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The stock price of Piramal Enterprises has cracked in the last 2 weeks. The name of Piramal Enterprises is now taken in the same breath as that of DHFL, Reliance Capital, Yes Bank, Indiabulls Housing Finance and other wealth destroyers.

If you are an investor in Piramal Enterprises, what should you do with your holding?
And even if you are not a Piramal shareholder, this article could provide an interesting perspective on investing and business valuations.

Let us directly jump into the valuations and get our hands dirty 

Sum of Parts Valuation of Piramal Enterprises
Piramal Enterprises comprises of four parts

1. Pharma Division
2. Healthcare Analytics and Insights Division
3. Stake in Shriram Group
4. Lending business

Valuation of the Pharma Business
Let us look at the valuation at which the peers of Piramal Enterprises (pharma business) trade at

* EV = Enterprise Value
* EBIT = Earnings Before Interest and Tax

Piramal’s pharma business comprises of complex branded generics and contract manufacturing for global pharma companies. All the manufacturing plants are based out of Europe. We can safely assume that Piramal should trade at similar valuations ie an EV/EBIT =22

For Piramal (Pharma division)
EBIDTA (2019) = Rs 1100 Cr
Depreciation = Rs 380 Cr
Thus, EBIT = Rs 720 Cr

Debt attributable to the pharma business are approximately Rs 4,500 Cr. We get this data from the conference call of Q4FY19

Debt in pharma business = Rs 4,500
Reverse calculated EV = 720*22 = Rs 15,800 Cr
Thus, we can assume that if the pharma business gets separately listed, the market will give a valuation of
Piramal (pharma division) market-cap = Rs 11,300 Cr

 Stake held in Shriram Group
As of 31.03.2019, Piramal Enterprises held

• 20% stake on Shriram Capital (unlisted)
• 10% stake in Shriram Transport Finance (22.6 Mn shares)
• 10% stake in Shriram City Union (6.58 Mn shares)

Let us calculate the value of the Shriram stake held by Piramal Enterprises as of today

• Shriram Capital (unlisted) = Rs 2,150 Cr (at cost)
• Shriram Transport Finance = Rs 2,300 Cr (stake sold in Jun-19)
• Shriram City Union = Rs 850 Cr (at a share price of Rs 1325 per share)

Total stake in Shriram Group is worth about Rs 5,500 Cr.

Valuation of Healthcare and Analytics Division
Total Equity invested in healthcare analytics = Rs 1,300 Cr
(Estimated from the segment results and the fact that Rs 4,000 Cr debt is attributable to the DRG business)
Revenue for 2019 = Rs 1,330 Cr
This division is not performing too well and is probably loss-making.
Let us make a guess that if Piramal decided to sell this business tomorrow, Piramal will be able to recover around 50% of the equity invested in the business (this is just a wild guess)

Valuation of Healthcare business = Rs 700 Cr

Valuation of Lending business

Total Equity in lending business is Rs 12,000 Cr
Clearly, the trouble is in the lending business of Piramal Enterprises and the stock price has crashed because of the doubts surrounding the real estate loan book.

Stock price as on 10^th Oct-19 = Rs 1358
Market Cap = Rs 27,010

Sum of parts valuation of Piramal Enterprises

• Pharma Division = Rs 11,300 Cr
• Healthcare & Analytics = Rs 700 Cr
• Shriram Stake = Rs 5,500 Cr

Total of 3 divisions = Rs 17,500 Cr
Thus, the market is giving the lending business of Piramal Enterprises a valuation of
27,010 – 17,500 = Rs 9,500 Cr
This comes to P/B value of 9500/12000 = 0.8 times P/B

Let us look at which of the lending businesses are trading at such a cheap valuation

Thus, the market is valuing the lending business of Piramal Enterprises on par with public sector banks with gross NPA ratios of anywhere between 10% to 17%.

On the other hand, some of the well-managed private NBFCs and banks are trading at between 2 to 5 times book value eg HDFC Bank, Cholamandalam, Muthoot Finance, Manappuram Finance, AU Small Finance Bank etc.

So, it all boils down to how much trouble is the lending business of Piramal Enterprises is in?
It is widely known that liquidity in the market for NBFCs especially those who have an exposure to residential real estate developers has dried-up after the IL&FS default in Sep-18.

• Real estate has been stagnating since the year 2014.
• Inflation has been low – around 3% since 2014.
• Real Interest rates have been very high for a long-time now.
• Demonetization and implementation of RERA have considerably slackened the demand for real estate and the recent slowdown in the economy has dealt a mortal blow to many real estate developers and NBFC businesses.

Consequently, companies like DHFL, Reliance Home Finance, Altico Capital have defaulted on loans and several others are on the verge of collapse.

Even though Piramal would have taken enough security and cash cover from all the entities that it has lent to, the company can still go bankrupt once the lenders to Piramal pull out their money. This is exactly what happened with DHFL and Altico Capital. The gross NPA ratios of both the NBFC companies were well within control, but the banks that have lent to these NBFCs lost confidence in them and thus stopped lending to them. This resulted in asset-liability mismatch and both the companies went bankrupt.

Will Piramal Enterprises also go bankrupt?

One can only make an educated guess based on the data we have from various public sources like credit rating reports, annual reports, quarterly presentation, con call transcripts.

Let us look at some hard data. One very good source to read about a NBFC business is the credit rating reports.

