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Why should investors consider IIFL Wealth despite volatile capital markets?

In the recent correction in the equity markets, IIFL Wealth’s stock has fallen to Rs 1,550 which is 7 percent lower than the Bain’s acquisition price

-IIFL Wealth enjoys strong market position, posted healthy earnings in FY22
-Business model has transformed for better, moved to an advisory model
-Focus on annual recurring revenue (ARR) is encouraging
-Profitability has improved
-Strong earnings visibility though linkage to capital markets can add to volatility
-Valuations attractive, only listed wealth player makes it a worthy bet in long term

In one of the largest deals in the wealth management space in India, Bain Capital — a leading global private equity player — has agreed to acquire a 24.98 percent equity stake in IIFL Wealth Management, the largest non-bank wealth manager. The existing PE investors General Atlantic (current holding 21 percent) and Fairfax Holdings owned by Canadian billionaire Prem Watsa (holds 14 percent) will divest 14.9 percent and 10 percent, respectively, in the company.

Bain will be acquiring the stake for around Rs 3,680 crore, which is Rs 1,666 per share. In the recent correction in the equity markets, IIFL Wealth’s stock has fallen to Rs 1,550 which is 7 percent lower than the Bain’s acquisition price. While this does offer a tactical investment opportunity, there are more reasons to add IIFL Wealth to the long-term portfolio.

IIFL Wealth (CMP: Rs 1,550; Mcap: Rs 13,755 crore) reported healthy earnings in FY22 with net profit rising 58 percent year-on-year (YoY) on the back of a strong growth in assets and better retention rates (revenue earned / average AUM) even as expenses increased.

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Leading player

Founded in 2008, IIFL Wealth has catapulted itself to one of the largest private wealth management firms, offering a full suite of services to clients, including distribution, advisory, asset management, broking, and lending. Its leading market position is reflected in the total assets under advice — management and distribution of Rs 261,745 crore — as of end March, which increased 26 percent in FY22.

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Wealth management is the largest segment with AUA (assets under advice) of Rs 206,170 crore as of FY22 end. Under wealth management, the company has an advisory platform named “IIFL One” that offers investment solutions to UHNI under a transparent single-fee structure. In IIFL One, the company does not earn any commission from the manufacturer (the fund house) but earns a contracted fee from a client as a percentage of the AUM, depending on the mandate (discretionary/non-discretionary). IIFL One is the leading model within the industry with assets of Rs 32,724 crore in FY22. The advisory model best aligns the client’s interest to that of the wealth manager, leaving no motivation for relationship managers to push a particular product/offering with high commissions.

In the asset management business (AMC), IIFL has a total asset under management (AUM) of Rs 55,574 crore as of FY22 end. The primary focus is on alternative investments (AIF), which include private equity, structured credit, real estate, and portfolio management services (PMS). Mutual funds (MF) form a very small proportion of its total AUM. IIFL Wealth is among the largest managers of alternate investment funds (AIFs) in India, with an AUM of Rs 32,550 crore as of March end.

IIFL Wealth Prime, its wholly owned non-banking financial company (NBFC), had a loan book of Rs 4,151 crore as of March, mainly consisting of loans against securities. The NBFC largely supports the wealth management business by providing loans to clients as a temporary bridge for their liquidity requirements.

As on March 31, 2022, IIFL had around 167 relationship managers (RMs) and 60 team leaders.

Business transformation with focus on recurring revenue

In the past, IIFL Wealth’s profitability was impacted by a change in the revenue recognition model. SEBI’s decision to ban upfront commissions on the distribution of MFs and to cap the total expense ratio (TER), the fees that the fund house charges from investors every year to manage their money, adversely impacted revenues of IIFL Wealth as most fund houses passed the cut by reducing distributors’ commissions.

IIFL Wealth’s business model underwent transition following the big regulatory changes with revenues now recognised on a trail basis even for the PMS and the AIFs.

More encouraging has been the management’s strategy to focus on increasing the share of annual recurring revenue (ARR) as opposed to transaction/brokerage revenue. This has helped to reduce the volatility in revenue.

The recurring AUM share in the total AUM has increased from 40 percent in FY20 to 49 percent in FY21 and further improved to 55 percent in FY22.

Consequently, the share of ARR in the overall revenue improved to 65 percent in FY22 and the company is well on track of reaching levels of 80 percent by FY24.

Improved financial parameters

IIFL Wealth has seen an improvement in all the key financial metrics. Net inflows have increased and the overall retention rate (revenue earned/average AUM), which declined to 0.57 percent in FY21 from 0.74 percent in FY19 due to the transition in the business model, is showing signs of stabilising and has jumped back to 0.63 percent in FY22.

Consequently, the ROE (return on equity) improved from 7 percent in FY20 to 13 percent in FY21 and has touched 20 percent in FY22.

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Upbeat guidance

Going into FY23, the management expects an AUM growth of 17-20 percent, with ARR assets expected to grow faster at 25-30 percent YoY. The last fiscal (FY22) had seen higher retentions due to stronger transactional & other incomes. The management expects retention rate to normalise/reduce to 0.55 percent in FY23. The earnings in FY23 is likely to be supported by a better cost-to-income ratio, which is expected to improve to 45 percent in FY23 from over 50 percent in FY22.

While the management’s guidance is encouraging, investors should note that IIFL Wealth’s revenue is exposed to fluctuations in the capital markets and any regulatory changes.

View and valuation

Opportunities in wealth management is huge and likely to grow in sync with India’s economic growth and rising income/wealth levels in the economy.

The wealth space is mostly dominated by private banks. However,  the contribution of wealth business to these banks’ total profits remains minuscule. For instance, Kotak Mahindra Bank is the largest wealth manager in the country, but the giant share of its profits (more than 60 percent) is contributed by the banking operations. Hence, the best way to play the wealth space is through pure-play wealth managers such as  IIFL Wealth.

We see IIFL Wealth’s business to be on a sustained growth path, driven by rising millionaires and billionaires seeking wealth advice. Earnings are likely to be strong in the near to medium term, which, along with the valuation re-rating, will drive the stock upside.

At the current market price of Rs 1,550, IIFL Wealth is trading at 16 times FY24 estimated earnings, which is attractive considering the improved business fundamentals and the good visibility of earnings growth. Long-term investors should buy the stock.

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