10.3

9.7 9.7 9.7

9.4

9.6

9.8

10.0

10.2

10.4

15.0

15.2

15.4

15.6

15.8

16.0

16.2

16.4

FY17 FY18E FY19E FY20E

Yield on loans Cos of borrowing (RHS)

8.4

9.1

9.39.2

7.8

8.0

8.2

8.4

8.6

8.8

9.0

9.2

9.4

FY17 FY18E FY19E FY20E



Rural recovery to drive sharp profitability upturn Weakening macro environment led to higher credit cost, offsetting NIM expansion NIM expansion over FY12‐17 did not translate into higher RoAs, as the benefit was more than offset by a disproportionate rise in credit costs. While NIMs increased 2.6%, RoA decreased 1% over FY12‐17 due to a 3.5% increase in credit cost. MGMA’s credit cost has seen consistent increase to 4.2% in FY17 from 0.7% in FY12, as the economic downturn since FY13 and two consecutive monsoon failures in FY15/16 impacted asset quality. Higher opex and credit cost (%).... …offset NIM expansion benefit (%)

Source: Company, PhillipCapital India Research MGMA is benefiting from improved cash flows in the rural geography With 80% branch network in rural‐ and semi‐urban regions, MGMA’s fortune is directly linked to the rural economy. Two consecutive good monsoons have boosted cash flows in the rural economy. While demonetisation in November 2016 and the farm‐loan waiver have had an interim impact on asset quality, things have settled now. A rise in agricultural production, higher yields, and rising crop prices in FY17 have started to aid rural cash flows, which is also evident from MGMA’s rising collection efficiency. With 15% higher allocation to MNREGA in FY19 and further 10% in FY20, the outlook looks even more rosier for companies operating in rural areas. We expect MGMA’s balance sheet to grow by 4% in FY18 and 15%/25% in FY19/20 with RoAs improving to 2.5%/2.8% by FY19/20 from 1.4%/0.1% in FY16/17.

Improvement in opex and credit‐cost ratios… …will drive improvement in RoA


4.3 4.4 4.3

4.9

4.2 4.3

0.7

0.91.4

1.7

2.5

4.2

0.0

1.0

2.0

3.0

4.0

5.0

6.0


Opex Credit cost

5.7

6.8 6.9

8.08.4 8.4

1.1 1.4 1.2 1.3 1.4

0.1

0

1

2

3

4

5

6

7

8

9


NIM RoA

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

FY16 FY17 FY18E FY19E FY20E

Opex/ AUM Credit cost

0

4

8

12

16

20

0.0

0.5

1.0

1.5

2.0

2.5

3.0

FY16 FY17 FY18E FY19E FY20E

RoA RoE (RHS)



Evenly spread branches minimise regional risks MGMA has 297 branches spread across all four regions of India, with a slightly higher concentration in the north, which comprises about 35% of its branch network; west/south/east are at 25%/21%/19%. Over the past one year, the company has ramped up its branch network in the north, followed by east and west. A well‐diversified branch network minimises region‐specific risk. Evenly spread branch network across regions… ...largely in rural and semi‐urban areas (%)

Source: Company, PhillipCapital India Research Its AUM is also well spread across states, with no single state contributing more than 9% (except UP at 14%). Uttar Pradesh, Maharashtra, Rajasthan, Haryana, and Madhya Pradesh are its top‐5 business‐generating regions. AUM share: State‐wise AUM: Share region‐wise


