This article first appeared in Corporate, The Edge Malaysia Weekly, on July 4 - 10, 2016.

THE shares of consumer finance company RCE Capital Bhd have plunged since April, falling 15.7% from 83 sen as at end-March to 70 sen last Wednesday. This came after its principal officer Phoon Kok Kam disposed of 50,000 shares in the open market on April 1 as well as the a poor set of quarterly results announced on May 26.

In the fourth quarter ended March 31, 2016 (4QFY2016), net profit fell RM4.2 million or 38.1% year on year (y-o-y) to RM6.9 million, largely owing to a RM5.9 million increase in loan impairment. However, net profit for the full year saw a 47.6% jump to RM39.6 million from RM26.8 million the year before, boosted by positive operating jaws, that is, income growth from a higher loan base that more than offset rising credit costs (see Chart 1).

Concurrently, the company proposed a final dividend of 3.5 sen per share, subject to shareholders’ approval at the upcoming annual general meeting. The dividend for FY2016 was significantly higher than the 1.5 sen final dividend that has been consistently paid since FY2010 (not adjusted for new shares issued), translating into an above-market average yield of 5% based on the current market price of 70 sen per share.

After months of selling pressure, RCE Capital shares are now trading at only 4.9 times its trailing 12-month earnings and at a huge 58% discount to its net asset value per share of RM1.65. With a price-to-book (PB) ratio of 0.42 times, the stock currently trades at more than one standard deviation from its five-year historical mean of 0.60 time its book value (see Chart 2).

This also makes RCE Capital the second cheapest consumer finance firm after TA Enterprise Bhd in terms of PB ratio (see Table 1). When valued using price-earnings ratio (PER), RCE Capital’s trailing PER is the lowest and gives the second highest dividend yield among its peers.

Given RCE Capital’s attractive valuations, as compared with its historical valuation and its peers, are fears of its worsening asset quality overblown and does the current share price weakness represent an opportunity to accumulate more of its shares? More importantly, can the company sustain its double-digit loan growth without sacrificing asset quality too much?

Too steep a discount?

When contacted by The Edge, the company says the underperformance of its share price was probably due to the heightened volatility and sell-off in the broader market. It clarified that the issues with cooperatives — such as Koperasi Wawasan Pekerja-Pekerja Bhd — that had severely restricted its loan growth have been resolved and the proportion of the loans is now lower. The company, however, declined to elaborate further as it is entering its close period for the 1QFY2017 results scheduled to be released in August.

To be sure, shares of most banks and non-bank financial institutions (NBFIs) are trading at historical lows, given the current credit down cycle and unexciting earnings prospects. A PB ratio of less than 1.0 times usually implies the market believes that either the company’s assets are overvalued or the company is earning a poor return on its capital. That said, is RCE Capital’s 58% discount to its book value too steep a discount?

As shown in Table 1, industry leader AEON Credit Service (M) Bhd and RCE Capital are the only two companies in the consumer finance subsector that posted positive earnings growth in the past year, despite the challenging operating environment. To put things in perspective, RCE Capital’s financial performance has been improving since its net profit plunged 90.4% to RM9.7 million in FY2013, owing to a shrinking loan base and a hike in impairment charges.

RCE Capital does not disclose its key financial metrics such as loan growth, non-performing loan (NPL) ratio and cost-to-income ratio, saying that they are commercially sensitive information. To gauge how well the business is running, we estimated and compiled these ratios based on publicly available information (see Table 2).

To beef up its capital base amid regulatory changes, RCE Capital raised RM178.4 million by issuing redeemable convertible preference shares in FY2013, the bulk of which came from indirect major and controlling shareholder Amcorp Group Bhd, which is controlled by Tan Sri Azman Hashim. However, back-of-the-envelope calculations indicate that the company appeared to be overcapitalised as it faced negative loan growth after the fundraising exercise.

Restructuring bears fruit

On the business front, the first thing the company tackled was its asset quality improvement following a thorough portfolio review and close monitoring of all existing and new loan receivables initiated in FY2013. As a result, its gross NPL ratio improved to 11.7% in FY2014 and further to 8.2% in FY15, leading to the earnings recovery in FY2014-FY2015.

