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 towards 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 Rs 20 bn in 3QFY16 to Rs 35 bn (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. Meanwhile, write-offs, as a percentage of two-year-lag average AUM, have been steady at 2.0-2.2%, suggesting that the rise in GNPLs is statutory and not economic.
We acknowledge that SHTF is highly levered to the economy. However, given its (i) niche, difficult-to-replicate business model, (ii) virtual monopoly in old vehicle financing and (iii) 12-15%+ AUM growth and 17-18% steady-state RoE, we believe that SHTG warrants a higher multiple. Every 25 bp higher margin/lower credit cost has a positive impact of 15-20 bp on ROAUM, leading to a 5% upgrade in earnings. We thus expect earnings upgrades for vehicle financiers, going ahead.
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. 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 Rs 1,500 (2.1x Sep’19E BVPS). Buy.
NBFCs gaining mkt share rapidly
Against overall system-wide credit growth of 9% in the past 5 years, the MSME lending book of banks and NBFCs grew at 13% CAGR. NBFCs have achieved stronger growth than banks with their MSME lending book growing at 32% CAGR vis-a-vis 10% for banks. Consequently, their market share increased from 8% in FY12 to 18% in FY17.
LAP a key driver of MSME lending
As is well known, LAP has been a focused product for several NBFCs over the past few years. As a result, the LAP portfolio (for banks and NBFCs) grew at 26% CAGR over FY12-17 as compared to 10% CAGR over the same time period for non-LAP MSME financing. It now accounts for 24% of overall MSME lending, compared to 15% in FY12. However, given increased competition, declining margins and lower demand post demonetisation and GST, the LAP portfolio is expected to growth at 13-15% CAGR over the next two years.