J M FINANCIAL Rs 140
Valuation of non-cash generating assets like art, gold, unrented real estate, vintage cars, crypto etc depends mainly on the push and pull between demand and supply which in turn is driven by but not limited to factors like risk-on-risk-off, interest rates, fashion, taste, perception etc. You buy any of these assets because consciously or unconsciously you feel they will get more valuable in the future due to one or more of the reasons given above. Perhaps a great artist passes away and now there is only a limited supply of his art thus creating scarcity which drives prices up or a war breaks out somewhere in the world and gold demand rises due to risk off behaviour or interest rates are expected to fall making the cost of holding lower thereby increasing prices of real estate…so on and so forth.
Valuation of cash generating assets like debt, equities, perpetually leased assets etc is also influenced by the above factors but ‘present value of conservatively estimated future free cash flows using a suitable risk adjusted discount rate’ is perhaps the most widely used and the most logical metric for calculating their intrinsic value. Free Cash Flows (FCF) are the funds left with the company after meeting all the revenue expenses and setting aside money to be used in capital expenditure for growth of the business. This FCF belongs to shareholders to use in distribution of dividends or buybacks or undertake new ventures etc.
If the management of the company distributes the FCF to its shareholders, they get their anticipated return (which is equal to the discount rate). And if the company undertakes a new venture, then the return to the investors, hinges on what the new venture generates. If the new venture earns good money, the return gets enhanced and if the new venture makes sub-par profits, the returns are compromised.
Having set the above lengthy context, let us turn our attention to a very old and trusted name in investment banking – J M Financial Ltd (JM). As old timers would know, JM led by Mr Nimesh Kampani was the leading deal maker in India. Even now, after Mr Nimesh Kampani’s retirement in 2016, JM has 50% share of large deals done in the country. This business of deal making is very profitable and best of all, it requires very little capital expenditure to grow. It spews loads of money, requiring very little to be ploughed back.
This is where JM’s story took a turn. Instead of distributing the huge FCF that its IB arm was spewing, management decided to venture into newer areas of lending (retail & wholesale) and ARC to improve shareholders returns. As luck would have it, wholesale lending and ARC incurred huge losses and profits of the company plummeted from 992 Cr in FY22 to a paltry 31 Cr in FY24. Intelligent managements take cognizance of their mistakes and correct them. This is what JM did. In May 2024, the company decided to wind down its wholesale lending and ARC arms to focus only on three verticals – Investment Banking (IB), core areas of Asset, Wealth, Securities (AWS) and retail lending. The declaration of intent in the right direction had an instant effect on its stock price which almost doubled from Rs 75 levels in May 2024 to around Rs 140 in Dec 2024.
IB is the mother vertical in JM. The cash it generates is mother’s milk for growth of other verticals. To illustrate, in FY2024, IB generated EBIT of 911 Cr out of 941 Cr the entire company posted before exceptional items. With buoyant equity markets and increasing traction in high value deals, this vertical is anticipated to grow at high rates which makes JM an interesting investment candidate.
At PE of 22 and loss making divisions discontinued, JM should be a screaming buy now, right? Well, it could be, but there is one niggle left. JM is continuing with its retail lending vertical, in fact it is planning to grow it aggressively. As per Q2FY25 concall, management expects the retail lending portfolio to touch 3000 Cr by FY25 end and thereafter grow at 25-30% without taking on more debt. Growth in lending portfolio without taking debt means, this vertical will have to take funds from the mother vertical. At 30% growth, the appetite of this vertical for funds is as large as what IB generates which means that there will be little FCF left to distribute to the shareholders. Success of the retail lending vertical thus becomes critical to success of the company. However, unlike IB, where JM is the leader, retail lending is a highly competitive, bad debt prone business and JM is nowhere in the leaderboard even.
This infuses shades of grey in an otherwise white and bright canvas that JM looked to become after doing the May 2024 pivot. Time only will tell whether JM is able to increase shareholders wealth or it has to rethink its strategy once again. Patient and risk taking investors can consider JM. Others may need more time to see how the retail lending vertical performs.