Shriram Transport Finance Research Reports By IIFL & Motilal Oswal

Research Report By IIFL

Set to flourish in a favourable cycle

Shriram Transport Finance (STFC) is entering a sweet phase of business cycle, which would be marked by steady asset growth recovery, robust growth in pre‐provisioning operating profit, and significant earnings jump, thereby collectively lifting valuations towards cyclical peaks. We believe the franchise’s unique and tough‐to replicate positioning helped it achieve healthy profitability despite multiple upheavals of past four years including cyclical headwinds, stringent regulation in the form of NPL and capital norms, and the burden of absorbing the loss‐making equipment finance business.

In its core customer segment of owner‐driver and SRTOs and vehicle vintage of 5‐10 years, STFC is a dominant organized player in used CV financing. The company has built a highly localized business over past three decades with unmatched skills in customer acquisition and credit assessment, vehicle valuation and disposal, and customer engagement & collections. Human capital is STFC’s greatest strength with high employee loyalty and stickiness pervading all levels of the organization.

In a scenario of hardening rates, STFC would be amongst the few NBFCs to witness reduced borrowing cost in ensuing quarters. Not having borrowed aggressively at the shorter end of yield curve unlike other NBFCs during the past couple of years, it should be able to maintain its desired lending spread. Seminal reduction in cost/income ratio since FY15, despite adverse operating conditions, reflects pure efficiency gains; most notable being the significant increase in clients handled per field officer. STFC’s substantial provisioning buffer will ensure smooth transition to 90dpd NPL recognition in Q4 FY18. A steady recovery in all‐round economic activity and consumption should drive improvement in vehicle utilization over FY18‐20, thereby causing credit cost to moderate meaningfully from current peak levels.

Whenever a business cycle turns for the better, a well‐positioned player like STFC is bound to record sharp upswings in profitability and earnings. In our estimate, STFC’s RoA and RoE would expand by 110 bps and 700 bps respectively over FY17‐20. Profit would grow 2.4x in the same span. A steep valuation re‐rating is hence highly plausible over the coming 12‐15 months. The stock currently trades at a modest valuation of 2.1x P/ABV and 10.4x P/E on FY20 estimates.

Research Report By Motilal Oswal

We believe that Shriram Transport Finance (SHTF) is on the cusp of a strong earnings trajectory. Company-specific drivers (reduction in credit cost, C/I ratio), along with a recovery in the CV market, should lead to 30 %+ earnings growth over FY17-20.

– Also, we reiterate our stance that SHTF will be a big beneficiary of CoF reduction due to a large share of high-cost legacy borrowings. Thus, contrary to investor fears of a margin contraction due to rapid migration toward lower-vintage vehicle financing,margins should actually remain steady or even improve, in our view.

– Asset quality has been stable on an apples-to-apples basis. Over the past several quarters, the GNPL ratio has ranged from 4-4.5 % on a 180-dpd basis – similar to the levels seen in FY16 before the NPL migration. However, a key point here is that the NPL provision buffer has almost doubled from INR20b in 3QFY16 (prior to NPL migration) to INR35b (ex-CE provisions) in 2QFY18. Despite the NPL migration, SHTF has stuck with a PCR policy of 70 %+, which impacted its earnings, in our view.

– SHTF’s return ratios are just off cyclical lows, with decadal high credit cost and NPLs. However, the elevated credit costs for the company over the past two years are just statutory and not economic – i.e. write-offs (as % of AUM) have been stable. Credit costs have been high only in order to maintain PCR and not because of high net credit losses. We believe that the worst of asset quality troubles is behind and that the company should witness improving return ratios due to lower credit costs.

– Additionally, we believe that margin compression fears are overplayed, with the company yet to reap benefits in its cost of funds (CoF).

– We expect RoA/RoE of 3%/17% in FY19 and similar return ratios in the subsequent years.

– With RoA of 3%, SHTF will be at the upper end of the RoA range of our NBFC universe.

– However, its relatively slow AUM growth may limit the multiple that investors will pay for the stock, in our view. We use an RI model, with Rf of 7%, CoE of 14% and a terminal growth rate of 5%, to arrive at a target price of INR1,500 (2.1x Sep’19E BVPS). Buy.