JM Financial: Shriram City Union: Buy target 730

Diversified consumer finance play
􀂄 Diversified consumer finance company available at attractive valuation:
Shriram City Union Finance (SCUF), a part of the Shriram Group, specialises in
small-ticket retail loans. It offers vehicle/auto loans (40% of AUM), small
business loans (19%), gold loans (16%), two-wheeler loans (13%) and personal
loans (9%). With strong focus on semi–urban and rural markets (c.80% of
branch network), the company is a diversified consumer finance play available
at attractive valuation.
􀂄 Auto, gold and business loans to drive 28% CAGR in AUM over FY10-13E:
We expect AUM CAGR of 28% over FY10-13 (vs 40% over FY05-10) on the back
of strong macro environment: a) Higher disbursements in the auto segment,
b) Rising demand for gold loans on the back of higher gold prices, c)
Increased lending opportunities to small business enterprises due to strong
business environment.
􀂄 Healthy 24% CAGR in NII over FY10-13E: Despite factoring in margin
compression of 68bps (NII/AUM) due to higher borrowing costs, we expect
healthy 24% CAGR in NII over FY10-13E on the back of robust AUM growth.
􀂄 Operating efficiencies to lead to 57bps decline in cost ratios over FY10-
13E: We expect SCUF’s cost to assets ratio to improve 57bps to 3.5% over
FY10–13E driven by improved productivity, focus on product expansion
across all branches and leveraging of associate group companies’ distribution
network. Hence, SCUF is in a unique position to grow its business without
entering new locations or adding to its workforce.
􀂄 Credit costs to remain stable at c.280bps with gross NPLs of c.2.3%: SCUF
increased its provisioning cost in the last 2 years primarily to increase its
coverage ratio from 41% in FY08 to 69% in FY10. Consequently, its credit
costs increased from c.230bps to c.275bps over FY08-10. Going forward, we
factor in stable credit costs of c.280bps over FY10-13E with gross NPLs of
c.2.3% and coverage ratio of 70% by FY13E.
􀂄 Earnings CAGR of 23% over FY10-13E driven by strong loan growth,
improved cost ratios and stable credit costs. We expect SCUF to report
healthy return ratios with ROA of 3.2% and ROE of 23% over FY10-13E.
􀂄 Initiate coverage with BUY and TP of `730: We value SCUF at 11x Sept’12
EPS, implying Sept’11 target price of `730, upside of c.25%. Key risks are
significant economic slowdown, spike in interest rates and higher than
expected delinquencies.