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Disproportionate beneficiary of headwinds in the NBFC space
We recently met the management of Cholamandalam Investment and Finance Company (CIFC) and came back reassured. In addition to the broader slowdown in the auto OEMs, the recent headwinds in the NBFC space and the consequent tight liquidity have forced most vehicle financing NBFCs to go slow on growth, but not CIFC. We feel, given CIFC’s franchise, it will be a disproportionate beneficiary of the distortion that has plagued NBFCs in the last nine months. With a diversified bouquet of products in the vehicle financing space and a much improved home equity (HE) franchise, it can use the levers to improve its NIMs while keeping the operating cost ratios stable. We expect it to contain credit costs within 80bps for FY20E resulting in a healthy RoA of 2.3% (with improvement bias). Maintain ADD with a target price of Rs305 (from Rs300 earlier).
* Behavioural migration to lower vintage in used vehicles positive for CIFC: There is a behavioural shift in the buying behaviour of customers. New vehicles are now typically sold in the fourth/fifth year compared with sixth year earlier. This can be partly attributed to the impending scrappage policy (in whatever form it comes – mandatory scrapping or massive hike in re-registration of old vehicles). As such, both the demand and the supply are good in the used vehicles segment. While HCV segment has shown negative growth this year, both SCV and LCV segments continue to do well.
* Focus on financing low-cost vehicles in car and MUV segment: While the passenger vehicles (PV) sector as a whole has slowed down, the car and MUV segment of CIFC continued to do relatively well. Its focus remains on low-cost vehicles like Alto and Etios in PV and the likes of Bolero in MUV which can be deployed for productive as well as personal use. Given its market share in car/MUVs is very small, we feel getting volume growth in this segment would not be a big challenge. Reduced competitive intensity/aggression from major peers and auto financing captives in products like 3W, 2W, tractors, cars and MUVs will also help CIFC in gaining market share and maintain strong asset quality.
* Having seen both demonetisation and GST, home equity segment is now more resilient: Instead of a centralised collections team focused on NPA cases alone, it now has a separate Stage-2 collection team. It does not have exposure to developers in its HE book. LTVs are broadly in the range of 50-55% with ATS of about Rs5mn5.5mn. Around 95% of the loan book is to SME customers with the remaining to salaried/self-employed professionals. Expect steady recoveries from its NPA accounts with little actual write-offs.
* Valuations and risks: Our estimates are broadly unchanged (c1% change). We model a loan AUM CAGR and PAT CAGR of 19% and 21%, respectively. Current valuation at 3.0x FY20E P/B is at a premium (~40-50% to most of its asset finance NBFC peers) and reflects its relatively superior asset quality and higher earnings predictability. Our target multiple of 2.6x (unchanged) FY21E P/BVPS leads to a target price of Rs305 (earlier Rs300). Maintain ADD on steep valuations. Deterioration in asset quality from poor monsoon remains the key risk.
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