This article first appeared in Corporate, The Edge Malaysia Weekly, on June 27 - July 3, 2016.

AEON Credit Service (M) Bhd has been one of the best performers among the non-bank financial institutions (NBFIs) and banks, with its share price up 12.1% year to date versus Malaysian banks’ 0.9%. Analysts are becoming more bullish on the consumer finance company after it posted stronger-than-expected 4QFY2016 results, but is there any further upside?

According to data compiled by Bloomberg, three out of the five analysts tracking the stock rate it a “buy” while the other two give it a “hold” rating. After the 4QFY2016 results announcement, analysts have also adjusted their target prices and FY2017 earnings forecasts upwards on a lower credit cost assumption. AEON Credit carries a consensus one-year target price of RM15.28, which represents an upside potential of 14.9% from the current price.

To put things in perspective, AEON Credit’s shares have underperformed the banking sector in the past three years despite its consistent double-digit revenue growth since its listing in 2007. The stock had declined 21.5% in the past three years, compared with an 8.3% drop for Malaysian banks. While AEON Credit largely tracks the performance of the banking sector, its share price is more volatile than its heavyweight banking peers’.

In March last year, analysts turned more cautious on AEON Credit as they perceived the micro credit financing provider was particularly vulnerable to softer consumer sentiment after the ringgit plummeted for months. AEON Credit subsequently lost RM201.6 million or 10.5% of its market value from March to December 2015 as institutional investors reduced their exposure to the company.

Nonetheless, a year later, AEON Credit reported a commendable set of results that beat analysts’ expectations in April. For FY2016 ended 

Feb 29, 2016, its net profit rose 5.8% year on year to RM228.2 million on the back of a 10.7% increase in revenue. This was attributed to better bad debt recovery, which more than offset a 28.2% jump in allowance for impairment loss and an 18.9% increase in finance costs (see Chart 1).

Financing receivables grew 19.7% y-o-y to RM5.4 billion, thanks to the strong growth in car financing (+45.7% y-o-y), personal financing (+37.5%) and motorcycle easy payment (+11.2%). More importantly, AEON Credit managed to bring down its non-performing loan (NPL) ratio to 2.47% from 2.76% a year ago, allaying investor concerns about deteriorating asset quality.

Even adjusting for coupon payments on its 6.5% perpetual notes, AEON Credit’s FY2016 core net profit still improved by 2.3% to RM214.6 million, although markedly lower than the 19.6% earnings growth a year ago. Maintaining its historical dividend payout ratio of 37% to 38%, the company paid out a higher dividend of 59.45 sen for FY2016, translating into an above average yield of 4.5% (see Chart 2).

Due to the slowing loan growth and net interest margin compressions, AEON Credit’s return on equity (ROE) in FY2016 slowed to 22.6% from 26.9% in FY2015. Nonetheless, its ROE remains the highest among the NBFIs and banks (Public Bank Bhd’s ROE was 18.2%) as it enjoys a very lucrative net interest spread of 13%, which compensates for the higher risk that it takes compared with banks, by lending to lower-income consumers.

Despite its small asset size versus banks, AEON Credit is highly profitable, generating RM228.2 million on a loan book of just RM5.4 billion. In contrast, Affin Holdings Bhd generated RM369.3 million in net profit on a much bigger loan book of RM43.3 billion. The high loan yields also provide a strong buffer against credit costs, should the debt-servicing capabilities of its target segments become adversely impacted by unfavourable economic conditions. That said, the lack of access to customer deposits and the reliance on capital-raising to fund aggressive receivables growth could expose it to refinancing risk.

Against the overall macroeconomic headwinds and credit down cycle, AEON Credit has so far performed relatively well vis-à-vis its consumer finance peers in the country, in terms of both share price and financials. So, is the stock a “buy”?

AffinHwang Capital analyst Tan Ei Leen opines that AEON Credit remains an alternative stock to the banking sector, given its high ROE of 20% and attractive dividend yields of 4.8% to 6% for FY2016 to FY2018. Kenanga Research analyst Desmond Chong concurs, noting that loan demand for its small-mid ticket consumer-based financing services is relatively inelastic and resilient. He adds that AEON Credit’s decent asset quality with an NPL ratio of 2.5%, healthy capital ratio of 20% versus capital ratio requirement of 16% and undemanding forward price-to-earnings ratio are also reasons why he upgraded the stock to “buy”.

However, AllianceDBS Research analyst Lynette Cheng, who has a “hold” recommendation on the stock, remains cautious on AEON Credit’s outlook, given that its target market is in the lower income range. “While management does not expect a deterioration in asset quality, we continue to be cautious on its portfolio of customers as 70% of them earn less than RM3,000, which puts them in the vulnerable income group. As the cost of living rises, we believe the debt-servicing ability of this group may face added pressure. Supporting our ‘hold’ call is the decent dividend yield of about 5%,” she says in a report to clients.

Established on Dec 6, 1996, AEON Credit is a 59.7%-owned subsidiary of AEON Financial Service Co Ltd, the consumer financing arm of Japan’s largest retailer AEON Co Ltd. Leveraging AEON’s retail channel, AEON Credit has established itself as one of the largest non-bank financiers of consumer durables in Malaysia with a sizeable merchant base of over 11,000. It has also developed a niche in motorcycle financing, commanding 21% of the total motorcycles sold in the country in 2014.

Moving forward, AEON Credit will continue to focus on the middle and higher income groups, particularly in the superbike and car financing space, although interest margins for these segments are lower due to competition. Additionally, the company will also expand its market reach and branch network by increasing the number of service centres at AEON Mall and in secondary towns from 60 currently to 64 by February next year.

As the company will be celebrating its 20th anniversary in December, there is market talk that it will reward shareholders with a special dividend as well as hold a promotional campaign for its customers. Recall that AEON Credit declared a special dividend of one sen per share (net of tax) shortly after it was listed on Bursa Malaysia in December 2007. 

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.