22% 24% 23% 18% 18% 19%

25%30% 31%

27% 26% 25%

30%27% 27%

31% 34% 35%

23% 20% 20% 24% 22% 21%

0%

20%

40%

60%

80%

100%


East West North South

46% 46%32.0% 36.6% 35.0% 32.0%

35% 35%

36.0%41.4% 44.0% 49.0%

19% 19%32.0%

22.0% 21.0% 19.0%

0%

20%

40%

60%

80%

100%


Rural Semi Urban Urban

Bihar5%

JKHND2%

Orrisa4%

WB5%

AP4%TEL5%

KTK6%

Kerala5%

TN4%CHTSGH

3%Gujarat5%

MP6%

Mah9%

UTKHND/ Delhi5%

Haryana7%

PJB/ HP4%

RJ8%

UP14%

West23%

East16%

South24%

North37%



Focus on underserved rural‐ and semi‐urban customers With almost 80% branches in rural and semi urban areas, the company’s target customer segments are largely underserved rural and urban customers – which largely do not have any formal income proof or credit history. For instance, more than 65% of the company’s customers in the car segment do not have any formal income proof. Similarly, more than 65% of its CV/CE/used‐asset customers have 0/1 vehicle ownership. However, in its SME segment (unsecured), almost all of its customers have formal documents and bank accounts. MGMA largely segregates its customer segments into four types: (1) first‐time buyers, (2) self‐employed non‐professionals, (3) SMEs, and (4) ones with limited banking/credit history. The customer profile in each customer segment is as follows: Customer Segments Description First‐time buyer Farmers with small landholdings (<4 acres), tractor buyers First‐time buyers with prior relevant experience (taxi/truck/machine driver/operators) Self‐employed non‐professional Self‐employed customer with informal income sources (home/car buyer) SME Small factory owner/contractor, trader/shop owner with working capital needs (SME/LAP customer) Small fleet operator (taxi/truck/equipment buyer) Limited banking / credit history Customer with informal income sources and low eligibility for bank loans Customers with no established credit track record Customers with limited banking transactions Source: Company, PhillipCapital India Research Products Key customer segments Details UV/ cars Entry‐level vehicles and UV/MUV ~65% customers do not have any formal income proof Small road transport operator (SRTO) Commercial vehicles 1‐5 vehicle owners (especially FTB segment) ~65% customers have 0/1 vehicle ownership SRTO Construction equipment Small‐scale entrepreneurs ~65% customers are first time buyers, rest small operators Used assets First‐time buyers, small fleet drivers Majorly 0/1 vehicle ownership customers M&HCV, refinance Tractors Land‐owning farmers Majority customers own less than 4 acres of land 25‐75 HP tractors SME loans SME segment ~100% Customers have all formal documents and have bank accounts Working capital, business expansion Mortgage Self‐employed ~85% of the portfolio comes from self‐employed Informal segment General Insurance Captive customers ~80% motor business; 20% non‐motor business (commercial and health) Rural agri‐based products Source: Company, PhillipCapital India Research



Valuation and view Historically, MGMA has traded at around 50‐60% discount to its peers (MMFS, CIFC, SHTF) due to sub‐optimal profitability ratios. While the discount has narrowed in the last 6‐9 months – aided by improvement in asset quality and a likely sharp turnaround in profitability – it remains high at 40%. With its new organisational structure, buoyancy in the rural economy should drive balance sheet expansion and sharp improvement in opex and credit cost ratios. We expect RoA to improve to 2.5%/2.8% in FY19/20 from an average RoA of 1.3% in FY12‐16; average RoE to increase to 16% from 11%. We initiate coverage with a BUY rating and a target of Rs 250 (2.2x FY19 book value) implying an upside of 44%. One‐year forward P/ABV band

Source: Company, PhillipCapital India Research estimates RoA to move closer to peers... …so will RoE (%)

Source: Company, PhillipCapital India Research Peer valuation

MCAP _________RoA (%)_______ _________RoE (%)_______ __________BV (Rs)_______ ________P/BV (x)_______Rs bn FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E

STFC 233 1.8 2.3 2.4 11.7 15.2 15.6 498.1 568.6 652.9 2.1 1.8 1.6SCUF 135 2.5 2.9 3.1 11.7 14.4 16.2 762.5 859.4 988.2 2.7 2.4 2.1MMFS 261 0.9 1.7 2.1 6.4 11.3 13.9 114.6 140.3 148.1 3.8 3.1 2.9CIFC 180 2.5 2.7 2.8 18.0 19.0 20.0 275.9 325.5 388.5 4.2 3.5 3.0MGMA 41 0.1 1.7 2.5 0.6 10.2 14.7 92 100 114 1.9 1.7 1.5

Source: Company, PhillipCapital India Research Estimates

0

40

80

120

160

200

Feb‐11

Aug‐11

Feb‐12

Aug‐12

Feb‐13

Aug‐13

Feb‐14

Aug‐14

Feb‐15

Aug‐15

Feb‐16

Aug‐16

Feb‐17

Aug‐17

0.7x

1.0x

1.4x

1.8x

0.0

1.0

2.0

3.0

4.0

5.0

FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E

MAGMA MMFS CIFC STFC

0.0

5.0

10.0

15.0

20.0

25.0

FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E

MAGMA MMFS CIFC STFC

Improvement across the financial matrices will drive a rerating



Background MGMA is a non‐deposit taking, non‐banking finance company (NBFC), registered with the Reserve Bank of India (RBI) as an asset‐finance company. MGMA’s products include financing of utility vehicles & cars, commercial vehicles, construction equipment, used commercial vehicles, tractors, and SME Loans. It also operates in affordable housing finance and general insurance segments. MGMA has a dedicated base of more than 500,000 active customers. It operates through 297 branches in 25 states / UTs and employs around 9,000 people.

