AEON Credit is scheduled to release its 2QFY13 results tomorrow. We foresee no major surprises and expect its 1HFY13 net profit to be largely in line with our full-year forecast for RM126.5m. As we expect better consumer sentiment to spur improvements across all loan segments, we are revising higher our FY13-FY14 netprofit forecasts by 5.6% and 6.5% respectively. We are also keeping an eye on its asset quality, although it remains fairly resilient. Maintain NEUTRAL, with FVraised to RM11.47 from RM10.70, based on a 11x forward 12-month EPS.
Lifting forecasts. We are raising our net profit forecasts by 5.6% and 6.5% for FY13 and FY14 respectively due to: i) expectations that increased fee income will offset the expected marginal NIMs compression, and ii) reviving consumer sentiment, which will drive growth across all loan segments.
Asset management improving. As we stated in our previous update, AEON Credit's asset quality is resilient, thanks to prudent risk management as well as the lower concentration risk emanating from the company's smaller average loan size. Our forecast for the company's full-year non-performing loans (NPLs) ratio is 1.8%. However, with about 1.8% of its FY12 receivables being renegotiated or restructured loans, we believe that it is prudent to closely monitor the potential relapse rate of its restructured portfolio especially in periods of economic uncertainty. Assuming a 100% relapse rate, the total NPL ratio for FY12 would have come in at 3.6%. We remain vigilant on this but would like to point out that the company's loan loss coverage is more than sufficient to cover even a hypothetical 100% NPL relapse rate on its restructured loan portfolio. Furthermore, we expect its asset quality to show continuous improvement moving forward.
Fee income to cushion shrinking NIMs. We think there will be some compression in net interest margins (NIMs) due to increasing competition from bank-backed and other micro-financing institutions. However, we believe that there may be potential upside in fee income, which will mitigate any downward pressure in NIMs. This will give AEON Credit some breathing space to diversify its income base.
Maintain NEUTRAL. We are pegging our FV of RM11.47 at a 11x forward 12-month EPS (previously at 10x forward EPS). Our forward PER assumption is based on a discount on the 17.1x forward PER of its parent company, Aeon Credit Service Co Ltd. Accordingly, our FV moves up to RM11.47 from RM10.70 previously. Note that this FV is ex-bonus. We will continue to monitor AEON Credit's asset quality and sustainability versus its loans growth.
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CLOSER SCRUTINY ON ASSET MANAGEMENT
Asset management generally improving. As we stated in our previous update on AEON Credit, the company's asset quality management has been improving owing to prudent risk management and a lower concentration risk emanating from the company's smaller loan sizes. Customers with loans approved by AEON Credit are deemed to have ample credit discipline under the company's credit scoring review. Its non-performing loans (NPLs) ratio translates into a full year forecast of 1.8%, which was computed based on the AEON Credit's credit risk portfolio.
So what is the actual NPL ratio? We note that a portion of AEON Credit's receivables are renegotiated, and these amounted to RM23.1m and RM27.5m for FY11 and FY12 respectively. These loans were restructured by way of extension of payment duration, modification or payment deferral. Although these loans are not technically delinquent, they were likely to have become non-performing had they not been renegotiated. These renegotiated loans account for 1.8%-2.2% of the group's total receivables. Moreover, given that small-scale lenders like AEON Credit typically have a higher proportion of non-collateralized lending in their loan portfolios, their NPL risk could heighten during economic downturns. Assuming a 100% relapse ratio on the renegotiated receivables, the company's total impairment loss ratios for FY11 and FY12 would have come in
at 3.9% and 3.6% respectively. Despite its rising NPL ratios taking into account these renegotiated loans, we note that there has been overall improvements, as seen in the 300bps decline in the ratio in the past two financial years. We will continue to monitor the company's NPLs, especially those relating to non-collateralized personal financing receivables.
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Loan loss coverage still healthy. Also, we note that AEON Credit has been consistently allocating healthy pre-emptive allowances for doubtful debts, with its current loans loss coverage at ~190%. Even taking into account a 100% NPL relapse rate on the portion of receivables under renegotiation or restructuring status, loan loss coverage would remain within the high ~105% level. Due to its prudent risk management, the company has been consistently recovering increasing amounts of bad debts since FY08. We expect management to maintain this level of loan loss coverage moving forward.
