JM Financial and Edelweiss: in the right trajectory

I remember studying JM financials a while back and only a week ago, took up Edelweiss. As I started reading, I realised that both of them are dealing with very similar situations and are using the same template to tackle the issue. That is why, I decided to take up both of these companies in the same blog and discuss the thesis for both. So lets begin with the business overview for both, followed by the thesis and anti thesis.

JM Financial

JM Financial is a financial services business which has multiple business verticals such as Investment banking and asset management, mortgage lending ( retail and wholesale), ARC (Asset reconstruction company) and finally, Syndication and AIF.

JM Financial was established in 1973 by Nimesh Kampani and has a rich history as a business house. It has been credited for bringing the first 100 cr IPO and the first billion dollar IPO for the Indian markets. It is the leading player in IPOs and QIP and has a very strong brand image.

Despite of such a rich history and strong tailwinds in the capital markets (which is their main business), JM financial has struggled to create value for its shareholders for the past decade.

Why?

Misallocation of Capital.

To understand the problems better, lets understand the whole business starting with its business structure and business segments and their dynamics.

Business structure

Damn confusing right? I was confused too. I will explain their business verticals with respect to the important subsidiaries to make the business very simple to understand.

Business verticals

Capital markets and advisory

This segment is the core of the business. It is where they have a strong command of the market and have performed well. The capital markets and advisory segments consist of Investment banking and capital advisory. This business segment comes under JM Financial Limited (the main company.) Investment banking is highly susceptible to liquidity which can be very cyclical and hence, this vertical too is quite cyclical. However, there is strong liquidity and the company sees many opportunities ahead. As India moves towards financialisation, IPOs and such funding activities will be common and businesses like JM financials are expected to thrive. Their services include Investment banking, PMS, institutional equity etc.

Wealth and Asset management

Another industry with strong tailwinds, JM Financials is focusing heavily on this segment and the results are visible. The AUM has jumped from 36,450 crores to 45000 crores in 2 quarters and the revenue is expected to grow at 30%+ CAGR. Leveraging their relations due to investment banking, JM has multiple advantages to keep growing at a faster rate. The Wealth management and PMS come under JM Financial Limited while the Mutual fund business comes under JM Financial Asset Management Limited. 

JM has been quite successful in building wealth management which was long neglected until three years ago. They have doubled the sales force in two years and have launched BlinkX to help compete with the digital players. 

Wealth management as a vertical goes really well with Investment banking as the cross-selling opportunities are many. Such an opportunity that JM is bullish on is MTF and such short-term loans to promoters as the yields are very lucrative and they are short-term in nature. The management is guiding us to grow at 25% here.

Mutual funds is a business that they are building on. In MFs, businesses need scale to break even as the bps share taken is very low. JM Financial expects this divison to break even by FY27. It has seen a good ramp up in the AUM in the past 2 years and a strong growth is likely to continue as the base is very small.

Mortgage lending

Mortgage lending has two business verticals and they come under JM credit solutions JM Financial Home Loans Limited.

Retail lending

Retail lending is a strong suit for their NBFC business. It primarily consists of home loans and has been growing its AUM rapidly. They are guiding for an AUM of 6000 crores by FY27. Moreover, the loan book is well diversified and granular, which prevents balance sheet erosion. The GNPAs and NNPAs have come up vs FY24, but we all know that the industry cycle is not company-specific. JM is a very conservative lender and has maintained reasonable provisions when needed. We can expect the business to continue growing at 35%+ and increase its ROE to 13-15% as the environment improves and JM deploys more of their cash.

Wholesale lending

Wholesale lending is the other side of mortgage lending, which has historically been problematic. Wholesale lending has faced multiple asset impairments, which has led to huge losses owing to high provisions. Moreover, the cost of funds is higher here than retail, which makes the expected returns higher (forcing the management to take riskier bets.) Adding this to the fact that competitiveness is increasing, leading to reduced yields, more robust regulations and grey areas in land finance (a big part of their loan book), giving an edge to AIF, JM Financial decided to wind down this business vertical in Q4FY24 and instead focus on syndication (distribution of the loan and making fees instead of taking it on their balance sheet). Due to this step, JM Financial is expected to generate 2500 crores cash+ by FY26.

ARC

Asset reconstruction companies are basically taking NPA like assets at a discount and recovering them. The nature of the business makes it quite risky but very profitable sometimes. However, JM financial has faced problems here and had to take substantial provisions in the past. JM Financial made the decision to pivot this business to an off balance sheet distribution model as it just made more sense and reduces the risks.

As the AUM winds down here, JM expects to generate significant cash flows here as well. We will get into the details of this soon. By FY26 end, the company as a whole should have 6500 crores of free cash or so!

Syndication and AIFs

Syndication is a new emerging business vertical on which the company is working. Basically, instead of loaning out the money themselves, it will involve multiple lenders, and they will earn a commission/fee instead of interest. However, Syndication does not mean completely off the balance sheet as JM will also participate in these loans, but the quantum of loans in their balance sheet will go down dramatically. Moreover, AIFs are better positioned to do land financing and other things that NBFCs used to do. Due to this, using AIFs as a strategy instead of NBFCs makes more sense, and hence, JM will leverage their existing skills and experience to take advantage of it. These are emerging businesses, and we will see their operations in the coming quarters.

Consol revenue

Now that the stage is set, lets briefly look into Edelweiss and discuss the thesis for both of them together.

Edelweiss financial services

Edelweiss too is a reputed business with a ruch history. Edelweiss has multiple business segments, so lets get to them.

You will notice that they do not have a investment banking and wealth management business that JM has and that is because they demerged that business some time ago and it is listed as Nuvama which has created tremendous wealth for shareholders ( a template that Edelweiss aims to use multiple times now)

Business verticals

The management in their latest concall did really well in explaining the business verticals by categorising them into blocks. We will use the same idea.

