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Disbursements at record high; RBI NPA guidelines play spoilsport

* SHTF’s PAT declined 12% QoQ/6% YoY to INR6.8b (16% miss) in 3QFY22 led by higher credit costs, which grew 95bp QoQ and ~80bp YoY to ~3.2%.

* SHTF reported ~60bp increase in its GS3 to 8.4% because of the RBI guidelines on daily stamping of NPA. With a target to reach the guided level of 4% NS3 by Mar’22, SHTF further increased the PCR on Stage 3 loans to ~52% without utilizing any COVID provisions during 3QFY22.

* SHTF is on course to report record levels of annual disbursements in FY22 and thus we expect the momentum to further improve in 4QFY22. Price hikes in both New and Used CVs (led by BS VI and higher steel prices), feed into higher ticket sizes and are aiding value growth in disbursements.

* The Union Budget 2022 along with the government’s spending on infrastructure will play a key role in the disbursements/AUM growth trajectory for SHTF from FY23E onward. We model an AUM CAGR of 11% during FY22-FY24E led by a 9% disbursement CAGR over the same period.

* SHTF’s customer/product segments cater to a benign competitive landscape. SHTF has not witnessed any undue pressure on its spreads/ margin, but has received sustained benefits on the cost of borrowings. Given that there have been no major economic disruptions from the third COVID wave, collections would further improve in the seasonally strong last quarter of the fiscal and reinforce asset quality.

* We cut our FY22E PAT by ~4% to factor in higher credit costs. We model in ~18% PAT CAGR over FY21-24E, leading to an RoA/RoE of 2.5%/14% by FY24E. Concern around potential (partial/complete) exits of investors, such as PIEL, Apax, TPG and Sanlam, after the merger is completed will remain an overhang on SHTF. We like its standalone business and maintain our BUY rating with a TP of INR1,500 (premised on 1.3x Dec’23E BV).

Disbursements at record high; economic activity has to improve for these levels to sustain

* Disbursements rose 4% QoQ to ~INR155b, and exhibited the demand buoyancy in Used CV Financing. This momentum will sustain in the seasonally strong 4QFY22 but economic activity has to improve for it to keep delivering healthy disbursement growth from FY23 onward.

* AUM was up 2.4% QoQ and 8.4% YoY to INR1.25t. We model in ~9% AUM growth in FY22.

Deterioration in asset quality primarily because of RBI NPA guidelines

* GS3/NS3 increased 60bp/20bp QoQ to 8.4%/4.4%, respectively. PCR on S3 improved ~170bp QoQ to 50.3%.

* Until 2QFY22, STFH had cumulatively restructured 39,410 borrower accounts worth INR11.5b. From among the restructured accounts, 3,308 accounts with exposure of INR688mn have been settled and the balance outstanding exposure in the restructured pool (of remaining 36,102 borrower accounts) stood at INR9.97b out of which 2.3% was >90 dpd.

* The company made no additional COVID-19 provisions in 3QFY22. Aggregate COVID provisions stood at INR28.53b (~2.3% of AUM).

* Management expects GS3 to improve 80-100bp in 4QFY22 and come down to 7.5%-7.6% level by Mar’22.

Improvement in spreads/margin; liquidity expected to normalize after Mar’22

* Improvement in spreads/margin led to higher NII. Earnings were further aided by higher other income on a direct assignment transaction.

* Yields (calculated) were flat QoQ at 16.6%, while CoB (calculated) declined ~44bp to 8.7%. Spreads rose ~40bp QoQ to 7.9%. NIM on assets (calculated) improved ~30bp QoQ to 7.1%.

* STFH will maintain the current high liquidity levels on its balance sheet until 4QFY22 and will start winding it down after Mar’22. Borrowing mix changed in favor of NCDs with the proportion of securitization continuing to moderate.

Key highlights from the management commentary

* RBI has advised the systemically-important NBFCs to maintain NS3 of <4%. The company took additional management overlay on stage 3 loans to deliver NS3 of <4% by Mar'22

* Expect a reduction of 10-15bp in the cost of borrowings driven by replacement of higher cost liabilities even as the bond rates have started hardening.

* Guidance of cost-income ratio at 22%-23% and long-term credit costs at 2%.

Valuation and view: Operationally strong quarter

* SHTF reported an operationally healthy quarter despite elevated credit costs led primarily by daily stamping of NPA and the company’s target of delivering NS3 of <4% by the end of FY22. We model an AUM growth of ~11%/10% over FY23E/FY24E. Liability-side challenges faced by the company (even before the pandemic broke out) have been addressed. It now has a relatively higher comfort in raising money from banks or debt capital markets and continues to maintain a higher-than-warranted liquidity buffer.

* Concern around potential (partial/complete) exits of investors, such as PIEL, Apax, TPG and Sanlam, after the merger is completed will remain an overhang on the stock. We have a neutral view on the announced merger, strictly from a business perspective, where we neither see any significant synergies from the merger nor have any significant negatives that could be highlighted.

* Except for the RBI guidelines-driven deterioration in asset quality, we believe that SHTF will be able to exhibit an improvement in GS3 as it educates its customers and the collection rigor shifts to the 30-60dpd bucket from the 60- 90dpd one. We estimate credit costs of ~2.1-2.2% in FY23/FY24.

* We cut our FY22E EPS by ~4% to factor in higher credit costs and raise our FY23/FY24 estimates by ~3% each driven by improvement in operating efficiencies. We model in ~18% PAT CAGR over FY21-24E, leading to an RoA/RoE of 2.5%/14% by FY24E. We like its standalone business and maintain our BUY rating on the stock with a TP of INR1,500 (premised on 1.3x Dec’23E BV).

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