2012-11-28 511218=in (icici securit) shriram transport finance

7/29/2019 2012-11-28 511218=in (ICICI Securit) Shriram Transport Finance

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Shriram Transport Finance, November 27, 2012 ICICI Securities

2

TABLE OF CONTENT

Histor ical response to stress shows remarkable strategic c larity .............................3Case study 1: Navigating the credit crisis of end 2008 to mid 2009 ...............................4Case study 2: Navigating the current macro slowdown..................................................5Current NPA classification & provisioning policy ............................................................6Impact of moving NPA reporting standards in line with banks is being overestimated ..7NPA stress test results provide comfort........................................................................11Credit loss sensitivity to macro-economic environment................................................12

Unique competitive advantage protects pricing power, growth opportun ities

remain heal thy................................................................................................................14Market dominance in used CV is absolute and protects yields ....................................18Used CV financing opportunity is Rs801bn growing at an estimated 15.6% over next 5

years..............................................................................................................................18 Internal capacity for growth remains robust..................................................................22Construction equipment finance is an exciting new growth opportunity.......................24

Automalls testimony to STFCs dominance of the asset class ..................................26Multiple growth avenues remain open given captive customer base ...........................26

Liabil ity strategy crucial to margins and business stabili ty .....................................27Diversifying the liability mix ...........................................................................................27STFC will be a beneficiary of softer interest rates ........................................................28Credit ratings are healthy..............................................................................................29Securitisation remains a key enabler of liability strategy and a profit enhancer...........29Multiple regulatory developments may reduce profitability of this route to some extent33

Healthy financials and attractive valuations ...............................................................35Margin outlook is robust................................................................................................35Significant leverage headroom .....................................................................................36Cash levels remain high, a case for higher payouts remain .........................................37Valuations appear quite attractive.................................................................................39Comparative valuations make the picture clearer.........................................................40Risks to our investment theses .....................................................................................41

Financials........................................................................................................................43Index of Tables and Charts ...........................................................................................45


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Case study 1: Navigating the credit crisis of end 2008 to mid2009

In the aftermath of the credit crisis in the US and the consequent global liquidity

crunch, being wholesale funded and being a credit provider in an end-user segment

that was severely affected by the industrial slowdown was a tricky situation for STFC

to negotiate. To understand this better, we need to analyse the impact of such aslowdown on a typical STFC loan end user, a first time truck owner who has just

graduated from being a driver.

Table 1: Trucker economics A typical single vehicle owner

Truck value (Rs) 500,000Loan (Rs) 300,000Annual interest rate (%) 20Tenure (months) 36EMI (Rs) 11,149

Normal scenario Credit crisi s 2009

Utilisation (days) 25


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Chart 1: New vehicle loan book was consciouslyreduced since Sep-08

Chart 2: Cash levels more than doubled in Mar-09,to stave any possible liquidity crunch off

40

45

50

55

60

65

70

Sep-08 Dec-08 Mar-09 Jun-09 Sep-09

(Rsbn)

0

2

4

6

8

10

12

14

(Rsbn)

New CV - AUMs New CV - disbursements (RHS)

16.819.9

53.6

37.6

44.8

0

10

20

30

40

50

60

70

Sep-08 Dec-08 Mar-09 Jun-09 Sep-09

(Rsbn)

Source: Company data, I-Sec research

Case study 2: Navigating the current macro slowdown

Early signs of macro-economic stress started emerging in H1FY12 with i) inflationcontinuing above the RBIs comfort zone of 6% of GDP, ii) elevated oil prices

threatening an already weak fiscal balance, iii) exports to Europe and USA slowing

down and iv) policy log-jams crippling under-construction projects in power, road and

mining segments. Though the government responded in H2FY12 with an elevated

borrowing plan while the RBI continued to hike repo rates in a bid to contain inflation

(at the same time providing liquidity assistance through open market operations since

then), the Index of Industrial Production (IIP) and the GDP growth registered decline

over H2FY12 and H1FY13. The twin effect of low demand and high interest rates

pressurised the profitability of corporate and Small and Medium Enterprises (SME)sectors. Banks too witnessed severe stress, with their mid-corporate and SMEportfolios registering elevated restructurings and slippages over December 2011-

September 2012.

