We downgrade Shriram Transport to Hold (from Buy) with a revised EVA (economic value added) based target price of Rs 830 [benchmarked off 3.25x (times) one-year forward P/BV (price-to-book value) , up from 2.5x].
Our downgrade is primarily based on valuation: the stock has run up significantly, +73% relative to Sensex, in one year, and at current levels (3.1x 1Yr Fwd P/BV) appears close to fair value and we believe will face headwinds in a rising interest rate environment. Fundamentally, the business should still deliver consistent growth and returns with a stable risk profile.
Shriram?s Q1FY11 NIMs (net interest margins) jumped sharply to 825 bps (+180 bps YoY) and were driven by additional capital infusion and low funding costs. We believe a tighter liquidity environment and the higher base effect will lead to some pressure (though modest) on NIMs, going forward. Moreover, its fee income growth in Q1FY11 was also low, and could dampen returns.
The Shriram management remains optimistic on the overall asset quality levels, and expects improvements from the current levels?but potential near-term concern due to a mining ban in Karnataka remains.
Shriram?s loan growth remains steady between 20% and 25% levels. A buoyant economy, strong CV (commercial vehicle) cycle and rising freight costs will likely keep growth strong at current levels. The management has launched a new construction equipment subsidiary and has aggressive targets for growth. These could provide some upside.
While we are cautious on NBFCs (non-banking financial companies), given the current high valuations and likely NIM pressures, Shriram is better positioned to pass on rate hikes, and remains our preferred play in this space. We might reconsider our Hold rating and become more positive if the share corrects about 10%.
Shriram has a unique business model, long track record of operating profitably in a segment considered difficult by banks, healthy asset quality, and an experienced and stable management team. Fundamentally, the business has cyclical upside from: (i) the turnaround in the Indian CV sales cycle and its linkage to the strong industrial production cycle; (ii) healthy demand for financing of used vehicles as CVs financed during the last growth cycle (FY03-07) come up for refinancing; (iii) an improving asset quality outlook for the industry as economic activity has picked up smartly and the prospects remain healthy; and (iv) a robust return profile for Shriram, with ROEs (returns on equity) of 23-26% over FY11-13E.
However, the stock has outperformed the market by a huge 73% in the last 12 months and now appears to be close to its fair value. While the business fundamentals remain consistent and healthy, we believe there is limited upside to the stock price from the current levels.
Risks: Key downside risks that could cause the stock to trade below our target include: (i) asset quality?good so far, but rapid pace of loan growth suggests credit costs can rise; (ii) wholesale funding?can hurt in a tight-liquidity scenario; and (iii) execution of the planned fee income initiatives.