PEL wanted to raise 2000 Cr thru rights issue but only allocated 1781 Cr. Does it mean that they will not raise the pending amount?
PEL stock has corrected from its high of 3088 posted in June 2017 to a recent low of 2280 levels. In the interim the results have been quite good but market perception to the company, the sector and general market sentiments have changed.
I think its time to look closely at the business of the company and try to figure out if there is an over reaction from the markets looking at the type of correction seen in the counter.
I think the biggest market fear has been about possibility of NPA in its main business of real estate lending. While AP has been maintaining that even if there would be defaults they could take possession of properties and get back their money, market fears would be that practically implementing this strategy might be difficult. Taking hold of property and then selling the assets could be time consuming and could face regulatory hurdles looking at the Indian judicial system.
Till date as on results of 31 Dec 2017, the NPAs have been under control.
Personally I feel all the problems faced by PSU banks have affected the mindset of investor community and hence a lot of companies in the lending space are being brushed by the same brush.
What impresses me about AP is that he has always been a step ahead of peers in terms of choosing the area of business he wants to be in.
As can be seen since past 2-3 quarters the company has started focussing more on construction finance and reducing the riskier mezanine finance.
With PSU banks being wary of lending with all their internal problems, the good quality NBFC might emerge winners as they would have a clear field to have strong growth rates in lending business.
Another interesting trigger which could play out in medium term could be the demerger if and when that happens. But once fear about one aspect gets into the mindset of people they cant see other things some distance away.
disc: invested in PEL and watching developments closely.
Can SREI also be major beneficiary due to the reasons stated by you?
I have been invested in PEL and few other stocks in NBFC space since some time and I feel, it is not appropriate to paint all NBFCs with same brush as each one of them have their own strength and weaknesses. Similarly, painting RE financing as risky is again taking it too far.
Few observations on RE financing based on various data points/information offlately.
- Clearly for RE financing side supply is shrinking as most of the public sector banks and even some private sector banks are not willing to lend. At the same time demand for financing is not going away. So, to assume that suddenly RE financing is turning extra competitive may not be accurate as NBFCs are filling in a void
- Secondly, most of the larger real estate players have indicated that consolidation is happening and smaller players are exiting. This is helping them gain mkt share (from Purvankara, Shobha, Oberoi, Godrej calls). Good NBFCs have typically lent to these larger players who are experiencing tailwinds.
- In such scenario, isn’t it fair to expect that larger players in RE financing can afford to be a bit more choosy and hence can actually get better covenants and structures? This combined with business momentum of Organized RE players, seems risk of default shall be lesser compared to earlier when somebody who had lent money at peak of cycle.
PEL’s latest investor presentation speaks of the pharma business’ EBITDA
rising sharply by FY20. IMHO that should be the trigger for the demerger.
There are also a number of other variables like the investments in Shriram
group of companies which have given only modest returns. Here AP is playing
for something bigger not all of which has come out in the public domain.
The latest presentation speaks of learnings from Shriram’s HFC business.
Need to watch out how this will play out since Rajesh Laddha has moved from
PEL to take charge of Shriram.
DRG also seems to be moving around in auto-pilot for the last few quarters.
Some surprises may be expected here as well.
disclosure: holding and got more in the rights issue. hence views may be
Valid Point why would they under raise it? was the notification to the exchanges is due?
can we assume that AP didn’t participate to full extent? or any large institution happen to give it a miss?
The remaining money in the rights issue was reserved for qip investors who
have CCDs. This is equivalent to 4%(1 rights issue share for 23 shares) of
5000 crore (qip ccds) that is around 218 crores.
Now the retail investors can also buy CCDs which are tradeable. Once we
convert the CCD to 40 shares each, we can apply for rights issue within 15
days. Management confirmed me regarding this over email.