Asset management

Asset management has two business verticals: Alternate asset management (EAAA) and mutual funds. Their MF is a very well-established business and is the third biggest AMC. Currently, they are focusing on increasing their Equity AUM part to 60% of the total AUM. Currently, the MF AUM stands at 1,40,500 crores, which is up 23% YoY, and Equity AUM is at 60,000 crores, which is up 73% YoY. Currently, the cost to income stands at about 85% or so, which is relatively high, but the reason is that they continue to invest heavily in the business as they see a lot of growth coming in. In the long run, they aim to maintain the cost to income of the industry average, which is about 55%. As they reach the industry average, 15-20 basis points of revenue from AUM is possible anf very achievable.

Lets understand EAAA a bit better.

Alternate asset management businesses have two categories to operate in (according to management) which are yields and income strategies and private equity. Edelweiss is currently focused on the former and has built a strong leadership there. The basis points of AUM revenue is between 65-80 basis points and they make 75 basis points of AUM as revenue. That is quite lucrative.

Out of all the business verticals, Asset management is th strongest and according to the management, is ready to be IPOed if they decide to go down the path.

Insurance

This business consists of General insuance and Life insuance. Both are emerging businesses and loss making at the moment (the losses are narrowing though) Edelweiss has collectively invested 4000 crores in these two businesses, with 2800(1200 by Edelweiss and 1600 by Tokyo marine) crores going to Life insurance and the balance going to general insurance. The business aims to break even by FY27 as the AUM expands.

Credit

In Credit, they have three businesses: NBFC, ARC and Nido housing finance.

Like JM, Edelweiss aims to focus on housing finance and wind down the other two verticals which have been poor capital allocation decisions. ARC has been hit with a few RBI restrictions, where they are not allowed to acquire new assets but can continue with recovery. That is honestly fine as the aim is to free up cash from this business and become asset light here.

Thesis

Its very interesting how both follow almost the exact same thesis.

Cash generation

As JM Financial winds down its NBFC businesses, such as wholesale mortgage and ARC, JM Financial will generate surplus cash. NBFCs hold a 3000 cash surplus and generate 2000 crores as the books wind down. By FY27, the business is expected to have a free cash surplus of 6200 crores. Such a strong cash generation will allow them to invest in superior businesses such as bespoke finances (loaning to promoters), lending against shares, etc. Moreover, they aim to invest 200 crores yearly in wealth and asset management businesses. Such businesses, too, are cash-throwing and have upfront costs with operating leverage in the future. We can expect good dividends to be rolled out by the company. (NBFCs have a 50% limit for dividends, but the promoters said they will be sending a request to RBI)

JM Financials, using this cash, also aims to become debt-free in the next three years. Management says that both NBFCs will be net debt to equity-free. They will be holding cash and no leverage. 

Similarly, for Edelweiss, Edelweiss is expected to sell some of its stake in EA (about 15-20%), which will give them decent amounts of cash to repay debt. Moreover, the winding down of ARC and wholesale will free up a lot of cash, which will also help reduce corporate-level debt, which they have been doing at a good pace. Like with Asset Management, EA also throws a lot of cash, which will help with debt reduction. Edelweiss, too, aims to continuously invest in its insurance business and ramp up its home finance lending, as most of the cash is lying idle there. They will also be selling the rest of the Nuvama stake, which will be used to bring down debt.

As you can see, cash generation as a thesis leads to multiple other theses. It creates multiple optionalities that can be leveraged to create great wealth.

Value unlocking

As we witnessed, both the businesses have a relatively complicated business structure which leads to problems such as discounting of the whole company. To tackle this, Edelweiss already demerged nuvama successfully and we are all aware of the success it created. They aim to do the same with their other business verticals with the latest one being EAAA which should be decided in the next two to three quarters. The decision will be between private sale or IPO.

Post a few quarters of EAAA, Mutual funds will be the business division in contention that could see its own IPO. Such opportunities can create a lot of wealth for Edelweiss shareholders.

JM aims to do the same in the future. It has succesfully seperated all the business divions and started giving their employees the ESOPs of that particular business. Demerging and IPOing is a optionality that stays for JM in the future.

P/B to P/E

As leverage goes down and the business revenue becoming recurring from interest to fees, we can expect JM financials to be start getting valued at PE multiples rather than PB multiples. This is a very good progress as it shows that the book value can not erode so easily and the business is transforming into a wealth management business.

It might not be the same case for Edelweiss as they still will have a good chunk of lending, but that is fine as their strategy is spinning of successful businesses rather than keeping them under a single roof.

Anti thesis

Highly cyclical

JM owes a lot to its investment banking business, but it goes without saying that investment banking is extremely cyclical. It is currently in tailwinds but we can not be sure of when the tide turns, if that does happen; the cash generation slows down and all the triggers get delayed which can hamper returns. And yes, wealth management and lending too are quite cyclical.

Edelweiss, although does not have investment banking too is quite cyclical due to EAAA and lending and hence one must be careful while investing.

I am not that worried because there is enough margin of safety in terms of valuations for both.

Repeating the same mistakes

The value we see right now is becayse of the mistakes made in the past. Mainly, capital misallocation. Although both the managements are extremely capable and experienced, we must keep track of if the strategic initiatives are being followed or not.

Cash generation slowdown

The two anti thesis above will lead to slower cash generation and hence, the debt reduction and investments might be delayed. Due to this, the business balance sheet will stay deteroirated and weak. Cash generation is the crux of both the thesis and hence that has to be key and carefully tracked.

This marks the end of the blog, I hope there was much to learn and understand here. Thank you!