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Stress, though baffling, is transitory; company prepared to grow as normalcy returns

Rise in Cholamandalam Finance’s (Chola) stress pool in Q1FY22 is baffling. Stage3 pool spiked to 6.79% (vs 3.96% in FY21), stage-2 assets more the doubled to 14% (vs 6.2%) and the company further restructured 3.9% of its loans under OTR 2.0. Consequently, credit cost hovered high at 3% despite utilising Rs4bn from the contingency buffer. Disbursements too plunged 55% QoQ (flat YoY) moderating AUM growth to 7% (from >15% in FY21).

What is encouraging: 1) collection efficiency retraced to 114% in July (near March levels). 2) 80-90% of stage-2/3 customers honoured their July obligation suggesting the spike is transitory. 3) Less than 2 months’ moratorium was extended to ~80% of restructured customers. Management is confident of better asset quality metrics in FY22 than FY21. However, we conservatively model credit cost at 2.1%/1.4% for FY22E/FY23E. RoE of 2.5% and RoE of 20% by FY23E can help Chola command valuations at 3.75x FY23E book. Upgrade to BUY (from Add) with an unchanged target price of Rs617.

* Stress pool (stage-2/3) including restructuring pool at ~25%: Stage-3 spiked to 6.79% (vs 3.96% in FY21) primarily led by vehicle financing. Stage-2 assets more than doubled to 14% (vs 6.2%). This compares with pre-covid average stage-3 at 3.0-3.5% and stage-2 at 3.5-4.0%. Collection efficiency (CE) declined to 84% in April/May resulting in forward flows into stress buckets. However, CE revived to 103% in June and further improved to 114% in July (vs 116% in March). This suggests that forward flows into stage-2/3 will be contained in Q2FY22 and that the Q1 spike was most probably transitory. Given that 88-90% of stage-2 customers and ~80% of stage-3 customers are honouring July dues, trajectory of the stress pool will be positive in H2FY22. Also, the company is not actively opting for repossession in current circumstances – it incurred a loss of Rs700mn on repossession in Q1FY22.

* Restructuring at ~5.4%; Q1 ECLGS disbursements negligible: Chola restructured Rs25.9bn under OTR 2.0 (3.9% of the book) taking the cumulative restructuring to Rs36.4bn (5.4% of the loanbook). As a matter of prudence, the restructured pool has been classified in stage-2 assets. Incremental restructuring has been implemented for customers associated with travel&tourism and hotel industry. These customers are being offered principal moratorium of maximum 6 months. In fact, 60% of customers have been granted moratorium only for one month and 20% for 2 months. Disbursements under ECLGS scheme in Q1 were negligible at Rs70mn and the overall pool is at ~3% of AUM.

* Credit cost at 3% after utilising contingency buffer; cumulative provisioning seems adequate: Credit cost was elevated at Rs5.5bn (I-Sec: Rs5.2bn), translating to 3% of AUM. Chola dipped into contingency buffer to the extent of Rs4bn and now carries management overlay of Rs7bn on stage-2/3 assets (1% of AUM). Release of provision was towards stage-1 assets that did not flow forward into stage-2/3. With spike in stage-2/3, despite creating Rs4.2bn-4.5bn additional provisioning in each bucket, coverage declined on stage-2 to 12.5% (vs 16.8%) and stage-3 to 35.5% (vs 44%), respectively. Cumulatively, the company carries 4.37% provisioning on stress pool of >25%. Management believes this is more than adequate and guides for credit cost in FY22 to be lower than FY21. However, we conservatively model credit cost of 2.1%/1.4% in FY22E/FY23E respectively.

* Diversified product bouquet and market positioning can help tap opportunities: Disbursements were significantly derailed due to ‘employee safety first’ and cautious approach in Q1FY21. Vehicle finance disbursements were down 55% QoQ / 12% YoY. Used vehicle, MUV, LCV and car led major part of the decline. LAP AUM grew 11% on a low base as disbursements YoY increased twofold. Home loan disbursements were flat YoY, but AUM growth (on a low base) moderated to 33%. With revival in activity levels and demand sentiment, the management sees an uptick in growth momentum in H2FY22. Jul’21 was better than Jul’19 and the management expects the trajectory to continue. We are building-in an AUM CAGR of 10-16% over FY21E-FY23E.

* Funding cost benefit supports NIMs: The group’s standing, AA+ credit rating, well-managed ALM and borrowing from banks at 55%, the consistent reset in borrowing rates has helped steady decline in cost of funds QoQ. Finance costs were down 2% YoY despite 8% increase in total borrowings. As compared to this, relatively lower reset in yields further supported by securitised pool reset, aided NIMs at >7.5%. We expect NIMs to moderate with stability in borrowing cost, competitive lending market and unwinding of securitised pool benefit.

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