In FY2015, RCE Capital also reversed its negative credit growth, posting 12.2% growth in its loan base. This in turn supported 23.8% growth in FY2016 revenue to RM162.4 million, reversing the flattish or negative revenue growth in FY2012-FY2014. As with other financial institutions, it saw some compression in net interest margins, owing to tightening capital market conditions.

In FY2016, while its loan growth accelerated to 16.9%, asset quality seemed to worsen with the NPL ratio rising 1.1 percentage points to 10.3%. Nevertheless, its return on equity (ROE) increased from a mere 1.8% in FY2014 to 5.6% in FY2015, thanks to its restructuring efforts to improve loan quality, operational efficiency and capital structure.

ROE improved further to 7% in FY2016, mainly due to a special dividend of 10.5 sen per share or RM134.7 million paid out to shareholders last October as part of its capital management strategy to achieve a more efficient capital structure. The company subsequently undertook a capital repayment exercise to distribute 0.75 sen per share or RM97.5 million to shareholders in 1QFY2017.

Instead, RCE Capital turned to debt financing to fund its aggressive loans and receivables growth — a funding model adopted by Aeon Credit. In FY2015, it relied on internally generated funds and bank borrowings to fund its loan growth of RM130.9 million to RM1.2 billion. As it gears up, perhaps what might worry investors is its low current ratio of 0.6 times and whether it has sufficient liquidity to meet its short-term obligations.

Asset-liability mismatch

Upon a closer look, the company seems to have a funding mismatch problem too, as at least 74% of its loans and receivables are now funded by debt. As at end-March, the company’s net loans and receivables stood at RM1.2 billion, of which only 10.5% or RM126.9 million are expected to be collected in the next 12 months. On the other hand, its total borrowings stood at RM1 billion, of which 50.3% or RM517.7 million is expected to be repaid on demand or within a year.

To reduce the maturity mismatch between assets and liabilities and to fund its future loan growth in a more sustainable way, the company announced on June 23 a Sukuk Murabahah asset-backed securitisation programme of up to RM900 million in nominal value via Al Dzahab Assets Bhd. The first tranche of RM155.5 million under the programme, rated final AAA/Stable and AA3/Stable by RAM Ratings, was launched on June 21.

“The issuance will be collateralised by personal-financing facilities originated by RCE Marketing Sdn Bhd (RCEM) through its business partners and extended to civil servants. These facilities are repaid via non-discretionary salary deductions processed by the Accountant General’s Department and Angkatan Koperasi Kebangsaan Malaysia Bhd (Angkasa), thereby substantially insulating the transaction from the credit risks of the borrowers as long as they remain in active service,” said RAM Ratings in a June 6 statement.

“The RM95 million Class A Sukuk and RM25 million Class B Sukuk will be backed by receivables with an outstanding principal value of RM148.6 million and RM3.4 million of cash balances, translating into respective overcollateralisation ratios of 60% and 26.66%,” it noted.

Based on this information, it is known that at least 12.2% or RM148.6 million of its total RM1.2 billion loan asset are government servant loans and collateralised. Nonetheless, the actual proportion has not been disclosed and it is unclear how much more government servant loans — which are virtually risk-free as long as the loan takers remain in government service — RCE Capital could collateralise in its future sukuk issuances.

Focusing on quality loan growth

RCE Capital has said that it will continue to focus on improving its asset quality and operational efficiencies. In this regard, it is still working closely with Bank Negara Malaysia to further fine-tune the system requirements to secure access to the Central Credit Reference Information System (CCRIS), a comprehensive borrower database maintained by Bank Negara Malaysia.

The company believes that the availability of the borrowers’ credit information from CCRIS will help it in making informed lending decisions and therefore enhance its credit risk management and improve its loan quality. RCE Capital claims speedy service delivery is its key competitive edge and has put in place process simplification initiatives to ensure more efficient and faster loan processes to differentiate itself from its competitors.

Those who believe in RCE Capital’s recovery story given the attractive dividend yield, big discount to its book value and improving profit should consider it for their portfolio. The things to watch for are its loan impairment trend and whether it can find the right balance between loan growth and asset quality. 

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