Management Mr Sanjay Chamria, Vice Chairman & Managing Director: He drives policy formation, strategic planning and its execution. He is a chartered accountant. He is one of the promoters. Mr Kailash Baheti, CFO. Handles treasury, investor relations, accounts, tax and corporate legal matters. Mr Baheti is a chartered accountant, company secretary, and a cost and management accountant. Mr Kaushik Banerjee, President and Chief Executive Officer, Asset Finance: Mr. Banerjee has over 25 years of experience in India’s retail financing sector. He has handled leadership roles in Esanda Finanz (a subsidiary of Grindlays Bank) and Cholamandalam Finance. Commerce degree from Sydenham College, Mumbai, and MBA (marketing) from the Asian Institute of Management Manila, Philippines. Mr Manish Jaiswal, CEO, Housing Finance & SME: Over 25 years of corporate experience (CRISIL, Dhanlaxmi Bank, Fullerton, Citigroup, and Eicher Motors). Member of SEBI’s Corporate Bonds and Securitization Advisory Committee (CoBoSAC); advised EPFO, PFRDA. Built and managed assets of more than Rs 150bn of SME secured portfolio in his career. Key shareholders Promoter family Number of shares(mn) % shareholdingPromoter 65.7 27.8Bank Muscat India Fund 9 3.7Kkr Mauritius Direct Investments I Ltd. 4 1.6Lavender Investments Limited 19 8.0Rimco India Limited 3 1.3International Finance Corporation 23 9.7Leapfrog Financial Inclusion India Holdings Limited 19 7.8Zend Mauritius Vc Investments Ltd 34 14.5Total 319 80

Source: Company, PhillipCapital India Research, BSE



Financials Profit and loss (Rs mn) Balance sheet (Rs mn) (Year Ending Mar 31) FY17 FY18E FY19E FY20E (Year Ending Mar 31) FY17 FY18E FY19E FY20E

Net interest income 12,190 12,482 13,931 16,343 Equity 474 474 474 474

Other income 550 581 700 785 Reserves 21,247 23,217 26,460 30,794

Net Income 12,740 13,063 14,631 17,128 Net worth 21,721 23,691 26,933 31,268

Operating expenses 6,204 6,337 6,485 7,301 Borrowings 100,753 101,459 118,246 148,807

Pre‐provision profit 6,537 6,726 8,146 9,827 Current liabilities & others 13,478 13,812 13,948 14,075

Provisions 6,069 3,350 2,713 2,615 Total liabilities 135,952 138,962 159,127 194,150

Profit before tax 468 3,376 5,434 7,213 Net block 2,853 3,020 3,563 4,745

Tax 341 1,063 1,712 2,272 Investments 5,465 4,601 4,601 4,601

Tax rate(%) 72.8 31.5 31.5 31.5 Loans 120,624 124,056 143,389 176,925

Adjusted Profit after tax 127 2,313 3,722 4,941 Current assets & others 7,010 7,286 7,575 7,879

Total assets 135,952 138,962 159,127 194,150

Dupont (as % of Assets) Key ratios (Year Ending Mar 31) FY17 FY18E FY19E FY20E (Year Ending Mar 31) FY17 FY18E FY19E FY20E