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Gearing and RWCR likely to stay at current levels. We note that AEON Credit's gearing ratio inched up by almost 300bps to 3.23x in FY12, although it was still within management's policy of maintaining a debt-to-equity (D/E) ratio of between 3.0x and 5.0x. Despite the aggressive loans growth, we think that the gearing ratio is likely to be maintained at the current ~3.3x level given the strong upside in profits, and the fact that AEON Credit can afford to lower its 37% dividend payout to channel more into retained earnings. However, we remain cautious on the gearing ratio as it is on a high side compared to some of its peers, namely RCE Capital's 0.89x and MBf Holdings' 1.15x, according to their last reported financials tracked by Bloomberg.
Based on the same forecast, AEON Credit's risk-weighted capital ratio (RWCR) is also likely to be maintained at the current ~23%, at least in the near- to mid-term, but may face a downward pressure towards the 16% capital adequacy ratio required by regulations after FY15.
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PROFITABILITY UPSIDE
LT borrowings still the focus but funding costs remain affordable. Management's strategy is to maintain a high long-term (LT) borrowing ratio of >70%. Given that the company's LT borrowings ratio went up to as high as 83.2% in 1QFY13 (vs 79.3% in FY12), we believe that AEON Credit is likely to maintain a LT debt ratio of above 78%, funded mainly via the issuance of term loans and medium-term notes (MTN). Moreover, this move will benefit from any potential upside in longer term yield. We maintain our cost of funding forecasts for FY13 and FY14 at around a slightly higher 4.3%.
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Competition crimps NIMs but cushioned by fee income. We foresee compression in NIMs due to increasing competition from bank-backed institutions in credit cards and micro-financing to small and medium enterprises (SMEs), as well as an uptick in funding costs. However, we think there could be potential upside in fee income to mitigate any downward pressure on NIMs, which will be positive for AEON Credit in diversifying its income base.
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Reviving consumer sentiment to fuel earnings growth. We foresee better q-o-q growth in all segments for 2QFY13 due to reviving consumer sentiment. We also expect personal financing to continue to grow aggressively due to its low base in FY10, as well as upside from i) used car financing (MEP), if AEON Credit successfully leverages on its network of >900 dealers partnership (out of a total of 5,000 dealers nationwide), ii) general easy payment (GEP), depending on the response of the small businesses to the niche, small-ticket loans for the purchase of equipment and machinery, and iii) slight upside in credit cards segment as its platinum credit cards are only expected to be rolled out by 2HFY13. However, we think the company should ride on the improvement in value of industry-wide purchases by credit cards in Malaysia, which has risen from RM42.8m in 1HFY11 to RM45.6m in 1HFY12, according to BNM figures.
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VALUATIONS REVISION
Lifting net profit estimates. We are revising upward our net profit forecasts by 5.6% and 6.5% for FY13 and FY14 respectively. This is premised on: i) a higher forecast for AEON Credit's fee income, which will offset the expected marginal dip in NIMs, and ii) improving consumer sentiment, which will propel growth in all loan segments. Our interest coverage is expected to be consistent with FY12's ratio of 4.0x, while those for FY13 and FY14 are forecast at 3.8x and 3.9x respectively. We also see higher depreciation charges of RM11m-RM13m in view of the higher value of fixed assets attained in FY11 and FY12 totaling RM12m.
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Valuation at current price. AEON Credit is currently trading at 12.2x FY13 earnings and 3.6x FY13 PBV. The stock has appreciated by some 350.4% since its listing in 2007, outperforming its parent and sister companies listed in Japan, Thailand and Hong Kong. We believe that it is the best performing stock among the four due to its earnings growth consistency as well as superior ROE and ROA.
Maintain NEUTRAL. We believe there is more upside potential given the company's superior earnings growth, ROE and ROA compared to its parent and sister companies. As such, we are pegging our FV of RM11.47 at a marginally higher 11x forward 12-month EPS (previously 10x). Our assumptions are based on the 17.1x FY13f PER of parent company Aeon Credit Service Co Ltd, with a discount on loss of control (DLOC). We will continue to monitor AEON Credit's asset quality and sustainability against its loans growth.
Dividend payout forecasts stays at ~37%. Management has reaffirmed its minimum 30% dividend payout policy. As we believe AEON Credit may possibly provide surprises on our earnings estimates, we believe there is less likelihood of it compromising on its dividend policy in the near term. We maintain our forecasts for a dividend payout of 37%, which is consistent with the company's historical net payout ratios.