CRISIL assigns fundamental grade of 3/5 to Magma Fincorp

CRISIL Research has assigned a CRISIL IER fundamental grade of 3/5 to Magma Fincorp Ltd . The grade indicates that the company's fundamentals are 'good' relative to other listed equity securities in India. CRISIL Research has assigned a valuation grade of 5/5, indicating that market price has 'strong upside' from the current levels. Our fair value of the stock is Rs 90 per share. The stock is currently trading at Rs 66 per share. The grades are not a recommendation to buy, sell or hold the graded instrument, or a comment on the graded instrument's future market price or its suitability for a particular investor.

Magma is a non-deposit taking non-banking financial company (NBFC) offering financial services to customers in rural and semi-rural areas. The assigned fundamental grade factors in Magma's established presence in the target market and its strong growth record (disbursements grew by 24% CAGR over FY07-12). CRISIL Research believes NBFCs such as Magma score over banks due to their wider reach, faster processing and inhouse collection/recovery infrastructure. Magma's loan book (including off-book assets) is estimated to grow at 30% CAGR from Rs 120 bn in FY12 to Rs 205 bn in FY14. The grade also considers the expected increase in average yields from 15.1% in FY12 to 16.7% in FY14 driven by the increase in share of high-yield products in the loan book and booking of income on assets securitised in FY12. Also, Magma's in-house collection/recovery infrastructure has helped it improve its asset quality and reduce bad debt write-offs (as a percentage of loan assets) from 0.66% in FY08 to 0.2% in FY12.

The stiff competition that Magma faces from other NBFC peers, who have a larger presence, constrains our grade. Specifically, NBFCs belonging to conglomerates and deriving synergies with group companies hold marginal competitive advantage over Magma. Magma's return on assets (RoA) is lower compared to that of its peers because of its relatively low-yielding loan book and high borrowing costs. Un-seasoned, fast growing loan book, increased focus on high-yield, high-risk products and a weak economic environment may affect Magma's asset quality leading to higher write-offs over the next two years. Given the dynamic regulatory environment, any change in regulation may adversely affect the business models of NBFCs such as Magma. Magma's ability to securitise its assets in the face of new regulations will be a key monitorable.

Financial outlook
Magma's FY12 net profit was impacted following its transition to a conservative accounting policy for booking of securitisation income. CRISIL Research expects operating income to increase to Rs 9,453 mn at 47% CAGR over FY12-14 with loan book posting 30% CAGR and an increase in portfolio yield over the same period. Net profit will grow faster at 67% CAGR over FY12-14 to Rs 2,067 mn as operating leverage kicks in and on account of a low base in FY12. RoA is expected to improve to 1.6% in FY14.

Valuation (the current market price has strong upside)
CRISIL Research has used the price-to-book (P/B) method to value Magma. We have assigned a P/B multiple of 1.2x FY14E book value per share of Rs 75 to arrive at a fair value of Rs 90 per share. Our assigned multiple is higher than the median multiple of 1.1x enjoyed by Magma over FY03-12. We believe an increase in the company's scale and the expected expansion in RoEs justify the expansion in multiple.

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