KEY INVESTMENT HIGHLIGHTS

• Gross financing growth has been impressive. However, it resulted in higher impairment loan provisions which dragged earnings down

• Collection rate remains high and sustainable, leading to relatively low NPLs

• Good margins despite not being able to take in deposits

• No change to forecast

• Maintain NEUTRAL for now with potential for upward rerating. Unchanged TP of RM15.60

Key takeaways. We met with the management of Aeon Credit Service (M) Bhd (ACSM) recently. Below are the key takeaway from our visit:

• Impressive growth in its gross financing receivables

• The strong growth in gross financing receivables had led to high net credit cost

• Collection rate remains high and stable Non Performing Loans (NPLs)

• Competitive cost of funds despite not collecting deposits, leading to attractive margins

• Laying groundworks for sustainable growth

Impressive gross financing receivables growth. One fact that struck us was the continued strong growth of its gross financing receivables. This was especially noteworthy given the recent slowdown in loans demand. It has maintained a double digit growth since at least FY13 and came in at +21.5%yoy to RM9.6b as at 2QFY20. Major driver for the growth was personal financing (+31.6%yoy to RM2.6b), motorcycle financing (+27.4%yoy to RM3.0b) and auto financing (+15.0%yoy to RM2.8b). The majority of the motorcycle financing were for 100cc to 150cc motorcycles while auto financing were for the used car segment.

Not specifically targeting low income group but it is a major segment contributor. Majority of ACSM’s customers are from the low income group (B40) with circa 68% coming from this segment. However, the management indicated that its strategy is not specifically to target a certain group segment but providing support to its customers’ income life cycle. For example, offering financing for consumer durable products for recently graduated employees, moving to vehicle financing as the customer progresses in its career, and then to personal financing and credit cards. The management believes that this strategy ensures sustainable growth in its financing receivables. We understand that the appeal to its customers is the speed of approvals rather than the interest rates which by our research, are not the most competitive in the market.

High collection ratio and it looks sustainable. Our initial concern was that its foremost customers group will increase the risk of delinquency rate rising. However, we noticed that collection ratio have been consistently high despite ACSM’s customer profile. Current collection ratio (i.e. not past due) has been maintained above 97% for the past three and half financial years. Meanwhile D1 collection ratio (past due 1 month) and D2 collection ratio (past due 2-3 month) have been maintained at above 80% and 70% respectively. Counter intuitively, with a majority customer profile from the B40 income group meant that its delinquency rate remains low. This due to the fact that this group is likely not to be overleveraged. Additionally, ACSM’s exposure are not concentrated to a particular sector and the average receivable size of circa RM11,000. Hence, we believe that this collection ratio could be sustained.

But through high number of personnel. One of the reasons for the high collection ratio is its proactive strategy. For example, we understand that ACSM proactively call its customers for collection. The drawback for this strategy is the requirement of large number of manpower. Approximately half of its workforce is for collection management. For 1HFY20, personnel cost grew +10.8%yoy to RM118.7m and accounted for 13.9% of total income. In our opinion, personnel cost will continue to grow in line with the growth of receivables. However, this could be mitigated with the adoption of technology to assist in the collection management. We understand that ACSM will roll out a semi-automated collection system which will improve efficiency.

Surprising relatively low NPLs. The consequence of a high collection ratio was a relatively stable non-performing loans (NPL). The NPL ratio as at 2QFY20 was 2.0%, slightly up from 1.92% as at the previous quarter. Nevertheless, in general it had trended downwards from as 2.74% as at 1QFY17. This suggests that ACSM’s collection management have been very strong and effective. Again, at first glance, it seems counter intuitive that the NPLs were relatively low given ACSM’s customer profile. However, as stated above, the data shows that this customer group tends to have less delinquency.

Good margins despite not being able to take in deposits. We estimated that annualised net interest margin (revenue from interest income, profit revenue and finance charges minus interest expense over average gross receivables) for 1HFY20 to be 12.2%. This was slightly lower than the 12.3% we estimated for 1HFY19. In essence, margins appear to be good despite the funding for ACSM is through borrowings rather than deposits. We understand that ACSM is able to tap into borrowings from Japan resulting in low cost of fund. While this may suggest currency risk, ACSM borrowings are denominated in ringgit.

Not too keen on the upcoming virtual bank license. We understand that ACSM are adopting a “wait-and-see” approach to the virtual bank license which Bank Negara Malaysia will be releasing the guidelines this December. This is because it does not see any specific advantage given that its cost of fund is only slightly higher and comparable to traditional banks’ cost of fund. Besides, the compliance cost may moderate any potential benefit from the license.

High credit cost weighing down earnings. Our concern with ACSM is its high net credit cost which had weighed down its earnings in FY20 thus far. Net credit cost rose to 4.04% in 2QFY20 from 2.99% the previous quarter. In 4QFY19, prior to the adoption of MFRS9, its net credit cost was 2.16%. However, we were pleased that the increase in net credit cost was not due to any stress in its receivables. It was mostly due to higher impairment loss provisions as required under MFRS9, which was in line with the strong growth in receivables. Management indicated that circa 3% of the new receivables have to be provided. Going forward, management indicated that it may have to slow down its receivable growth to better manage the net credit cost.

No stress to asset quality as yet. The management noted that it does not yet see any stress in its asset quality. Based on past experience, it is confident that it will be able to weather any potential economic shocks due to its customer profile, provided employment are not severely affected. Furthermore, it believes that demand for personal financing from more affluent group could trend higher in such a situation, potentially fueling receivable growth. Nevertheless, the management indicated that it will not ease on its credit policy. We understand that the approval rate averaged around 30-40% suggesting conservatism.

Revised earnings forecast downwards. We make no changes to our forecast.

Valuation and recommendation. We are impressed with ACSM’s asset growth and quality especially given its customer profile. We noted that ACSM managed to maintain its strong revenue growth momentum. The strong growth in financing receivables suggests that there is still demand for its financial products. Our slight concern is that the fast growth increases the risk for higher NPLs in a significant economic slowdown, despite the historical experience showed otherwise. Nevertheless, we believe that there is a potential re-rating for the stock. The main re-rating catalyst would be the normalization and stabilization of its net credit cost. Hence, while we maintain our NEUTRAL call, we believe that any share price weakness presents a very good opportunity for investors to accumulate the stock. We maintain our TP of RM15.60 pegging ACSM's FY21 BVPS of RM7.60 to PBV of 2.1x (one standard deviation below of its 5 year average PB ratio).

Source: MIDF Research - 19 Nov 2019