I have a different take here. Some excerpts from the recent conf call of PEL:
From the recent presentation:
Growth/RoE/Price to Book: First to start with PEL has been growing the book at a stellar rate, the book has grown over 100 times in 6 years from 350 cr to 38000 cr. also Mr. Piramal in no uncertain terms has been extremely boisterous about this growth and RoE. T
Returns: The RoE is basically RoA*Leverage and with a limited leverage of less than 3x the higher RoE is achieved because of the higher spread. The NIM as mentioned in the presentation is 8% +. I am certain most real estate groups of repute including Godrej/Shobha and other higher rated developers have all access to loans at a much lower spread from banks (bank cost of funds around 6%) and incase they are accessing loans from NBFCs the spread would still be much lesser. Clearly in order to give loans at higher spreads the loans are given to below investment grade companies with an assumption that the project will be delivered and loans paid and the risks assessed accordingly.
Seasoning of book and NPAs: If your book size has grown to 100x in 6 years clearly the book is not mature. GNPA although at .4% has very little relevance other than saying the newer loans are doing fine.
Comparison: Mr. Piramal also loves to compare PEL with other NBFCs and highlights how PEL is doing better than most of his contemporaries and yet trades at a lower P/BV metric.
On defaults: Mr. Piramal has said that incase of defaults PEL will take up the business and recover their money. It would be interesting to see what % of NPAs in RE finance has been sorted out in this manner my guess would be very low do add the time + effort + interest burden + inflation leading to cost escalations, Also an NBFC with 3x leverage is good a builder with the same leverage not so good. Owning a project to recover also implies that the company is making certain demand side assumptions. I would expect PEL to do good prudent lending, the idea that a lender would start taking up projects is preposterous. I am sure with the same reasoning on corporate side Mr. Piramal could run every business that defaults.
M&A: I am sure by no stretch of imagination is the stake buying in SCUF/STFC can be called a success. The merger with IDFC Bank was another ill conceived idea. Generally when a financial is ready to own the underwriting done by some other chap the question is whose underwriting is worse.
My take: This is the first time Mr. Piramal is running a leverage driven lending business and despite that if you take AP out of the equation a lot of investors would run away. I have previously owned RBL bank and every time Mr. V Ahuja spoke of 35% growth an alarm bell would ring making me uncomfortable. The NPAs in RBL bank though under control have increased every quarter since listing. Incase of PEL unless the book matures and the growth rates come down to more manageable number NPAs do not give the true picture. The other point generally made is around covenants, and I think this again is a fallacy since there is no better (other) protection than prudent underwriting. Most investors I have come across have a huge devotion to AP and seems like that is the only reason for their investments in PEL, take AP out and the investment thesis collapses.
Finally from JM’s conf. call from previous quarter:
an assessment of sector and aggressive lending from two of their competitors.
Discl: I have no investments in PEL and have cut down on my financial sector exposure considerably in last one year. I am not averse to taking a short term opportunistic bet.
There is no fixed period for knowing when the loan book is seasoned. it all depends on the duration of the loan and the nature/ economic situation of the borrower. If you have a micro loan or gold loan, a loan seasons within 2 months and in most cases there is no NPA till something line Demon happens and then all hell breaks loose.
you will find the same situation in almost all cases. the true quality of the loan is clear when the borrower faces some stress. In the case of PEL, the common theme is that they are counter cyclical with all their investments including lending.
In case of financial services, an outside investor will never know the quality of under-writing by looking at the books. Even the CEO will not know as we saw in the 2008 financial crisis and with PSU. The only variable one can depend on is the culture of the company and the incentives for the management. If one looks at the past history, the same banks always get into trouble in india and globally.
In case of PEL, we know that the AP has major part of his networth in the company and so it is in his interest to build the appropriate culture. We can see already see how he has built the second tier of management for each business and this not a one man show.
A single individual cannot run a firm of this scale and if you track the evolution of the company, they have built a strong second level to head individual business. so this is no longer a one man show.
In terms of spread, it also depends on the nature of the product and not just the nature of the borrower alone. we pay far more for personal loan than housing loan. the same seems to be the case for PEL’s loan book.
I think it really does come down whether AP has built the right culture and team and whether as an investor you believe that he has. No amount of numbers will help here …if numbers were helpful then PSU would have been great bet, but we know the type of culture and incentives the management has in all those firms
discl : i have been invested with PEL for a long time
IMO a seasoned loan book is one where loan book growth is stable and more in line with a country’s macro numbers, ofcourse some institutions will grow fast and some will grow slow, something similar to what we can see in most mature private sector banks. Incase of PEL the super normal growth itself hides the NPAs incurred historically and until the super normal growth subsides I would say the NPAs does not present a clear picture.
