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Favored play in a stable-to-declining interest rate environment

Vehicle financiers typically bear the brunt of a rising interest rate environment in the form of margin compression because of the fixed rate nature of a vehicle finance product. However, in a stable-to-declining interest rate regime, vehicle financiers will be better placed in terms of margin than other product segments. They are well-positioned to ride the strong underlying demand for vehicles, will incrementally start exhibiting plateauing of NIM and subsequently witness margin improvement. We model an AUM CAGR of 23%/20%/14% and a PAT CAGR of 32%/20%/15% for CIFC/ MMFS/ SHFL over FY23-25. We have a BUY rating on all the three Vehicle Financiers viz. Cholamandalam Finance (CIFC – BUY; TP: INR1,350), Shriram Finance (SHFL – BUY; TP INR2,100) and Mahindra Finance (MMFS – BUY; TP: INR400).

* CV sales to outshine previous peak: We are only two years into the current auto up-cycle and CV volumes have not even scaled back to the all-time peak level (~1.03m units) that was achieved in FY19. CV sales grew 34% YoY in FY23 to 0.96m units. Even with very modest growth expectations, we expect CV sales volume to surpass the FY19 peak in FY24 itself.

* Anticipated higher government spending will be a positive:Historically, we have seen stronger AUM growth for the vehicle financiers in the fiscal year prior to the general elections(refer Exhibit 23). India’s Lok Sabha elections will be held in 2024 and we expect the CV demand momentum to sustain due to the government’s higher spending and push towards Infrastructure, mining and real estate sectors.

* HCV demand strong; NBFCs changing product mix towards higher-yielding segments:Our channel checks suggest that demand in HCVs is strong but the NBFCs are not very keen to lend aggressively in this segment because: a) it is a highly competitive segment with banks enjoying a higher market share due to their dominance among the fleet operators and b) quite naturally, the yields in this segment are lower and the vehicle finance NBFCs have been trying to alter their product mix in favor of higher-yielding segments such as used vehicles.

* Diversifying into secular segments: To mitigate the deep cyclicality in the auto segment, most of the vehicle financiers have piloted or already entered into newer product segments such as Consumer, MSME, and Personal/Business loans where demand is more secular in nature. We expect the new product segments (ex. of LAP and Home Loans) to contribute ~10-15% to the AUM mix within the next three years, for both CIFC and MMFS.

* Margin compression to moderate; minor NIM expansion for CIFC:We believe that expectations on NIM compression will moderate in FY24. This has been aided by the view that interest rates should now broadly stabilize before we enter into the interest rate down-cycle (which we believe could happen within the next 9-12 months). In FY24, we estimate margin expansion of ~5bp for CIFC and compression of 20bp each for MMFS and SHFL. We would also reiterate that CIFC with a higher share of non-vehicle floating rate loans will be able to deliver a better margin performancethan rest of its peers.

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