Buy Shriram Finance Ltd for the Target Rs. 800 by Motilal Oswal Financial Services Ltd
Asset quality headwinds to gradually subside
Normalization in surplus liquidity and declining rate cycle to boost NIM
* The last quarter of FY25 was a mixed bag for Shriram Finance (SHFL) as its AUM growth and disbursement momentum were healthy but its asset quality exhibited minor deterioration over the previous two quarters. The weakness stemmed from a slowdown in demand amid muted government capex and weak cashflows in the hands of customers. Additionally, SHFL reported margin compression, primarily driven by surplus liquidity on the balance sheet from the large ECB issuances during Dec’24-Mar’25.
* While both factors weighed on the company’s performance over the last two quarters, we believe these transitory headwinds will now gradually recede. Margins are expected to improve going forward, supported by a gradual normalization of excess liquidity and potential repo rate cuts during the year. An improving product mix with a higher contribution from non-auto segments is expected to support blended yield expansion, further aiding margin improvement.
* Credit costs remained high in 4QFY25, due to high net slippages and minor deterioration in asset quality. Beyond the weak seasonality of 1HFY26, we expect the asset quality outlook to improve in 2HFY26. This is also reflected in the company’s guidance of near-term stability in asset quality. That said, we believe that 1QFY26 will be an acid test for SHFL as well as other vehicle financiers (VFs) in terms of asset quality and collections.
* The FY26 outlook looks better for SHFL amid expectations of an economic revival, supported by forecasts of a favorable monsoon and higher government capex. Favorable monsoons can lead to a higher agricultural output and stronger rural cash flows, which in turn will drive credit demand across the vehicle finance and MSME segments. These factors would improve disbursement momentum and portfolio quality in FY26.
* We expect SHFL to deliver a PAT CAGR of ~19% over FY25-27E and RoA/RoE of 3.3%/17% in FY27E. SHFL remains our top pick in the NBFC space for CY26, driven by its diversified portfolio, strong execution and healthy return ratios. Since we highlighted SHFL as our top NBFC pick in Jan’25, the stock has delivered a robust ~22% return, outperforming the Nifty Financial Services Index, which has returned ~15% over the same period.
* SHFL’s valuations have already re-rated from 1.4x to 1.9x 1-year forward P/BV over the last 12 months. The stock can see a further re-rating if the company is able to sustain the execution on its AUM growth, improve margins and exhibit stability in its asset quality. Reiterate our BUY rating on the stock with a TP of INR800, based on 2x FY27E P/BV.
Non-auto products to drive growth; branch expansion to boost reach
* SHFL has effectively capitalized on cross-selling opportunities within its non-auto portfolio, creating a more favorable loan mix with an increased focus on MSME, gold loans and personal loans. The diversified composition of the company’s loan book has mitigated its exposure to the cyclicality of the CV business.
* SHFL will be converting its 750 rural centers into full-fledged branches. This expanded physical footprint will not only enhance reach in underserved markets but also enable greater cross-selling of non-auto products, supporting sustainable long-term growth. We estimate a CAGR of 16%/17% in disbursements/AUM over FY25-27E.
NIMs to get a boost from liquidity normalization and potential repo rate cuts
* SHFL is well-positioned to benefit from a declining interest rate environment. The recent 50bp reduction in repo rates, coupled with the expectation of further rate cuts in CY26, should ease the company’s borrowing costs. About 30% of the company’s borrowings will mature in FY26 and will be repriced at lower rates, resulting in a likely reduction in its cost of borrowings. Additionally, the surplus liquidity on the balance sheet, which stood at ~INR310b as of Mar’25 (Dec’24: INR27b), is expected to normalize to INR18-19b over the next two quarters. This normalization of excess liquidity is anticipated to further support NIM expansion. We estimate NIMs (as % of total assets) to improve to 8.4%/8.6% in FY26/FY27 (vs. ~8.2% in FY25).
* 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 PL, gold loans and MSME loans in the AUM mix.
Asset quality to remain range-bound; credit cost has largely peaked out
* SHFL has maintained resilient asset quality and stable credit costs over the past year compared to its peers, driven by strong underwriting and collection efforts. However, the company exhibited a deterioration in asset quality, higher net slippages and elevated credit costs in 4QFY25 due to factors discussed earlier in this report. That said, we believe credit costs have largely peaked and are likely to stabilize going forward, driven by improvement in economic activity.
* Notably, the company also undertook technical write-offs of ~INR23.5b in 4QFY25, which contributed to a sequential decline in GS3. Excluding technical write-offs, GS3 rose ~3bp QoQ. GS3 improved from ~6.9% in FY22 to ~4.6% as of FY25, while NS3 improved from ~3.3% to ~2.7% over the same period.
* Over the past year, the company’s PL portfolio has remained resilient, exhibiting no deterioration, despite industry-wide stress in the unsecured retail credit segment. GNPA in the PL portfolio improved from ~5.2% as of Sep’23 to ~4.2% as of Mar’25. We expect a gradual improvement in GS3 to ~4.4% by FY27E (FY25: ~4.6%) and model credit costs (as a % of avg assets) to remain largely around 2.0-2.1% over FY26E-27E.
Valuation and view
* SHFL is currently facing transitory headwinds in its asset quality (compounded by weakness in economic activity) and NIM compression (driven by surplus liquidity on the balance sheet). We expect these headwinds to gradually subside as over the last two years, the company’s execution on AUM growth and asset quality has been far ahead of its peers.
* Notably, SHFL has yet to fully leverage its expanded distribution network. We anticipate that tangible benefits from this enhanced reach will continue to materialize for another 12-18 months, driving further improvement in its performance.
* Shriram Finance offers a combination of market leadership, strategic diversification into high-growth non-auto segments, potential for margin and operating efficiency improvements, and attractive valuations with strong earnings visibility. The current valuation of ~1.6x FY27E BVPS is attractive for a ~19% PAT CAGR over FY25-27E and RoA/RoE of ~3.3%/17% in FY27E. SHFL is our top pick in the NBFC sector with a TP of INR800 (based on 2x FY27E BVPS).
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