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Shriram Transport Finance (SHTF IN; Mkt Cap USD3.6b, CMP Rs721, Buy)
- STF being a wholesale funded company could face pressure on its margins in the backdrop of tightening liquidity scenario.
- To mitigate the interest rate risk (STF’s entire truck loan portfolio carries a fixed rate), STF has reduced the proportion of floating rate borrowings to ~25-26%.
- Robust scenario for new CV sales over FY10-12E and strong CV sales during FY04-FY07 leading to better prospects for used CV sales would drive business.
- With positive outlook for both verticals and strategic presence in CV finance market, management expects to grow AUM at 20-25% CAGR over next 2 years.
- With healthy balance sheet, sound track record and uptrend in economic activity, concerns about asset quality have abated.
Catering to the second-hand commercial vehicle financing segment, marked by limited competition, STF delivered high RoEs of 27%-28% and a high disbursement CAGR of ~38% over FY06-10. We expect 29% earnings CAGR over FY10-FY13E and an average RoA of 3.3% (on AUM) and average RoE of 28%. Maintain Buy with target price of Rs960 (3.5x FY12 BV and 14x implied PE).
Tight liquidity scenario is unlikely to have material impact on STF
STF being a wholesale funded company could face pressure on its margins in the backdropof tightening liquidity scenario, however management has been proactive and has ensured
that the impact of increase in interest rates would be minimal. With diversified borrowing
mix, healthy ALM profile, surplus liquidity on the books and effective resort to securitization
STF is well placed in the rising rate scenario. In anticipation of tightening liquidity scenario,
STF continues to carry surplus liquidity on the books. As at the end of 2QFY11, liquid
funds (cash and bank balance + investments) comprised ~22% of the total assets.
Persistent liquidity shortage, as reflected by the average bank borrowing of Rs1t from the
RBI in November, has started to affect the interest rate, short-term wholesale rates have
increased ~120bp QTD. In our view, the liquidity situation is likely to ease in 4QFY11,
with (1) the impact of three rounds of RBI's open market operations being felt, (2)
expectation of further OMO of Rs240b in the rest of FY11, (3) improvement in real
interest rates driving up deposit growth, and (4) increased government spending. On the
back of improving liquidity situation, we expect the whole sale cost of funds to remain
under check.
Diversified borrowing mix to contain rise in cost of funds
STF sources funds from multiple channels like banks and financial institutions, retail
borrowings and also through securitization/assignment of its assets. Loans from banks
dominate total funding profile which constituted 62% of total borrowings in FY10, which
typically has one year reset. STF has of late increase the proportion of fixed rate borrowing
in anticipation of rising rates. Management has guided to further increase the proportion
of fixed rate loans to mitigate interest rate risk.
Healthy asset liability management (ALM) to mitigate pressure on NIMs
About 25-26% of STF's borrowings carry a floating rate as compared 50% in the past.
The entire truck loan portfolio carries a fixed rate. As such, STF faces interest rate risk in
a rising interest rate scenario. However in its bid to grow at a moderate and sustainable
rate of 20-25%, management expects that there is no large need for it to raise funds and
manage incremental disbursals through monthly repayments and securitization of assets.
Management states that incremental lending are ~Rs15b per month and the principal
repayments are at ~Rs10b. This coupled with excess liquidity on the balance sheet of
Rs45-50b and effective resort to securitization of assets would keep the incremental demand
for funds low. Also, in light of the upturn in the CV industry, STF is well placed to pass on
the hike in interest rates to its customers.
Excess liquidity will reduce resource need
STF has been carrying excess liquidity on its balance sheet over the last 4-5 quarters (part
of it would be on account of FDs kept with banks as credit enhancement towards securitized
assets). Surplus liquidity on the one hand would result in lower margins but on the other
side would enable STF to keep its incremental cost of funds under check in tightening rate
scenario.
Effectively using securitization route to manage funding requirements
Loan securitization/ assignments have diversified STF's (debt) fund raising options. Loan
securitization is one of best tools for banks/ NBFCs to manage their ALM position. Unlike
traditional bonds, securitization does not pose risks on account of maturity mismatches
and interest rate volatilities. Securitization of assets is conceptually similar to assets
equivalent to the loan pool being financed at a fixed rate.
Typically, the securitized portfolio's composition for STF has been 70% new-vehicle loans
(that yield about 15%) and the balance 30% old-vehicle loans. While the securitization of
assets has been on the higher side, STF has been conservatively amortizing the income on
securitized assets over the life of the assets.
Securitization will contribute on an average 24-25% in operating income from FY11 to
FY13E as compared to single digits contributed in the past.
