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Growth outlook remains strong

* Chola Investments (CIFC) posted Q2 earnings of Rs6.1bn, up 40% yoy. The key highlights are – 1) Pick-up in disbursements reversed the AUM decline seen in Q1FY22. 2) Reduction in the cost of funds resulted in NIM expansion qoq. 3) Restructured loans keep the proportion of stage 2 loans near Q1FY22 levels, contrary to market expectations. With improving collection efficiency mom, the proportion of stage 2 assets should decline.

* CIFC is a comprehensive financial services provider, offering vehicle finance, home loans (HL), loans against property (LAP) and SME loans, among others. Along with its investments in ‘buy-now-pay-later’ (BNPL) related fin-tech Paytail, CIFC seeks to come up with new products like consumer loans and SME loans. It stands to benefit from the improvement in macro-economic prospects in FY23 and pickup in the capex cycle.

* We assume coverage of CIFC with Buy and a Sep'22 TP of Rs700, using the excess return on equity (ERE) method for FY23E-24E RoE of ~20.6%, which implies a multiple of 3.7x Sep’23E BVPS. The key downside risk is persistent asset quality stress.

Portfolio stress declines at a moderate pace

* Q2 result highlights: Strong disbursements resulted in AUM growth of 4% yoy (3% qoq). Faster growth for the LAP and HL segments helped increase their share qoq. Within vehicle finance, used CV and tractor segments are seeing strong demand. NIMs increased by 7bps qoq on lower cost of funds and better asset yields. Better business momentum and salary increments during Q2 led to a 27% yoy rise in overall costs. While GS3 and NS3 ratios improved qoq, the culmination of the OTR2 process with restructured loans (though exhibiting stage 1 behavior) being classified as stage 2 meant the proportion of stage 2 loans showed a minimal improvement qoq. CIFC maintains aggregate coverage of ~4.1%, with the restructured loans having a cover of 10% and stage 3 loans a normalized coverage of 36%. It also has a management overlay buffer of Rs7bn for COVID exigencies. Improved mom collections (Oct: 116%) is likely to reduce the stress in FY22.

* We forecast a 33% CAGR in disbursements over FY21-24E, resulting in a 18% AUM CAGR. Considering strong underlying demand for vehicles, LAP and HL, asset yields are expected to remain firm over the forecast period. We expect NIMs to improve in FY22, aided by lower costs of funds and better yields on assets. The operating expense-to-asset ratio is likely to be ~2.6%, in line with management guidance. We estimate the credit costs to average 116bps, near the upper end of the guidance range (80-125bps). In the absence of a third Covid wave, ~Rs4.5-5bn of the overlay buffer can be utilized. We estimate ECL provisions to reduce from current 4.1% to 2.4% over the forecast period. Over FY22E-24E, we estimate the average RoA to be ~3.0% and RoE at ~20.5%.

* We assume coverage of CIFC with Buy and a Sep'22 TP of Rs700, using the ERE method for FY24E RoE of ~20.5%. The fair value implies a multiple of 3.7x Sep’23E BVPS.

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