Cholamandalam Investment & Finance- Turnaround story:: UBS

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UBS Investment Research
Cholamandalam Investment & Finance
Turnaround story

􀂄 Niche asset financing company
Cholamandalam Investment & Finance (CIFC) is a leading non-bank financial
company focused on asset financing; its key growth driver is commercial vehicle
financing (62% of loan book as at Q2 FY11). The company focusses on new light
commercial vehicle financing (14% market share), which is less cyclical than
medium and heavy commercial vehicle financing and has a stronger growth
outlook. Its home equity (23% of book at Q2 FY11) and business finance (8% of
book) divisions are characterised by strong operations and low NPLs.


􀂄 Strong turnaround story with exit from personal loan business
CIFC entered the personal loan (PL) segment in 2006 when DBS Bank bought a
37.5% stake. The economic downcycle led to high NPLs, and CIFC has exited the
business. It has been cleaning up its loan book by providing for PL losses over
FY10-11. We expect strong earnings from FY12 onwards, with little provisioning
for the PL business (we forecast Rs230m of PL provisioning in FY12).

􀂄 Expect strong earnings growth and high ROE
We forecast an FY10-13 earnings CAGR of 86% and ROE of 19.2%/22% in
FY12/FY13, driven by strong growth in assets, stable NIMs, operating leverage
and lower provisioning. Efficient asset liability management (ALM) should limit
the impact of any increase in interest rates.

􀂄 Valuation: Buy rating, Rs252.00 price target
We initiate coverage with a Buy rating and a price target of Rs252.00, implying
2.3x FY12E P/BV and 12x FY12E PE, comparing favourably with peers. We
expect the stock to re-rate towards peers as earnings turn around. We value the
company using a residual income model, which is the sum of BVPS for FY12E
and the present value of income generated over and above the cost of equity.


We initiate coverage on CIFC with a Buy rating and Rs252.00 price target.
Our price target implies 2.3x FY12E P/BV and 12x FY12E PE.
CIFC, part of the reputable Murugappa Group, is a leading non-bank
financial company (NBFC) focussed on asset financing. We believe CIFC is
a strong turnaround story. It diversified into PL when DBS Bank purchased a
37.5% stake in the company in 2006. CIFC faced challenges in managing a
new business, and the economic downcycle aggravated problems, leading to
high NPLs. CIFC exited the PL business in March 2010, as promoters
bought DBS’s stake in CIFC. In our view, CIFC is effectively cleaning up its
books over FY10/11 by providing adequately for this business. With its
focus returning to its core strengths, we believe CIFC is well positioned to
capture growth opportunities in the asset financing business by leveraging its
strong distribution network, customer relationships and brand equity. We
expect strong results from FY12 onwards. We forecast an FY10-FY13
earnings CAGR of 86%, FY12/FY13E ROE of 19.2%/22% and stable NIMs.
We are positive on the outlook for the Indian commercial vehicle (CV)
industry given strong GDP growth and industrial production (IP) trends. CV
financing is CIFC’s key growth driver, representing 62% of book as of Q2
FY11. We forecast an FY10-13 CV financing book CAGR of 31%. The
company focusses on new CV financing, which represents 76% of its CV
financing). CIFC is focused on new light commercial vehicle (LCV)
financing, which is less cyclical than medium and heavy commercial vehicle
(MHCV) financing and has a stronger growth outlook. This is a profitable
niche for CIFC, with a low-cost operating model. Its focus on rural/semiurban
and micro and small enterprises places it well vis-à-vis banks, in our
view. About 65% of disbursements are to agri-based micro/small enterprises.
Nearly 90% of its 210 locations are in growing tier II and tier III Indian cities.
It has a nationwide distribution network (36% of branches in southern India
and 27% in the west). We believe this is a sweet spot in terms of growth and
profitability. Its home equity (HE) and business finance (BF) segments have
low NPLs (1.04% in FY10 for HE and zero for BF since inception). We
forecast FY10-13 book CAGRs of 20% and 7%, respectively.
We think higher interest rates would be unlikely to impact NIMs given
CIFC’s effective ALM (see Table 14). It also has operating leverage given its
low-cost model, and consumer finance operating costs are declining with its
exit from the segment. However, funding is almost entirely wholesale, with
63% from bank borrowings, so the company remains sensitive to wholesale
funding rates over the long term.
The stock is trading at FY12E PE of 9.0x and P/BV of 1.8x. This compares
with peers’ (Shriram Transport Finance (SHTF), Sundaram Finance and
M&M Finance) FY12E PE range of 10-15x, P/BV range of 2-3x and ROE
range of 21-29%. We think the stock should continue to re-rate towards its
peers’ multiples as it delivers strong numbers.



Key Catalysts
􀁑 Improving asset quality: Cholamandalam’s overall gross non-performing
assets (NPA) stood at 6.7% of all loans (1.26% excluding personal loans) in
FY10 compared to 0.8% in FY08. CIFC’s exit from its unsecured PL
business will lead to a cleanup (run down of existing receivables and
provisioning for delinquencies) by end-FY11. We expect FY12 numbers—
we estimate only Rs230m of PL provisioning—to be a key catalyst for the
stock. We forecast FY12 profit after tax (PAT) to increase 143% YoY, with
ROA and ROE of 2.9% and 19.2%, respectively.
􀁑 Writebacks: CIFC has provided for its unsecured PL business (Rs3.08bn
provided over the previous three to four years and current managed book (net
of provisions) is Rs5.85bn. With an improved economic environment and
focus on collections, we think there is potential for writebacks as collections
from this portfolio could improve in FY12.
􀁑 Continuing buoyancy in freight markets: Increases in freight capacity and
freight rates augur well for the underlying profitability of CIFC’s primary
customers and are also important demand drivers in the CV segment.
􀁑 Stable margins: In a rising rate environment, concerns on cost of funds will
be a consideration in share price movement. We expect CIFC’s sound ALM
strategy to lead to stable margins (for the non-PL book), which could be a
positive surprise.

Risks
􀁑 CIFC’s business is linked to economic activity, as the key driver of its
customers’ profitability is freight availability and freight rates. Small
transport operators particularly are more sensitive to any slowdown as their
capacity to bear shocks is low.
􀁑 The wholesale nature of liabilities exposes the company to liquidity and
interest rate risks, which we believe can be mitigated by sound ALM practice.
􀁑 Increase in competition could lead to lower profitability, especially as a
growing market attracts banks and potentially new entrants.