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Growth complementing typical good asset quality; constrained NIM outlook limit upside at current valuations

* Sundaram Finance (Sundaram) has reported good Q2FY23 result as quantified by standalone PPOP growth QoQ (as opposed to decline or flat PPOP growth for peers). Key factors that led to its outperformance include: (1) relatively lower increase in cost of funds, (2) better growth in CV AUM; the company has also gained market share, (3) higher other income partially offset by lower yields. NIMs declined on YoY basis due to yield decline of 78bps which was driven by run-down of higher yielding pre-covid loan book. However, the same is expected to increase going forward as the company is passing on rates to customers. Only 26bps QoQ increase in funding cost could be due to the use of extra cash on balance sheet. While the CV cycle is unfolding gradually and credit costs will continue to support PAT, the possible lower NIM outlook (higher cost of funds and competition environment) limits the upside. We believe current valuations (2.8x FY24E P/B (derived for lending business)) balance risk-reward well. Hence, basis rich valuations, we downgrade the stock to HOLD from Add with a revised target price of Rs2,249 (earlier: Rs2,235) based on 2.5x/3.0x P/B on FY24E book value of NBFC+HFC / insurance business and 15x P/E on AMC’s FY24E PAT.

* Standalone disbursement increased 5%/42% QoQ/YoY to Rs51.4bn in Q2FY23. This was the highest ever Q2 disbursements for Sundaram. AUM grew 5%/7% QoQ/YoY to Rs320bn as of Sep’22. Disbursements were led by cars (12% QoQ), and others segments (48% QoQ) whereas CV disbursements were flat and tractors and CE disbursements declined sequentially. YoY total disbursements growth of 42% was driven by CV (53%) and others (95%). QoQ AUM growth of 5% was broad-based across segments barring CE (2% QoQ growth) and others (8% QoQ). The company mentioned gain and extension of market share across most asset classes.

* Net interest income (NII) grew 1.8% QoQ despite yield decline of 6bps to 10.8% and 26bps increase in the cost of funding to 6.0% in Q2FY23 due to AUM growth. However, it declined 7% YoY due to 78bps YoY yield decline while funding cost improved marginally. Consequently, NIMs to AUM was 5.3% (annualised) in Q2FY23 vs 5.4%/6.0% in Q1FY23/Q2FY22, respectively. Funding cost increase containment seems to be driven by the usage of on-balance sheet liquidity as cash and cash equivalents, and investments as %age of total assets decreased 11% as of Sep’22 vs 17% as of Mar’22 and 13% as of Sep’21. Debt to equity also decreased to 3.9 times as of Sep’22 vs 4.0/4.1 times as of Jun’22/Sep’21. Absolute borrowing also declined marginally QoQ. The yield decline is driven by run-down of higher yielding pre-covid (covid was lower rated environment) loan book. Other income grew 63%/28% QoQ/YoY and it stood at 2.7% (annualised) as %age of AUM Q2FY23 vs 1.7%/2.2% in Q1FY23/Q2FY22, respectively. Sequential growth was led by dividend and securitisation income.

* Operating expense (opex) remained elevated and grew 6.5% QoQ (higher than 5% QoQ AUM growth). Opex to AUM was 2.6% (annualised) in Q2FY23 vs 2.5%/2.3% in Q1FY23/Q2FY22, respectively.

* PPOP growth QoQ is better than peers. PPOP grew 22% QoQ to Rs4.3bn in Q2FY23 led by strong growth in other income (excluding the impact of dividend and securitisation income, QoQ growth was 3%). This was opposed to -2%/-9% QoQ PPOP growth for Chola/MMFSL. It declined YoY by 4% due to NIMs compression and opex increase.

* Credit cost remains impressive at 0.3% (annualised) of AUM in Q2FY23 vs 0.7%/2.2% in Q1FY23/Q2FY22, respectively. Gross stage 3 (GS-3) remained flattish at 2.54% as of Sep’22 from 2.5% in Jun’’22 but improved from 3.5% in Q2FY22. GNPA as per IRAC norms also improved to 4.3% as of Sep’22 from 5.2% as of Jun’22. The company adopted new norms effective from Apr’22, ahead of regulatory guideline of Oct’22. As a matter of prudence, company slightly amended its ECL model to accommodate for the same which resulted in additional provisions of Rs173.7mn in Q2FY23.

* Standalone PAT increased by 35%/44% QoQ/YoY to Rs3.0bn in Q2FY23. RoA/RoE was 3.4%/16.8% vs 2.5%/12.9% in Q1FY23 and 2.5%/13.1% in Q2FY22, respectively.

* Consolidated PAT increased by 20%/21% QoQ/YoY to Rs3.3bn in Q2FY23. Net interest income (NII) grew 3% QoQ, but declined 4% YoY to Rs5.2bn in Q2FY23. Sequential increase was led by standalone AUM growth and NII improvement in Sundaram Home. Other income increased by 16%/14% QoQ/YoY. Operating expense (opex) increased by 11%/27% QoQ/YoY, higher than standalone parent company, hence, driven by subsidiaries. Credit cost declined 39%/78% QoQ/YoY to Rs0.4bn in Q2FY23. PPOP grew 5% QoQ to Rs4.4bn in Q2FY23 but declined YoY by 12% due to higher opex increase and lower NII. Sundaram Home’s AUM growth traction continues with it growing at 4.6% QoQ in Q2FY23 (2.6%/2.5% in Q4FY22/Q1FY23). Royal Sundaram General Insurance reported PAT of Rs350mn as per IND-AS (as against loss of Rs340mn in Q1FY23) which could be driven by mark-to-market gains. On the other hand, Sundaram AMC’s AUM grew 8% QoQ after declining 9% QoQ in Q1FY23. However, its PAT remained lower in H1FY23 (Rs340mn) due to amortisation of asset management rights consequent to the recent acquisition.

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