Apart from the usual pressures of a slowdown in industrial activity impacting thefreight market and hence utilisation of trucking fleet, STFC was hit by another event.

The company suffered a slippage of about Rs1bn in a single geography, Bellary,

where a ban on illegal mining hit small truckers involved in transferring mined ore in

the region. Based on this and lowered utilisation adversely affecting the profitability of

truckers in a manner similar to that in FY09 in the aftermath of credit crises (although

freight utilisation was higher this time around), the companys GNPAs touched around

3% for the first time since comparable financials have been available after the three-way merger in 2006. The company affected the following measures to deal with thesituation.

Illegal mining ban

impacted someborrowers


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Chart 3: New CV disbursements consciouslyslowed down since June 2011

Chart 4: With major focus on old CVs, theirproportion increased steadily

0

10

20

30

40

50

60

Old CV New CV

(Rsbn)

Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12

Steady grow th

No growth

76 76 77 77 7879

24 24 23 23 22 21

60

70

80

90

100

Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12

(%)

Old CV New CV


It sharply slowed down disbursement of loans against new commercial vehicles

but let old vehicle loans grow at a healthy rate. The loan book mix consequentlyshifted.

Decreased maximum allowed LTV to 65-70% from 80%.

Cash this time been lower than usual but stood at ~Rs30bn. With the current Non

Convertible Debenture (NCD) issue being subscribed, the cash levels should be

much higher in the next quarter.

Almost completely exited mining as an end-user segment by Q2FY13.

Increased the proportion of retail liabilities as a pre-cautionary insurance against

any liquidity squeeze.

Current NPA classification & provisioning policy

STFCs current provisioning policy is industry-leading in its conservatism. The

company has provided almost twice the minimum requirement stipulated by the RBI. It

has maintained coverage ratio at 80%+.

Table 2: Asset classification and minimum provisioning norms NBFCs

Asset classi fic ation Asset provis ioning

No default in payment of principal andinterest amount

0.25%Standardassets Currently, non-performance of 180 days

results in classification as NPAStandard asset provisioning along with loanloss provisions can be included in tier 2capital to the extent of 1.25% of RWA

Asset is in the NPA state for more than 18months

10%Sub standardassets If loan has been restructured, the asset

remains sub standard for the 12 months ofsatisfactory performance

10%

Asset remains sub standard for a period ofmore than 18 months

100% to the extent which asset is notcovered by security20% if doubtful for 12 month30% if doubtful for 1 year to 3 years

Doubtfulassets

50% if doubtful for more than 3 yearsLoss assets Identified as loss 100%

Source: RBI


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Impact of moving NPA reporting standards in line with banks isbeing overestimated

In keeping to the RBIs circular and guidelines on accounting for NBFCs in 2007,

STFC recognises NPAs on a 180 days basis than on a 90 days basis. The Usha

Thorat Committee report in August 2011 has recommended moving NPA accounting

standards for NBFCs in line with those for banks (90 day recognition). However, thecompany expects NBFCs will be given a window of two-three years to comply with the

guidelines and the raising of standards would be a gradual process. We feel that theimpact of moving NPA standards for NBFCs in line those for the banks has been

exaggerated.

The company is already reporting its off-book assets, which constitutes 35% of itsbooks in line, with the 90-day norm. Hence, the regulation will impact only 65% of its

AUM. The companys incremental bad assets in the 90-180 day bucket lie principally

in the 90-120 day bucket with very little in the 150-180 day bucket. The current

bucketing of doubtful loans is shown in the following chart.