Agree a complete picture is just not possible, but you can always get some sense of how deals are being done by looking at specific deals more like scuttlebutt, of course you run the risk of taking anecdote as evidence. Even today most builders of some repute have access to funds at much lower rates than quoted by Piramal. As I said as an investor I do get worried when I see this relentless focus on building a book and RoE since the losses are back ended. I do not know much about PELs culture of lending, risk management and processes involved thereof, but if someone has, it certainly can be big help in making an investment decision.
Agree. I think the metrics I would weigh against are the spread of competitors and their LTVs in similar products. Somehow JMs perspective is different as I pointed out earlier.
The question that I ask when I am looking for a long term investment in PEL is: Would I invest in PEL in the absence of Mr. Piramal? The answer is no, when the answer for that question is yes for me I would be able to trust the organization, until that time it remains a one man show. A similar question for Bajaj Finance/HDFC Bank/Kotak/HDFC/Sundaram/ is a yes.
disc: I own Piramal and it is about 20% of my portfolio.
You are so right about risks in investing with a financial company. The risks are much higher when compared to a non-financial company. Even Charlie Munger says the only thing that matters in financials are the management.
I remember he said something on the lines of - ‘When holding such a company, if the rewards are available in other investments and especially if they are higher, one should prudently think/re-think about investing in a leveraged entity.’
I remember when Shriram Tranport’s Equipment finance had no NPAs and suddenly almost 400 crores of NPAs came out of no where! And apparently to some (including me) , it was a better managed NBFC until the NPAs came out.
Piramal will have its NPAs, but what they do when that happens is what it matters. If you think, they will survive, you can invest if the returns are higher than the ratio you would want.
Assuming a loan book of 60000 Crores ( lets include the non-disbursed amount too), let us imagine a scenario of 10% Net NPAs. So about 6000 Crores goes kaput, do you think PEL will survive?
I, in my biased view, think, they will be able to deal with the scenario better than most banks, hence my 20% allocation.
The Godrej/Sobha companies, will probably not go to Piramal for their Loans. It is only the distressed companies that would go to Piramal. So, I see Piramal’s RE foray as a distressed debt venture, similar to what the Bain/KKR/Oaktrees of the world do. Not really as a pure NBFC RE venture.
Dilution in equity and P/E contraction will definitely put pressure on downward journey compare to upward price in short run …may be opportunity to enter / accumulate !
Those who think Piramal is a one trick pony show should spend about 30 mins on:
a) Knowing all others in senior management.
I think it is a bit of underestimation of the value that Jijina brings to the table. Look at all other key management personnel.
b) Very strong board of directors.
c) Both the children are well educated and are already running part of the companies. Succession planning is on.
d) Go through last 12+ investor presentations to understand how the story is unfolding.
Disc: Self and family invested. Both as side car investment on AP story “and” a strong corporate house of contra play.
Disc: Non-material investment
@ajaychauhan Thanks for posting the Ambit Report.
I thought I will share some key aspects of the report relevant to Piramal.
Why is the report different and important?
What makes the report interesting is the quality of statistics (breadth and depth of developers and loan sanctions) and depth of analysis (MCA analysis of loan charge documents) that has gone into it.
Background to the report
Over the past 4 years NBFCs have increased their exposure to Real Estate (RE) financing, from a 30% share to a 60% share at Rs 2.2 trillion (listed NBFCs). Credit growth in both PSUs and Pvt Banks to this sector is low and NBFCs financing is astoundingly high. We know it’s much easier to get a loan from an NBFC compared to a bank but rates will be higher. This shift from Banks to NBFCs indicate that either banks were unable to give credit (PSU) or relatively unwilling (Pvt Banks) and thus NBFCs even at a higher rate were sought out.
Demand for residential real estate is sluggish. We know that.
