Buy Shriram Finance Ltd For Target Rs. 700 by Motilal Oswal Financial Services Ltd
A beacon of resilience and opportunity
Execution as a merged entity has been superior to its peers
Execution as a merged entity has been superior to its peers
*Shriram Finance (SHFL) offers a well-diversified product suite and has emerged as a strong player across all its product segments. It has demonstrated strong execution capabilities and asset quality resilience while navigating multiple credit and economic cycles.
*Even though things might appear to be moving slowly on the economic front in India, we believe that economic activity (such as infrastructure, real estate, and mining) will pick up in the next 3-6 months, resulting in healthy demand for commercial vehicles (CV). On the flipside, even if the new CV segment slows down, SHFL remains better positioned than its peers, owing to its strong foothold in the used CV segment.
*The diversified composition of the company’s loan book has mitigated its exposure to the cyclicality of the CV business, a challenge faced in the past. By capitalizing on cross-selling opportunities within its non-auto portfolio, the company has strategically positioned itself to achieve a more balanced loan mix while maintaining healthy asset quality.
*SHFL has demonstrated higher stability in its asset quality compared to its peers. Unlike the broader industry, the company's CV and personal loan (PL) portfolios have healthy asset quality, with delinquencies well managed. We estimate credit costs to remain stable and range-bound between 2.3-2.4% (as % of gross loans) over FY26-27E.
*SHFL has completed the sale of its housing finance subsidiary to Warburg Pincus for ~INR39b. We estimate SHFL to realize a post-tax exceptional gain of ~INR13b from this sale. Higher capitalization on the balance sheet could help it engage constructively with credit rating agencies for an upgrade.
*We expect SHFL to deliver a PAT CAGR of ~19% over FY24-27E and RoA/RoE of 3.3%/17% in FY27E. SHFL’s valuations have already re-rated from 1.2x to 1.5x 1-year forward P/BV over the last 12 months. We see scope for further re-rating if the company is able to sustain the execution on its AUM growth, margins and credit costs. SHFL is our TOP pick within our NBFC coverage with a TP of INR700, based on 1.7x FY27E P/BV
Non-auto products to drive growth; diversification reduces cyclicality
*The merger has bolstered SHFL's position in non-CV loans, reflected in the improving contribution of gold loans, MSME loans, and personal loans in its AUM mix. Even if there is a downtrend in auto in the future, we expect non-auto products to emerge as a growth driver for SHFL. We model AUM CAGR of ~16% in CV and ~23% in non-CV product segments over FY24-27E. This will translate into a total AUM CAGR of ~18% over this period.
*SHFL has sustained its dominant position in the used CV segment. While recent demand for CVs has not been exuberant, we anticipate a rebound in 1HFY26, supported by higher government spending on infrastructure and improvement in economic activity.
NIM to benefit from product mix improvement and expected cut in repo rates
*A shift in the product mix to high-yielding non-CV products is marginally accretive to the blended yields. A large proportion of this improvement in yields is expected to be driven by a higher proportion of gold loans and MSME loans in the AUM mix.
*With repo rate cuts expected in 1HCY25, SHFL is well equipped to reap the benefits of a declining interest rate environment. As of Sep’24, ~77% of its liabilities were linked to a fixed rate, while the remaining are linked to a floating rate, the majority of which are bank term loans linked to MCLR. Additionally, SHFL is actively engaging with credit rating agencies to secure a potential credit rating upgrade. We expect NIMs (on AUM) to improve to ~9.2%/9.4% in FY26/FY27 (from ~9.1% in FY25E).
Operating leverage to become more prominent over the next two years
*Over the past two years, the opex ratio for SHFL was higher because of postmerger activities (like gradual rollout of non-CV products in its CV branches) and expenses incurred toward advertising and branding activities. While it will gradually keep introducing its non-CV products like MSME and gold in several branches, a large part of this initial expansion activity is now nearing completion. We anticipate that the operating leverage will now become prominent over the next two years, driven by improvement in productivity.
*The company is leveraging cross-selling opportunities effectively, and with better branch and employee efficiency, it is set to keep improving its cost ratios going forward. We estimate the opex-to-average asset ratio to moderate to ~2.6% by FY27E from ~2.8% in FY25E.
Asset quality has been resilient relative to peers; credit costs to be range-bound
*Although the company has a higher proportion of its business in the cyclical CV segment, it has demonstrated lower asset quality stress compared to its peers, driven by strong underwriting and collection efforts.
*GS3 improved from ~6.9% in FY22 to ~5.3% as of Sep’24, while NS3 improved from ~3.3% to ~2.7% over the same period. SHFL is confident of sustaining healthy asset quality and is focused on improving Stage 3 to ~5%.
*Over the last year, the company’s PL portfolio has remained resilient, exhibiting no deterioration (refer Exhibit 22), despite industry-wide stress in the unsecured retail credit segment. GNPA in the PL portfolio improved from ~5.2% as of Sep’23 to ~4.5% as of Sep’24.
*We expect a gradual improvement in GS3 to ~5% by FY27E and model credit costs to remain largely range-bound around 2.3%-2.4% over FY26-27E.
Valuation and view: Good execution and strong visibility on earnings
*SHFL is yet to fully tap its expanded distribution network (from the merger) to offer a much wider product bouquet to its customers. The company is effectively leveraging cross-selling opportunities to reach new customers and introduce new products, resulting in improved operating metrics and a solid foundation for sustainable growth.
*The current valuation of ~1.3x FY27E BVPS is attractive for a ~19% PAT CAGR over FY24-27E and RoA/RoE of ~3.3%/17% in FY27E. SHFL is our top pick in the NBFC sector with a TP of INR700 (based on 1.7x FY27E BVPS).
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