Chart 5: NPA bucketing for STFCs CV business

(%)

2.9

0.5

1.0

1.4

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

180+ 150-180 120-150 90-120(days)

Large proportion of

incremental

NPAs lie in 90-120 day bucket


Hence, if the move to 90 day standards is a gradual one, there may not be much

near-term impact on STFC until reporting norms touch 120 days level.

We feel moving to 90 day standards will raise NPA levels by about 250-300bps on a

secular basis (unless underlying credit quality also improves by means of aneconomic upturn) but will not have much long-run impact on the earnings. The initial

spurt in provisions (if the current provisioning coverage policy is followed) is most

likely to be written back in the subsequent quarters, as the underlying asset behavior

of credit loss will not change (thereby increasing quantum of write-backs as well). If

the company does not keep the coverage ratio at such high levels in the transition

phase, even the initial impact on earnings will be more muted.

The companys management has always been upfront about the fact that if NPA

recognition for NBFCs is moved in line with those for banks, its NPA levels will roughly

double. Changing the disclosure norm may have an immediate impact through an


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earnings shock, but unless there is a significant departure from the levels guided for,

we do not foresee a long-term impact on price.

A strategic concern now being voiced is that with tighter norms, the effectiveness of

targeting STFCs niche customer base will be under pressure, as the customer

segment needs some leeway in payment schedules given their economic standing

and earning patterns. We think that such concerns are unfounded, as STFC as acompany is concerned about the underlying credit loss and will not do anything to

compromise operational fidelity by targeting what in essence is nothing more than a

normative classification (GNPA). We do not mean that the company will not be

sensitive to the same, but changes (if any) in collection method timelines will keep

operational viability as the first priority.

We are assuming that on a conservative basis the regulation will move to 150 days in

Q2FY14, to 120 days in Q4FY14 and to 90 days in Q2FY15. The NPA levels we have

assumed are presented in the following chart. We have built in no improvement in

underlying credit quality.

Chart 6: GNPA trajectory, assuming phased migration to 90 day recognition

(%)

5.85.8

4.34.34.3

3.33.3

2.82.93.02.9

3.0

2.7

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Jun-11

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

Jun-14

Sep-14

Dec-14

Mar-15

180 day recognition 150 day

recognition

120 day

recognition

90 day


A study of the long term P&L provisions and write-offs show that the number hasfluctuated around 0.4% of AUM per quarter (peaking at 0.5%), tying in with the

companys commentary of a sub-2% long-term annual credit loss.

Collection model

unlikely to be

tweaked by much


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Chart 7: Provision ing as propor tion of assets to rise commensurately

(%)

0.7

0.4

0.50.5

0.5 0.5

0.6 0.6 0.6 0.6 0.60.7 0.7

0.30

0.35

0.40

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

Jun-11

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

Jun-14

Sep-14

Dec-14

Mar-15

180 day recognition150 day

recognition

120 day

recognition90 day


We have built in incremental provisioning going up to 0.7% of AUM per quarter in

order to build in the impact of the new NPA norms. We do see significant upside tothe numbers if the implementation is delayed and if the coverage ratio is lowered.

(Our lowest level of assumed coverage is 74.4%, which is probably higher than whatthe actual number will be, as the company has already provided for almost double the

requirement of the current RBI norm).

The securitised portfolio is provided for to the extent of 4.5% in the end of FY12. Wehave been very conservative and have provided for the entire first loss of 5%.


