Downgrade STFL to neutral, target Rs.800

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SummaryWe downgrade Shriram Transport Finance from ‘buy’ to ‘neutral’ as we believe the stock offers limited upside in the near term due to the recent strong rally.

We downgrade Shriram Transport Finance (STFL) from ‘buy’ to ‘neutral’ as we believe the stock offers limited upside in the near term due to the recent strong rally. The stock has rallied 16% in the past one month, gained around 74% year-to-date and outperformed the Sensex and CNX Bankex by 49% and 18%, respectively.

The stock is currently trading at 2.0x book, which is 10% lower than its five-year average P/BV. We believe the stock would trade close to its historical average P/BV even in an improving macro, given the lower ROE profile versus history.

We believe the stock is already pricing in the improving growth outlook and declining asset quality risks. We raise our price target to R800 (from R750 earlier) based on our residual income model (13.5% CoE). Our new price target implies 2.1x FY14e book and 10.5x FY14e earnings. We raise earnings marginally by 2% for FY13/14e and expect the loan book (AUM) to increase at a CAGR of 17% in FY12-14e. We expect NIMs for FY14e to stay flat at ~7.7% and expect credit costs at 2%/1.8% for FY13/14e.

For Q3FY13, we expect net income of R390 crore, a growth of 27% y-o-y, led by growth in net operating income of 20% y-o-y to R1,000 crore. We estimate NII growth at 18% YoY to R950 crore.

We also expect an improvement in NIMs by 47 basis points to 7.86%, and AUM growth of 22% y-o-y. Loan growth has picked up from the lows of 11% y-o-y in Q4FY12 to 16% y-o-y in Q2FY13. Disbursal growth has also shown improvement in the past two quarters and is getting reflected in estimates.

Further improvement in margins will depend on the combined impact of falling wholesale funding cost and rising cost of funds on securitised loan book.

We expect margins to plateau at 7.75% in FY14e.

As per the new NBFC draft rules proposed by RBI, Tier-I capital is required to be increased to 12% (from 7.5%), NPL to be recognised at 90 days over three years (from 180 days), and standard asset provisioning to be raised to 40 basis points (currently 25 basis points).

New securitisation rules are leading to lower incremental spreads, though this would be partly offset by a decline in the cost of wholesale funds. Similarly, the positive impact of an improving economy on credit cost is likely to be offset by the proposed rules on NPL

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