But there are now multiple dampeners that will make real estate demand slower. They are (supplied with ample evidence which I omit here):
a. Impact of Rera increasing costs for end user and likely causing delays
b. Impact of black money crackdown reducing cash transactions
c. Impact of GST making under construction projects much costlier on a like-to-like basis vs a completed projects, by 12%
d. Adverse impact of capping maximum interest amount deductible making effective interest rate for loans higher. Now with interest rates going up this will have a bigger impact. Further, there is a widening gap between rental yields and effective cost of ownership of an asset with a negative view, worsening the situation.
e. Adverse employment situation in the country.
Developers and their financiers are now in a corner with dampening demand and rising rates
Inventory now (finished and under construction) requires 3 - 5 years to clear in the key cities, and the developers are responding with fewer launches. However this supply side reaction ain’t enough to match demand side issues. So pricing will be under pressure. And developers have lots of leverage and thus will get under stress. They have been able to avoid such because of frequent refinancing. That is likely to stop with rising rates. That will impact NBFCs.
Such NBFCs are in a commodity business that will suffer from these developments. NBFCs have little to offer that makes the developer stay with them. At the customer end developers can re-finance very easily, these NBFCs have no pricing power, and on the supply side they cannot control borrowing rates. (as an aside, Japan’s history suggests that if troubles start with the developer, the financier can get into trouble. For eg 80% of the loan disbursed in the 5 year prior to bursting of the bubble had to be written off.)
So why are things likely to get worse for such NBFCs?
a. Bad state of Real Estate is not reflected yet in the NBFCs because these loans have a moratorium period where interest keeps getting accrued but not due. And recent loans have a longer moratorium period.
Snapshot (from the report)
b. These NBFCs may lend at higher rates, implying are taking higher risks. That’s because rates are a commodity and the the spreads are determined solely as a compensation for risk. PEL rates are lower
Snapshot (from the report)
c. A loan book with increasing tenure is indicative of stress (minus standard long term products like lease rental discounting). PEL has loans with 5 year tenure, which is quite high!
Snapshot (from the report)
d. These loans are ‘unseasoned’, meaning most of the loans do not probably reflect developer stress. That’s because they are all new in relation to the total tenure. 100% of PEL loan sanctioned in FY 16-18 are unseasoned
Snapshot (from the report)
e. Even as developer’s ratings may not indicate true level of risk (implying it will be worse), these NBFCs have mostly lent to BBB and lower. PEL has about 75% lent to such deveopers.
Snapshot (from the report)
f. Many of these NBFCs have lent to only a few developers, so if one of them sinks, it can have a big impact on the NBFC. PEL has 90% loan sanction exposure to the top 10 developers.
Snapshot (from the report)
So what can go wrong with developers that can put the NBFCs on the mat?
The refinancing game with NBFCs that was defraying NPA recognition for developers is coming to an end with rising rates. Further these NBFCs are running with ALM mismatches with shorter duration assets. As liquidity tightens, short term rates spike, they will have trouble rolling over their loans and / or have their spreads squeezed. PEL has an ALM mis-match of 3 years.
Snapshot (from the report)
What can prove Ambit wrong (according to Ambit)?
A pickup in sales arising from falling equity markets making real estate again a preferred investment option.
Finally, in their ranking of NBFCs based on risk, PEL is the riskiest.
I first came to know about Piramal through the investment theseis by Prof Sanjay Bakshi. There were few things which stopped me from proceeding further.
- Over reliance on AP’s skills.
- His approach towards M&A.
- My inability to comprehend Pharma.
- I felt he was diversifying into RE and later on into Finance without having expertise and probably will bite dust.
I was immature to study the company and left it there.
But after a long gap I again looked at the company, all the above points have to got resolved as I looked at.
- There was a strong second tier management which was empowered and trusted by him. So it was not a one man show.
- He continues with M&A, but I decided to trust his instincts as I have seen Godrej CP use similar approach and handle it well. So I overcame my own hesitation.
- While I have yet to understand the generic Pharma companies, here I felt the company is concentrating on niche segments and buys under used brands and expands the market. In India it is more into OTC with specific products and has expanded by having a strong sales team.
- RE and Finance seem to have been handled very well and Khushru Jijina seem to have played a pivotal role in this.
These convinced me to include the company into my portfolio.
A overwhelming promoter holding convinced me to be aligned with this company. So I am late entrant but my expectations are not very high growth but a decent growth under a minority friendly management.