Credit Rating report of Altico Capital (before default)
https://www.indiaratings.co.in/PressRelease?pressReleaseID=38482&title=India-Ratings-Downgrades-Altico-Capital-India-to-%E2%80%98IND-A%2B%E2%80%99%3B-Outlook-Negative

• 31% of the loan book is to real estate projects at the approval-stage (construction has not started)
• 70% of the loan book is under moratorium as on Jun-19 ie the borrowers have to only pay interest and principal repayment has not yet started.

Given that such a large part of the loan book was to approval-stage projects and most of the loans were in moratorium, the banks lost their faith in the ability of Altico Capital to recover their loans in time. Thus, the banks stopped lending additional funds to Altico and the company collapsed.

Credit Rating report of KKR India Financial Services
https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/KKR_India_Financial_Services_Limited_October_01_2019_RR.html

• 70% of the loan book is under moratorium
• Though gross NPAs are 2%, they are expected to substantially increase in the next few months

Credit Rating report of ECL Finance (Edelweiss group)
https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/ECL_Finance_Limited_October_04_2019_RR.html

• A “sizeable portion” of the wholesale book is currently under moratorium with bullet/staggered repayments
• Asset quality in the past has been supported by “active refinance market” especially for real estate.

What is the position of Piramal Enterprises?

Compared to the other troubled NBFCs, about 35% of the lending book of Piramal Enterprises is under moratorium – not a small number, but not too big either.
What does the credit rating report for Piramal tell us about its ability to resolve cases of stressed assets?
https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/Master%20Trust%202019%20Series%20I_September_27_2019_RR201909270606.html
Piramal Enterprises has demonstrated its ability to resolve loan cases with stress in one of the following ways

1. Bring in a strong developer to take over the project and the loan.
2. Initiate legal action to monetize additional security already provided by the borrower.
3. Providing extra loans so as to ensure completion of projects – comprehensive workaround.

Thus, losses from defaulting or stressed assets have been minimal so far.

Is there a silver lining?

There is – though real estate sales have been very sluggish for the last several years, those projects which the customer is sure of getting completed are selling well. There are two reasons why projects don’t get completed on time

• Cash shortfall for the builder
  Piramal is typically the only lender to the real estate developer and if it makes sure that the project gets completed, the real estate will be able to sell and repay the loans to Piramal.

• Commercial real estate in doing very well – 23% of the Piramal loan book is for commercial real estate

Reading the quarterly presentation, con call transcripts and other documents, we realize that out of the total loan book of about Rs 56,000 Cr,

• only 48% is towards residential real estate.
• 90% of the residential real estate loan book is towards construction finance and
• 66% of the book is for late-stage projects – which are nearing completion.

Though the Indian economy is in a slow-down and the real estate is sluggish, the situation is far from desperate. Real estate has seen far worse days in 2009 and back in 1997 during the Asian currency crisis. (Check out this link about property price crash in 1997). If the construction of the real estate project is not hampered, the real estate developer is and will be able to sell the inventory at a reasonable price and repay the Piramal loans.

The latest press release on 10^th Oct-19 does have some interesting data points to ponder upon.
https://www.bseindia.com/xml-data/corpfiling/AttachLive/23c83562-8f57-45f4-8dad-7bac12111361.pdf

Piramal Enterprises has raised Rs 24,000 Crs of long-term loans from financial institutions in the last 1 year. All the lenders would have definitely done a rigorous due diligence on the underlying assets of Piramal with far more data than what we have access to.

Piramal has issued a pass-through certificate (PTC) in Sep-19. The structure of this PTC is very interesting and unique and is the subject of a separate article. The fact that there is demand for the PTC of Piramal Enterprises goes to show that the counter-parties are not dis-comfortable with the asset quality of the underlying loans.

Piramal Enterprises has been able to borrow additional Rs 3,000 Cr from public sector banks in Sep-19 which was one of the worst periods for raising additional debt capital.
Gross NPAs are still below 1%, but this is a metric we will be watching very closely.

So, what should I do with my Piramal holding?
In my opinion, the stock market is pricing the Piramal Enterprises stock for bankruptcy of the lending business. It is not distinguishing between the credit underwriting skills of a company like Altico Capital, KKR India and Piramal Enterprises. Unlike a DHFL, Reliance Home Finance

This is not a time to sell the stock in distress at severely depressed prices. Just assume that you have gone on a vacation to the snowclad mountains of Lahaul and Spiti in Himachal Pradesh and return after 6 months to bother about the stock market and your investments in Piramal Enterprises.

What could prove me wrong?

1. It is my assumption that the pharma and healthcare analytics are decent businesses with reasonably steady earnings predictability.
2. There is an uncontrollable rapid rise in the NPAs and stressed assets at Piramal Enterprises.
3. Piramal is not able to raise long-term debt funds in time from banks and institutions.

Is the price low enough for me to buy into the stock?
A lending business depends on the mercy of strangers (banks in case of Piramal) lending it money especially during crisis periods like what we are witnessing now. The business model is inherently risky. Though I am of the opinion that one need not sell their current holding in Piramal right now, I do not advocate buying into the Piramal stock at this price.

The problems and risks faced by Piramal Enterprises are largely out of the control of the management and we never know what will be the worse-case scenario. The intelligent investor is better-off trying to find some quality bargain businesses elsewhere. If one searched hard enough, one can find some good investment opportunities in this bear market.
One such example is
https://candorinvesting.com/2019/09/04/stocks-for-the-bear-market-cyclical-play-ashok-leyland/

Disclaimer:

Please do not consider this article as a stock recommendation. The article is an illustration of the kind of analysis that goes into fundamental research and equity investing. I continue to hold shares in Piramal Enterprises.
Please seek advice from your investment advisor before making any investment decisions.
The author (@amey153) is a SEBI registered Investment Advisor.

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