We initiate coverage on Aditya Birla Capital (ABCL) with ADD rating and SoTP-based FV of Rs 145.
Brighter times ahead. We believe that Aditya Birla Capital’s focus on profitability improvement across businesses through a combination of shifting to high-margin segments, expense management and improving operating leverage supports its valuations. A favourable credit cycle, strong banking partnerships, exploration of group synergies and benign funding cost provide tailwinds. Initiate with ADD; FV of Rs 145.
We initiate coverage on Aditya Birla Capital (ABCL) with ADD rating and SoTP-based FV of Rs 145. While ABCL’s asset management business continues to deliver strong performance, turnaround in the lending business will drive value; this will be complemented by improving VNB margin in life insurance and expected breakeven in the health business.
We expect ABCL’s lending businesses to generate 14% medium-term RoE from about 8-10% in FY2020, largely supported by mix-driven rise in margins. The housing business will shift focus to higher-yielding affordable housing, while NBFCs will focus on retail and SME loans, a shift from large and mid-corporate lending. These NBFCs will have a tightrope walk delivering growth in some of the crowded customer/product segments, with a firm handle on cost ratios and credit quality. Even as relatively low seasoning of retail and affordable housing loans poses overhang, an improving corporate credit cycle provides upside as well. A strong parentage as well as the associated capital (debt/equity) backstop is a strategic cross-cycle advantage.
A diversified product bouquet and channel mix, underpinned by HDFC Bank’s strong franchise (~45% of individual APE) will drive market share gains for Aditya Birla Sun Life Insurance. Rising share of high-margin protection and improving operating leverage will likely support post-overrun VNB margin expansion to ~16% by FY2024E from ~10% in FY2021E and ~7% in FY2019; this will drive operating RoEV to mid-teens (~15% by FY2024E from 12-13% levels in FY2020-21E).
Aditya Birla Sun Life Asset Management is well-placed to deliver strong (18%) growth in core earnings during FY2021-24E supported by similar growth in equity AAUM CAGR and improvement in operating leverage, driving up core PBT ratio by 4 bps to 26 bps in FY2024E. Its fund performance, diversified distribution mix and focus on business expansion in smaller cities will support MF AAUM growth.
Key risks to ABCL’s businesses include the following. Unseasoned loan books in NBFCs/HFCs high-growth segments poses asset quality risks. Any likely debt recast at Vodafone may pose risk to credit rating of ABCL and its NBFCs. The AMC business is exposed to industry headwinds, viz. rise in passives due to investor focus on IRR and likely rise in distributor payouts. VNB margin expansion in the life insurance business is predicated on strong volumes and protection growth; while the former is vulnerable to HDFC Bank’s ecosystem, the latter has recently seen some signs of slowdown.