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Growth outlook revised upwards

* Cholamandalam Investment and Finance Company (CIFC) reported Q2FY23 earnings of ~Rs.5.6bn,~7%/~6% below ours and consensus estimates. Higher-than-expected compression in NIM, due to lag effect of PLR hikes, coupled with elevated credit costs resulted in earnings coming below our estimates. Disbursements grew by 9.7% qoq/68% yoy, driven by 47.7% qoq growth in the SME and consumer finance verticals. As a result, AUM grew by 7% qoq/25.2% yoy. The share of SME/Consumer vertical stood at 5.4% (Q1:3.6%). Calculated NIM declined by 44bps qoq due to a sequential increase of 68bps in CoF. CIFC conducted rate hikes of 40bps for its home loan and LAP product in Jun-22, 40bps in Sep-22, and plans to do a further 40bps hike in Nov-22. While the impact of the June hike is reflected in Q2, the Sep-22 and potential Nov-22 hike would have an impact in Q3 and Q4, respectively. Operating expenses remained elevated (+14% qoq/+27.6% yoy), resulting in PPOP of Rs10.36bn (est. Rs10.67bn). Headline asset-quality numbers improved, with GS3 and NS3 declining by 32bps and 22bps to 3.84% and 2.25%, respectively. PCR on stage-3 assets stood at 41.5% (Q1: 40.7%). Credit costs for the quarter declined by 20bps to 1.31% vs. our estimate of 1.19%. ECL as a percentage of gross loans declined by 20bps qoq to ~2.7% on account of overall ECL on the book remaining flat sequentially.

* Management guidance: 1) Increase of 50-60bps in CoF during FY23, 2) Opex-to-Assets to be tad below 3% for FY23, 3) PBT-ROTA for FY23 of 3.5%, 4) Full year AUM growth could be ~25% considering the usual trend of strong H2, 5) Rate hikes conducted to date would minimize the impact of higher CoF in the coming quarters, 6) Management does not expect to increase the its overlay provision and would decide on utilization strategy by the end of the current fiscal.

* We retain our Buy rating on the stock with a Sep-23E TP of Rs860 (earlier Rs835), using the excess return on equity (ERE) method, which implies a multiple of 3.9x Sep-24E BVPS. Key downside risks include operating expense and credit cost ratios exceeding our estimates for the forecast period.

* What we liked: 1) Sustained growth momentum in Consumer/SME segments and positive commentary on growth, 2) Guidance on PBT-ROTA remaining consistent at ~3.5%. What we didn’t like: While headline asset quality numbers improved, credit costs were higher than expected.

* Changes in estimates: We have increased our disbursement and AUM growth expectations for FY23E to 64.2%/27.7% vs. 49.8%/24.6% earlier on account of robust H2FY23 growth prospects highlighted by the management driven by a strong Rabi season, and increasing construction and mining activity expected. We factor in higher contribution from the consumer/SME segment by revising our estimates upwards for NII, opex, and credit costs. We have increased our NII estimates for FY23E/24E/25E by 1%/4.4%/5.7%. We have raised our opex-to-AUM for FY23E/24E/25E by 9bps/19bps/21bps. We have also revised upwards our credit cost estimates for the forecast period by 27bps/7bps/16bps for FY23E/24E/25E to factor in the higher credit risk carried by SME/Consumer loan products.

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