Interest Income 16.1 16.2 16.5 16.7 NIM (%) 8.4 9.1 9.3 9.3

Interest Expense 7.7 7.1 7.1 7.4 NIM (%) ‐On AUM 7.1 7.6 7.8 7.6

Net Interest Income 8.4 9.1 9.3 9.3 Cost/ Income (%) 48.7 48.5 44.3 42.6

Other income total 0.4 0.4 0.5 0.4 Credit cost (%) 4.2 2.4 1.8 1.5

Net Income total 8.8 9.5 9.8 9.7 RoA(%) 0.1 1.7 2.5 2.8

Operating expenses total 4.3 4.6 4.4 4.1 RoE (%) 0.6 10.2 14.7 17.0

Preprovision profit 4.5 4.9 5.5 5.6 Leverage (x) 6.7 6.1 5.9 6.1

Provisions 4.2 2.4 1.8 1.5 Tier I (%) 15.4 16.5 17.3 16.8

Profit before tax and ex items 0.3 2.5 3.6 4.1 CAR (%) 20.4 20.7 21.5 21.0

Profit before tax 0.3 2.5 3.6 4.1 No of shares (mn) 237.0 237.0 237.0 237.0

Tax total 0.2 0.8 1.1 1.3 Gross NPA (%) 6.7 7.5 5.9 5.4

Profit after tax 0.1 1.7 2.5 2.8 Net NPA (%) 5.6 5.5 4.7 4.0

Provision coverage (%) 17.7 26.8 40.5 45.5

Growth (%) Valuation ratios (Year Ending Mar 31) FY17 FY18E FY19E FY20E (Year Ending Mar 31) FY17 FY18E FY19E FY20E

Net interest income ‐4.8 2.4 11.6 17.3 FDEPS (Rs) 0.9 9.6 15.5 20.5

Net Income total ‐3.1 2.5 12.0 17.1 PER (x) 201.4 18.1 11.2 8.5

Preprovision profit ‐4.0 2.9 21.1 20.6 Book value (Rs) 91.7 100.0 113.7 132.0

Profit before tax ‐84.7 621.5 60.9 32.7 P/BV (Rs) 1.9 1.7 1.5 1.3

Profit after tax ‐94.0 1,716.3 60.9 32.7 Adjusted book value (Rs) 54.1 61.4 85.0 102.0

Loan ‐14.6 2.8 15.6 23.4 P/ABV (Rs) 3.2 2.8 2.0 1.7

Disbursement ‐6.5 15.0 25.0 25.0 P/ PPP 6.3 6.1 5.1 4.2

AUM ‐11.5 4.0 14.7 25.2 Dividend yield (%) 0.5 0.6 0.7 0.9

Source: Company, PhillipCapital India Research Estimates



NOTES



Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition

BUY >= +15% Target price is equal to or more than 15% of current market price

NEUTRAL ‐15% > to < +15% Target price is less than +15% but more than ‐15%

SELL <= ‐15% Target price is less than or equal to ‐15%.

Management Vineet Bhatnagar (Managing Director) (91 22) 2483 1919 Kinshuk Bharti Tiwari (Head – Institutional Equity) (91 22) 6246 4101 Jignesh Shah (Head – Equity Derivatives) (91 22) 6667 9735 Research Automobiles Engineering, Capital Goods Pharma & Specialty Chem Dhawal Doshi (9122) 6246 4128 Jonas Bhutta (9122) 6246 4119 Surya Patra (9122) 6246 4121 Nitesh Sharma, CFA (9122) 6246 4126 Vikram Rawat (9122) 6246 4120 Mehul Sheth (9122) 6246 4123 Banking, NBFCs IT Services & Infrastructure Strategy Manish Agarwalla (9122) 6246 4125 Vibhor Singhal (9122) 6246 4109 Naveen Kulkarni, CFA, FRM (9122) 6246 4122 Pradeep Agrawal (9122) 6246 4113 Shyamal Dhruve (9122) 6246 4110 Neeraj Chadawar (9122) 6667 9764 Paresh Jain (9122) 6246 4114 Logistics, Transportation & Midcap Telecom Consumer & Retail Vikram Suryavanshi (9122) 6246 4111 Naveen Kulkarni, CFA, FRM (9122) 6246 4122 Naveen Kulkarni, CFA, FRM (9122) 6246 4122 Media Manoj Behera (9122) 6246 4118 Preeyam Tolia (9122) 6246 4129 Manoj Behera (9122) 6246 4118 Technicals Metals Subodh Gupta, CMT (9122) 6246 4136 Cement Dhawal Doshi (9122) 6246 4128 Production Manager Vaibhav Agarwal (9122) 6246 4124 Ganesh Deorukhkar (9122) 6667 9966 Economics Mid-Caps & Database Manager Editor Anjali Verma (9122) 6246 4115 Deepak Agarwal (9122) 6246 4112 Roshan Sony 98199 72726 Shruti Bajpai (9122) 6246 4135 Oil & Gas Sr. Manager – Equities Support