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Table 3: Key NPA details for on-book assets

(Rs mn)

FY09 FY10 FY11 FY12 FY13E FY14E FY15E

Gross NPA (Rs.mn) 3,843 5,113 5,286 6,989 9,491 16,521 26,518Net NPA (Rs.mn) 1,475 1,285 745 992 1,309 4,226 5,944Gross NPA (%) 2.1 2.8 2.6 2.9 2.9 4.3 5.8Net NPA (%) 0.8 0.7 0.4 0.4 0.4 1.1 1.3Provision coverage ratio (%) 61.2 74.9 85.5 85.8 86.2 74.4 77.6


Table 4: Provis ions on consolidated P&L

(Rs mn)


For NPA 1,335 1,458 715 1,455 2,186 4,112 8,280For standard assets 0 0 504 93 221 142 183For credit loss on securitisation 446 797 1,780 1,881 2,493 2,658 2,742For erosion of value in investments 8 2 (8) 18 20 20 20Bad debts written off 1,344 1,867 2,260 4,311 5,237 6,147 7,315Bad debt recovery (77) (55) (63) (61) (1,191) (109) (1,417)Total provisions and write offs(P&L) 3,057 4,069 5,187 7,696 8,966 12,971 17,123


Table 5: Provisions on consolidated balance sheet(Rs mn)


For non-performing assets 2,368 3,826 4,541 5,996 8,182 12,294 20,574% of on-book loans 1.3 2.1 2.3 2.5 2.5 3.2 4.5

For standard assets 0 0 504 597 818 960 1,143For credit loss on securitisation 894 2,499 5,201 7,275 9,147 10,982 12,847

% of off-book loans 1.7 2.2 3.2 4.0 5.0 5.0 5.0Others 1,065 2,133 1,710 1,779 2,290 2,533 2,878Total provi sions 4,327 8,458 11,956 15,646 20,437 26,770 37,443



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NPA stress test results provide comfort

We have also tried to examine the case where the new norms are implemented

overnight in Q1FY14. In this case, we assume NPA levels immediately double to

5.8% and provisioning coverage of 77.6% is still maintained (provisioning being 0.7%

of assets), which will lead to a large profitability knock in Q1FY14. This will shave off

17.3% from FY14 EPS and reduce RoE from 20.9% to 17.6%. However, the impacton FY15 EPS is only 5.1%. We underscore here that this stress test is a combination

of two unlikely outcomes immediate implementation of 90 day norm and coverage

ratio being maintained at 77.6%. Also, FY15 numbers may look much better as creditcosts may fall on account of higher write-backs if the underlying asset quality does not

change.

Chart 8: NPA progression base and st ress case

(%)

3.0 2.9

2.8

3.3 3.3

4.3 4.3 4.3

5.8 5.8

3.0 2.9

5.85.8

5.85.85.85.85.85.8

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Dec-12

Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

Jun-14

Sep-14

Dec-14

Mar-15

GNPAs - base case GNPAs - stress case

Source: I-Sec research

Table 6: Stress test result summaryFY14E FY15E

Base case phased implementationGNPA (Rs.mn) 16,521 26,518NNPA (Rs.mn) 4,226 5,944GNPA (%) 4.3 5.8NNPA (%) 1.1 1.3Provision coverage 74.4 77.6EPS (Rs) 74 85ABV (Rs) 384 457RoE (%) 20.9 20.2Stress case one shot im plementationGNPA (Rs mn) 22,284 26,518NNPA (Rs mn) 4,995 5,944GNPA (%) 5.8 5.8NNPA (%) 1.3 1.3Provision coverage 77.6 77.6EPS (Rs) 61.0 80.7ABV (Rs) 372 439RoE (%) 17.6 19.9Impact on key parametersGNPA (bps) (150) -EPS (%) (17.3) (5.1)ABV (%) (3.3) (3.7)RoE (bps) (328) (33)



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surely have a lagged impact on the broader economy, thereby affecting other two

categories as well.

Chart 11: Lagged impact of industrial activity (IIP) on NPA levels

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

FY07 FY08 FY09 FY10 FY11 FY12 YTD13E

(%)

(10)

(5)

0

5

10

15

20

(%)

GNPAs IIP (RHS)



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The company divides its country operations into six regions. The next level of

reporting is strategic business units (SBUs), each of which has specific number of the

total 513 branches allocated to them. The branches are the basic operating units ofthe business. The number of field officers per branch is about 12-15. Apart from them,

it also has a branch manager and a support staff.