I am more optimistic about the RE market strengthening with RERA and companies deploying newer technologies and cutting cost. RE will gradually mature into another decent industry from its unsavoury past.
Disc: Invested around 6℅ of my portfolio and continue to buy.
Few things that stand out
- The management has been trustworthy, have walked the talk
- Exposure to pharma but no FDA issues and impact on pricing etc as being faced by other players
- Exposure to Real Estate financing but no impact of the slowdown in the real estate sector. Most of the other players like JM Financial have slowed their lending to the sector and the management commentary is clearly negative.
On Real Estate Financing
If PEL was facing NPA issues or any kind of stress in their real estate book then they would have slowed their lending activity, taken a pause to rethink their strategy, systems, and controls etc (similar to what MOSL is doing for their retail housing finance book). Management has on calls mentioned that part of the real estate industry has been facing stress due to RERA, Demon, GST etc. But have also mentioned that they have lent only to strong players and their debts are structured well to take control of projects in case of any defaults.
They spend a lot of time to understand the market and are very strong in structuring their deals. Another point to note is that they are present across the value chain and could really help builders provide support in form of private equity, debt, retail housing loans, sales, and marketing etc.
For a project costing 100 and retail price of say 130, they would lend 50-60% of the cost. They structure their lending in a way that if the builder defaults they should be able to take control of the project finish it and sell the same in the market. Their exposure to the project would say 60 and even if you include interest at 15% for 2 years it would add up to 80. The retail price for the project is still 130-150. Even if they give a 40% discount on retail they should be able to get their money back.
As per my understanding, they till date haven’t taken control of any of the project due to NPA.
I trust the management to disclose if they are facing a challenging environment involving NPAs or at least intelligent enough to slow down and rethink given the huge exposure AP has in the company.
AP has invested more money in the company at these levels and in the current difficult market situation via rights as well as convertibles. I would trust his understanding of the business to avoid investing money if he wasn’t confident of the business model.
So, in summary, we have a company run by an intelligent and trustworthy leadership of AP and is doing well in sectors where others competitors are struggling.
Invested and increasing exposure. Its a long-term compounding story for me till I see signs challenging my thesis.
Seems folks have forgotten the bet on NCE. Few years back he complained that analysts are giving zero value to its drug discovery biz. Ultimately he scaled back the investments largely accepting the fate. Pls keep in the mind that pharma was his own backyard. So the man is not so immune to error of judgement. Definitely bet on real estate is very very aggressive and should pay off in the long run. Just imagine what would happed if there is sharp disruptive rise in interest rates due to continued spike in US. We have already seen a trailer in the local bond yields. What if he is already seeing some stress and trying to plug potential craters ahead. I am also not impressed with his bet on Sriram group. With his capability, I would have loved to create the biz from scratch or buy the biz 100% and steer it the way he would have liked.
Disc - No Holding but watching with interest
Thanks will do more research on the drug discovery business. I would like to understand how management’s commentary changed from upbeat, to stress, to complete write-down. Would be fine with them making mistakes but integrity in disclosing the issues as and when they arise and honestly admitting them would give a lot of confidence in the current business.
On Sriram Group PEL has generated an IRR of 18% to date. Could have been better but wouldn’t complain too much. They also control the management with AP being the chairman (edited and corrected). So AP is running the company without owning 100% of it. I wouldn’t be surprised if he increases stake in the business when the valuation is better or merge them with other financing business over time. Could be part of the demerger which is expected to happen in mid-term
Check these old articles. At one time they were very bullish and then sudden exit.
Regarding Sriram group, let’s think this way when NBFC biz at a macro level is growing leaps and bounds, they have generated 18% IRR despite having adequate control. It is all about culture of a lending institution that mattars. Either you create it from scratch or aquire quality at a price.
The whole real estate biz has attained such a large size in the group that they have to make it work. There is no going back on this. Impossible to exit and difficult to hide if pain is prolonged.
Instead of talking in air — can we start research on ground. Lets find (1) where PEL has invested in RE (2) What is reputation of the RE (3) What is progress of projects (4) How the overall RE market doing in the pockets where PEL financed REs ? (5) Do PEL financed REs defaulted in past and lost credit?
While googling i found following contradictory links -