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Growth and Asset Quality in good shape

Used PV, MSME and Gold Loans to spearhead growth  

Post-merger entity Shriram Finance is a multi-product play having synergistic growth spurt at disposal. Its stronger AUM growth of 4% qoq/18.6% yoy in Q1 FY24 surprised many. In our view, the growth momentum could likely continue through the year aided by 1) residual benefits of value growth in used CV/PV financing (50%/19% of AUM), 2) firm replacement demand for used PVs, 3) phased roll-out of MSME Loans (10% of AUM) in vehicle financing branches, 4) distribution of Gold Loans (3% of AUM) taken to substantial number of vehicle financing branches, and 5) sustained momentum in Personal Loans (4% of AUM).

In longer run, the growth levers would be 1) stronger volume growth in used CV/PV financing (co. has been gaining market share consistently), 2) availability/supply of used BS VI vehicles, 3) operational policy driven emphasis on realization of crosssell/distribution synergies, 4) tapping of market outside Shriram ecosystem customers for erstwhile SCUF products and 5) conversion of rural centers into full-fledged branches. Management expects to deliver a 15% AUM CAGR over the next three years with a diversified product portfolio offering growth fungibility. The AUM mix is expected to move meaningfully towards Used PV, MSME and Gold Loans.

Collections, portfolio construct and ECL coverage healthy

The improvement in operating environment for Vehicle Finance and MSME Loans customers has translated into healthy collection efficiency for the company. New delinquency creation and existing delinquency flow across buckets has come down and bucket corrections are happening. This is reflected in meaningful decline in absolute Stage-2 bucket over the past three quarters notwithstanding controlled fwd. flow into Stage-3. The Stage-3 assets have seen limited increase in recent quarters adjusted for the write-offs which have also nearly normalized. We believe that collection efficiency and stage-wise portfolio construct are in good shape and overall ECL coverage is adequate. Hence, we estimate credit cost to be around the guided level of 2%.

Micro factors which are supportive of asset quality include a) rising vehicle prices, b) shift within MSME portfolio towards secured loans (now almost 90% from below 80%), c) nearly 95% of PL portfolio comprising of erstwhile 2W customers or existing 2W customers who have repaid >80% of the loan, d) no longer tenor (>3 years) loans offered in Vehicle and MSME financing and e) loan eligibility (even during cross-sell) determined on assessed cash flows/income and FOIR.

NIM to stabilize with transmission of hikes and product mix shift   

NIM is likely to bottom out in the current quarter with further increase in CoF and lagged/slow benefit of the lending rate hikes taken (25-100 bps) across products. The co. has not raised rates in case of high-yielding products (>18-19% yield) such as PL, 2W and small-ticket (<Rs3 lakh) MSME loans which combined form 15-20% of AUM. Besides the transmission of rate hikes, the continued AUM mix shift towards better yielding products of MSME, Gold Loans and PLs should improve the blended portfolio yield in medium term and support stable margins (around 8.5%).

Reasonable valuation for healthy growth and profitability

We expect 14-15% AUM CAGR and 18-19% earnings CAGR over FY23-25 with average RoA/RoE delivery of 3.3%/16%. For reviewing estimates, we would closely monitor a) pricing and volume growth in used CV/PV segment, b) distribution roll-out of GL and MSME Loans in vehicle financing branches and success in cross-sell, c) emerging signs of stress in PL and MSME Loan portfolios (Stage-2 coverage seems low in these products) and d) cost of funds. Even after a strong run-up in the past 3-4 months, the stock’s valuation is reasonable at 1.4x P/ABV and 8.5x P/E on FY25 estimates. Retain BUY with an upgraded 12m PT of Rs2300

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