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Disbursement momentum healthy and asset quality stable

* PAT grew 38% YoY to ~INR10.7b in 2QFY23 (in line), driven by NII growth of 18% YoY and credit costs of ~2% (annualized).

* SHTF’s customer and product positions it to operate in a benign competitive landscape, and gives it the pricing power to pass on its higher cost of borrowings to customers in new loans disbursed. While we expect margin to improve in FY23, we estimate a compression of ~40bp in FY24.

* We model an AUM CAGR of 12% over FY22-24, led by 13% CAGR in disbursements over the same period. We raise our FY23 EPS estimate by ~3% to factor in higher loan growth. We estimate ~23% PAT CAGR over FY22-24, resulting in a RoA/RoE of 2.5%/14% in FY24.

* Concern around potential exits by investors (such as PIEL, Apax, TPG, and Sanlam) still remains an overhang on the stock. We like both the standalone businesses, and believe the merged entity will emerge stronger than the respective standalone businesses. We maintain our Buy rating with a TP of INR1,500 (based on 1.2x FY24E BVPS).

Higher ticket sizes and momentum in new CVs aid healthy disbursements

* Operationally, SHTF clocked a healthy 2QFY23, with: a) a 20% YoY and 14% QoQ growth in disbursement to INR178b, and b) an AUM growth of 11% YoY and 3.5% QoQ to INR1.35t.

* Given that the resale values of used CVs are now higher, customers who had earlier postponed their upgrades are now upgrading to new CVs, which has aided new CV disbursements for SHTF. The proportion of new CVs in the disbursement mix marginally improved to 6% (from 4-5% earlier).

* The company utilized additional COVID-related provisions of ~INR951m in 2QFY23. Aggregate COVID-related provisions stood at INR17.4b (~1.3% of AUM).

Asset quality stable; write-offs at steady run-rate levels

* GS3 fell by ~7bp QoQ to 6.9%. NS3/PCR was stable QoQ at 3.5%/ 52%.

* Credit costs fell 16% QoQ to INR6.7b (2% annualized). SHTF utilized additional COVID-related provisions of ~INR950m in 2QFY23. Aggregate COVID-related provisions stood at INR17.4b (~1.3% of AUM).

* SHTF expects to utilize its management overlay of INR5-6b in 2HFY23 and the remainder of FY24. It doesn’t expect write-backs from these provisions since these will be utilized for granting waivers to restructured contracts.

* Write-offs fell to ~INR4.3b (in line with the last six quarters run-rate of INR4-5b, except 4QFY22).

Spreads contract QoQ, while margin is broadly stable

* Yields fell 20bp QoQ, while CoF grew 5bp, resulting in a contraction in spreads by ~30bp.

* Reported NIM was stable sequentially at 7%.

* C/I ratio increased by 2pp QoQ to 23.5%, including a one-off expense in OPEX of INR650 due to settlement in litigations on the taxation side.

Key highlights from the management commentary

* The management guided at a NIM of 7%, with a 20bp tolerance band on either side. It is currently carrying six months of liquidity, and is looking to gradually reduce the same to three months over time. This will aid margin.

* The borrowing cost will increase by 8-10bp in 3QFY23 since banks have increased lending rates to the extent of their MCLR rate hikes.

* The company has not declared any interim dividend in 2QFY23 because of the merger. The merger will be completed in Nov'22, and dividend can be expected over the next two quarters.

* SHTF does not have any arrangements with third-party collection agencies for collections or repossessions. All such activities are undertaken in-house by its employees.

Valuation and View: NCLT merger approval expected within a week

* SHTF’s operational performance has been strong, as evidenced in the healthy growth in disbursements, which translated in a YoY AUM growth of ~11%.

* Asset quality was stable, with GS3 at pre-COVID levels of ~7%. It maintained a healthy (52%) PCR on its Stage 3 loans and delivered a NS3 of sub-4%.

* Technical reasons (of a potential supply overhang after the merger) aside, the merged entity will emerge stronger than the respective standalone businesses. We reiterate our Buy rating with a TP of INR1,500 (based on 1.2x FY24E BVPS).

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