Event update: JM Financials (Outperformer) - 4Q18 – A strong quarter. Earnings call strengthens our buy conviction

This is a post earnings call update to our result note yesterday. JMF reported a strong quarter with consolidated PAT growing 25% yoy and 12% qoq to Rs1.3bn.  The earnings call strengthened our conviction that JMF at the current valuation of 2xPBV FY20E is an attractive investment opportunity that offers strong growth with superior asset quality and adequate capital in a capital starved sector.

The key highlights of the call:

1)    Management sees growth coming back in the real estate segment and believes yields have bottomed out. Real estate accounts for 63% of total loans. While loan growth in FY18 was moderate at 14% as JMF consolidated the real estate book in 1HFY18 following RERA and GST, loan growth in FY19 is expected to be strong at 30-35%. Consolidated loans are set to grow 30-35% with a pickup in real estate and strong growth in SME and corporate loans where JMF is poised to acquire share from state owned banks.

2)    The key reason for consolidated cost of funds rising by 40bps qoq to 8.9% was an annual rating fee charged to subsidiaries for leverage over 1x Had it not been for this charge, cost of funds would have been lower at 8.6%. The increase in proportion of loan term borrowings to 66% from 50% yoy also contributed 10bps to the increase in CoF.  

3)    Consolidated NIMs appear to have bottomed out. In FY18, the real estate business slowed down in 1HFY18. With the rising proportion of non- real estate loans, consolidated yields and NIMs were under pressure. With a strong and consistent growth in real estate expected in FY19, NIMs will likely stabilize. Also the borrowing mix is more than comfortable with the proportion of long term borrowings well above management’s comfort zone of 60% which means that there will be no further pressure on cost of funds from moving towards long term borrowings.

4)    The ARC business is in a sweet spot with a) the earnings momentum seen in 2HFY18 likely to sustain in FY19 as JMFARC continues to benefit from deals closed a few years ago and b) AUM growth likely to accelerate given the huge build-up of stress in the banking sector.  Most incremental ARC deals are happening on an all cash basis.

5)    JMF will likely scale up investments / opex in wealth management from 2Q19.

6)    GNPAs remained stable qoq. A single real estate loan accounts for a large portion of GNPAs. JMF has over 2x collateral cover on that loan and hopes to resolve this account in 1HFY19 which is why the provisioning cover on GNPAs is low.  Credit cost for the fund based business rose qoq due to mandatory RBI provisions on ARC assets.

Valuation and view:

We reiterate Overweight on JMF. We expect JMF to deliver strong earnings growth of 23% over FY18-FY20E. We expect RoA to remain strong at 4.4% in FY20E and RoE of 18.6%.