Sabri Hazarika (9122) 6667 9756 Rosie Ferns (9122) 6667 9971

Sales & Distribution Corporate Communications Ashvin Patil (9122) 6246 4105 Sales Trader Zarine Damania (9122) 6667 9976 Shubhangi Agrawal (9122) 6246 4103 Dilesh Doshi (9122) 6667 9747 Kishor Binwal (9122) 6246 4106 Suniil Pandit (9122) 6667 9745 Bhavin Shah (9122) 6246 4102 Ashka Mehta Gulati (9122) 6246 4108 Execution Archan Vyas (9122) 6246 4107 Mayur Shah (9122) 6667 9945

Contact Information (Regional Member Companies)

SINGAPORE: Phillip Securities Pte Ltd 250 North Bridge Road, #06‐00 RafflesCityTower,

Singapore 179101 Tel : (65) 6533 6001 Fax: (65) 6535 3834

www.phillip.com.sg

MALAYSIA: Phillip Capital Management Sdn Bhd B‐3‐6 Block B Level 3, Megan Avenue II,

No. 12, Jalan Yap Kwan Seng, 50450 Kuala Lumpur Tel (60) 3 2162 8841 Fax (60) 3 2166 5099

www.poems.com.my

HONG KONG: Phillip Securities (HK) Ltd 11/F United Centre 95 Queensway Hong Kong Tel (852) 2277 6600 Fax: (852) 2868 5307

www.phillip.com.hk

JAPAN: Phillip Securities Japan, Ltd 4‐2 Nihonbashi Kabutocho, Chuo‐ku

Tokyo 103‐0026 Tel: (81) 3 3666 2101 Fax: (81) 3 3664 0141

www.phillip.co.jp

INDONESIA: PT Phillip Securities Indonesia ANZTower Level 23B, Jl Jend Sudirman Kav 33A,

Jakarta 10220, Indonesia Tel (62) 21 5790 0800 Fax: (62) 21 5790 0809

www.phillip.co.id

CHINA: Phillip Financial Advisory (Shanghai) Co. Ltd. No 550 Yan An East Road, OceanTower Unit 2318

Shanghai 200 001 Tel (86) 21 5169 9200 Fax: (86) 21 6351 2940

www.phillip.com.cn THAILAND: Phillip Securities (Thailand) Public Co. Ltd.

15th Floor, VorawatBuilding, 849 Silom Road, Silom, Bangrak, Bangkok 10500 Thailand

Tel (66) 2 2268 0999 Fax: (66) 2 2268 0921 www.phillip.co.th

FRANCE: King & Shaxson Capital Ltd. 3rd Floor, 35 Rue de la Bienfaisance

75008 Paris France Tel (33) 1 4563 3100 Fax : (33) 1 4563 6017

www.kingandshaxson.com

UNITED KINGDOM: King & Shaxson Ltd. 6th Floor, Candlewick House, 120 Cannon Street

London, EC4N 6AS Tel (44) 20 7929 5300 Fax: (44) 20 7283 6835

www.kingandshaxson.com UNITED STATES: Phillip Futures Inc.

141 W Jackson Blvd Ste 3050 The Chicago Board of TradeBuilding

Chicago, IL 60604 USA Tel (1) 312 356 9000 Fax: (1) 312 356 9005

AUSTRALIA: PhillipCapital Australia Level 10, 330 Collins Street

Melbourne, VIC 3000, Australia Tel: (61) 3 8633 9800 Fax: (61) 3 8633 9899

www.phillipcapital.com.au

SRI LANKA: Asha Phillip Securities Limited Level 4, Millennium House, 46/58 Navam Mawatha,

Colombo 2, Sri Lanka Tel: (94) 11 2429 100 Fax: (94) 11 2429 199

www.ashaphillip.net/home.htm INDIA

PhillipCapital (India) Private Limited No. 1, 18th Floor, Urmi Estate, 95 Ganpatrao Kadam Marg, Lower Parel West, Mumbai 400013 Tel: (9122) 2300 2999 Fax: (9122) 6667 9955 www.phillipcapital.in



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No

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