J.P. Morgan - Shriram Transport Finance

Shriram Transport Finance (SHTF IN) Growth slowing though asset quality under control; still too early to call a recovery in CV financing cycle		Neutral Price: Rs775.35 28 Apr 2014 Price Target: Rs660.00 PT End Date: 30 Mar 2015

SHTF’s 4Q EPS of Rs13 (down 17% Y/Y) came in below expectations, primarily due to one-off tax adjustment (Rs150MM impact) and lower loan growth. On the operating front, asset quality trends were encouraging, with credit costs coming off in 4Q and GNPA levels well contained. Growth for the company, though, remained sedate (AUM growth flat Q/Q) and the trend is likely to continue in the near term. NIMs (at 6.46%, down 5bp Q/Q) have been coming off over the last few years and are at their lowest in the last five years. While there are signs of the CV cycle bottoming out given recent increases in freight rates, we think it is still too early to call a recovery given overall stressed operator profitability and over-capacity in the industry. Maintain Neutral.

· Loan growth slowing down – AUM at Rs531B fell (by 1% Q/Q) for the second consecutive quarter, given conservative lending stance taken by the company. On a Y/Y basis, growth stood at 7% Y/Y, with disbursement witnessing de-growth of 11% Y/Y. In terms of AUM mix, the New CV segment saw a sharp decline (-34% Y/Y) offsetting the growth in the Used CV segment (+17% Y/Y). The company is guiding to 10-12% AUM growth in FY15; however, this is likely to be 2H-weighted. 1H is likely to remain muted given ongoing elections followed by monsoons and given near-term focus on collections.

Figure 2: SHTF – AUM growth trend

Source: Company

· Credit costs surprised positively for the Q at 1.8% (vs. 2.2% last Q), especially in the context of stressed profitability of the transport operators and deterioration registered by other peers in the CV segment. The company expects to maintain credit costs within a 1.8-2.1% range going into FY15. GNPA increase (in absolute terms) was also contained at 5% Q/Q in the Mar-Q. Overall GNPA and Net NPA in percentage terms stood at 3.86% (+30bp Q/Q due to base impact) and 0.8% respectively.

Figure 3: SHTF - GNPA trends

Source: Company

· 4Q NIMs largely stable at 6.5% - Reported NIM for Mar-Q of 6.46% was down by a marginal 5bp Q/Q (FY14 at 6.68%, down 80bp Y/Y), despite rate increases taken by the company (of 50bp) in Dec-Q. This was primarily due to a) excess liquidity being carried on books (Rs90B cash + current investments); b) lower LTVs on new loans; and c) accounting of securitization income on net tax basis (15bp impact). NIMs for SHTF have been coming off over the last few years (from 8%+ to c6.5%) due to a portfolio mix shift towards lower-vintage (3-7 years) vehicles. However, the overall portfolio mix for the company now seems to have stabilized and FY15 should see NIMs improving, given the benign base of FY14.

Figure 1: SHTF – Quarterly NIM trends

Source: Company reports

· CV financing: Bottoming out but still too early to call a recovery – The CV financing cycle, after being under stress for the past three years, now seems to be bottoming out. Recent firming up of freight rates, marginal increase in resale values, and lifting of the mining ban in Goa are positives at the margin. However, it is still too early to call a recovery, in our view, which we believe would hinge on overall macro and investment activity picking up in 2H. New CVs (up-trending) and MHCVs (given the low base) are likely to see a faster revival, as and when activity picks up. Leading CV peers (Chola) indicated that GNPA levels will likely stay elevated over the next two Qs given that transport operators’ financials are still stressed. There is excess capacity in the industry which we believe will first need to be absorbed before we see any meaningful revival in the CV financing market or freight rates.

Table 1: SHTF – 4Q/FY14 results

Rs MM, YE Mar.	4Q13	3Q14	4Q14	Q/Q ch (%)	Y/Y ch (%)	FY13	FY14	Y/Y ch (%)
Interest Income	13,104	16,834	16,379	-3%	25%	44,988	62,666	39%
Interest cost	(8,057)	(10,405)	(10,011)	-4%	24%	(28,439)	(38,916)	37%
Net Interest Income	5,046	6,429	6,368	-1%	26%	16,548	23,750	44%
Income from securitization	3,892	2,919	2,756	-6%	-29%	18,057	12,796	-29%
NII (including securitization)	8,951	9,357	9,128	-2%	2%	34,618	36,575	6%
Operating income	8,951	9,357	9,128	-2%	2%	34,618	36,575	6%
Operating expenditure	(1,072)	(1,502)	(1,444)	-4%	35%	(4,012)	(5,563)	39%
Personnel cost	(977)	(949)	(1,023)	8%	5%	(3,849)	(4,066)	6%
Pre-provision profits	6,902	6,907	6,662	-4%	-3%	26,757	26,947	1%
Other income	557	378	238	-37%	-57%	1,856	1,954	5%
Provisions	(2,193)	(3,008)	(2,458)	-18%	12%	(8,451)	(10,612)	26%
Profit before tax	5,266	4,276	4,442	4%	-16%	20,162	18,289	-9%
Tax	(1,713)	(1,254)	(1,493)	19%	-13%	(6,556)	(5,638)	-14%
PAT	3,552	3,013	2,950	-2%	-17%	13,606	12,641	-7%

Source: Company reports

Investment Thesis

SHTF is trying to manage a trade-off between growth and margins with movement into newer vintages coming at the cost of some yield compromise. Asset quality and the operating environment continue to be under pressure. While there are some signs of the CV cycle bottoming out, we think it is still too early to call a recovery.

Valuation

Maintain Neutral with Mar-15 PT of Rs660 based on our three-stage Gordon growth model. Our PT implies a 1.3x forward book, which is at a 20% discount to its mean trading range.

Valuation Assumptions
Cost of Equity	15%
Terminal Growth	5%
Normalized ROE	18%

Risks to Rating and Price Target

Key upside risk: 1. Margin surprise on sharp decline in interest rates or improvement in yields. Downside risks include a) slowdown in CV cycle being extended thereby impacting used CV segment; and b) sharp deterioration in asset quality and increase in credit costs.

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