RBI has released draft guidelines on securitization of assets; a minimum loan seasoning of
one year, before the loans are sold down by the originator (STF, in this case), and retain at
least 5%-10% of asset sold are the key proposals. If the guidelines are implemented and
includes bilateral transactions, it would imply certain change in economics (for sell down
transaction) for STF.
Net interest margins to remain firm
In the past, STF's cost of funds has exhibited strong co-relation with movement of 6
months CD rate (with a lag of 2 quarters). While we expect on an incremental basis the
same trend will continue but with better ALM profile, excess liquidity and stable growth
impact on NIMs will be limited. We expect margins to decline gradually from 2QFY11
levels of 8.34% (AUM reported). For the year we expect margins on AUM to be at 7.9%
(cal) v/s 6.6% in FY10.
Robust economic trend to drive business growth
The economic recovery has put CV sales back on the growth track. Strong GDP growth
is expected to boost freight capacity growth. We expect the growth in new-CV sales to
sustain on back of robust economic trends. New CV disbursements constitute 20-25% of
the incremental disbursements for STF.
Robust new-CV sales - 1.5m units in four years over FY04-07 will drive STF's used-CV
disbursals over the next 2-3 years as the company's target segment is the +5 year old
trucks. STF has a leadership position in pre-owned (5 to 12 year old) CV finance with 20-
25% market share and it is amongst the largest organized player.
With positive outlook for both verticals (new and used trucks) and STF strategic presence
in CV finance market, we expect assets growth to accelerate in coming years. We have
modeled disbursal and AUM CAGR of 24% over FY10-13E
Asset quality to remain healthy
STF's asset quality has remained healthy even during the time of economic slowdown
(from Oct-08 to Sep-09). Although, gross NPAs increased to 2.8% in 4QFY10 from 1.5%
in 4QFY08, STF has prudently utilized its strong operating income to step-up its provision
coverage ratio to ~76% from 52% over the same period. The company has further improved
its asset quality by increasing provision coverage ratio to 81% in 2QFY11. We believe
would enable it absorb any negative shock.
With healthy balance sheet, sound track record and uptrend in economic activity, concerns
about asset quality have abated. We expect credit cost to remain stable at 1.3% of AUMs
over FY11-13E. We continue to believe that the economic cycle is favorable and STF has
strong core competencies in its niche segment.
Other highlights- New Business Verticals
Construction Equipment Business: In order to diversify its revenue stream and to
benefit from infrastructure boom, the company has added construction equipment financing
to its portfolio. STF has floated a separate subsidiary for this segment. Subsidiary will
work as a separate SBU focusing on rapidly growing construction equipments (earth
moving equipments which are incidental to logistic transport such as dumpers, tippers etc)
financing. STF targets AUM of Rs60b by Mar-12. We are not assigning any value to this
business as it has yet to achieve visible output.
Auto mall - innovative concept: STF is planning to introduce auto mall through a separate
subsidiary Shriram Automall India Ltd, wherein a) It will sell its repossessed trucks from
defaulters (STF repossess nearly 1% of trucks it finances every year), b) STF will sell
repossessed truck of other financiers, where STF will act as agent and earn commission
(3-5%). In addition to this, it will finance the purchaser (loan disbursements) and c) STF
will purchase the old trucks and re-engineering them and sell it through auction under its
own brand name called "Shriram new look". STF will not only earn profit on the transaction
but would get opportunity to finance the purchaser. Auto mall will be in the form of yards
wherein it will park trucks (repossessed both own as well as of the other financers plus reengineered
old trucks). The company is planning to set-up first such auto mall in Chennai
and ramp it up to 50 to 60 centers across pan India over next 2 years. This business is
expected to commence from middle of 4QFY11.
RoA to expand to 3.5%+, RoE to sustain at 27-28%+ over FY10-13E
Catering to the second-hand commercial vehicle financing segment, marked by limited
competition, STF delivered high RoEs of 27-28% and a high disbursement CAGR of
~38% over FY06-10. On the back of a buoyant economy, we expect disbursement CAGR
to remain healthy at 22.8% over FY10-13E given: (1) CVs sold during FY04-FY07 (CAGR
of 23%) coming up for refinancing and (2) robust economic trend to drive sales of new
CV sales. We thus expect 29% earnings CAGR over FY10-FY13E and an avg. RoA of
3.3% (on AUM) and avg. RoE of 28%. Maintain Buy with target price of Rs960 (3.5x
FY12 BV and 14x implied PE).
STF has been generating high RoEs of 27-28% while its business growth is likely to be
around 20-25%. Even adjusting the payout ratio of 20%, STF would be left with sufficient
funds to manage its growth without diluting return for shareholders.
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