Chart 12: Process flow Loan life cycle

Field

office

Leadgeneration

throughreferrals

AssetInspection &

valuation

Due diligencewith RTO

Collection(including

cash)

Repossess incase of default

DisbursalFixing loantenureAppraisal

LTV Pricing

NPA

B

ranch

M

anager

SBU

Manager

Top

Management


The field officers are the foot soldiers who have conquered this profitable niche for

STFC. They are the one who are in regular direct contact with the customers and the

bulwark of this close-to-the-customer business model. Their skill is the key

competitive strength of the company and includes asset (vehicle) valuation, which is

key to determination of true marketable value of collateral, generation of sales leads

for future origination by utilising their elaborate social networking in the customergroup, collection management (mostly in cash) and if needed repossession as well.

The assessment of credit worthiness of any application rests with the branch manager

as do the responsibility of having proper documentation in place and also of doing due

diligence at the Regional Transport Office. The final power of approval for both fresh

loans and top-ups lies with SBU heads.

A quick glance at the business model of the company reveals that it has quite a few

unique features the disbursement, lead generation and collection responsibilities lie

with the same person, which rules out any conflict of interest or moral hazard; new

customer recruitment relies heavily on referrals, which brings with it an attendantbenefit of social peer pressure in case of adverse borrower behavior; focus on an

underfinanced asset class (5-12 year old vehicles) and an under banked or unbankedcustomer group; and finally, field officers relationship with borrowers including

collections at customers doorstep or at important nodal points of freight trade.

It becomes very obvious on close study that the key competitive advantage of thiscompany is its operating model, and maintaining the fidelity of the same is critical to

its competitive position.

Field officers are key

to the business

model

Hard to replicatemodel is key

competitiveadvantage


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The operational group is like an army within itself. There is almost no lateral hiring in

operational roles with field officers being the only recruitment level. Both the current

and earlier managing directors of the company had started off as field officers androse to the top. The company routinely moves out the non-performers in this group by

either dismissing them or moving them to non-operational activities.

Being from an operational background, the umbilical cord is never really severed forthe top management, as every case of a defaulted loan is continuously escalated,

coming finally to the managing directors purview at a certain point in time.

The company understands the criticality of retaining this field force that is both itsoperating arm as well as its store of domain knowledge, and human resource (HR)

policies are designed to minimise undesirable attrition. Attrition numbers in this group

is low as 1% overall. Apart from the obvious aspiration factor of moving onto a senior

management role someday with educational background that renders such aspiration

unlikely elsewhere, the company has an aggressively designed compensation policy

that rewards performance. As much as 50% of the total take home pay of field officers

is variable. The company also runs an Employee Stock Option Plan (ESOP) scheme

that has already created substantial wealth for a large group of employees.

It is this operational base with an experience and learning of about 33 years in the

domain (since 1979) and its unique policies and systems that are the companys

greatest competitive advantage. This allows it to manage a supposedly ruinous

financing activity at long term credit losses of less than 2% in spite of having grown itsportfolio size from virtually nothing to Rs440bn.

The company runs a business which has two thirds of its collections in cash going on

in a continuous basis to diverse geographies with a minimal leakage. This model hasproved extremely difficult to replicate and has emerged as an example of a naturally

high entry barrier in the asset financing business. All manners of financial institutions

and banks, inspired by STFCs success, have tried to get into the business, but havefailed to make any serious dent in the space. The examination of STFCs competitive

franchise in a Porters five forces framework brings out its strengths.

Management hasears close to the

ground

Entry barriers remainhigh


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Chart 13: Porters five forces analysis

Low competition(lack of organised

player of consequence)

Customer power is low(Best possible opinion

despite high rates)

Suppliers Power is medium(Dependence on

wholesale funding)

Threat of entrants is low

(Operating model

difficult to replicate)

Threat of substitut es is low(100% equity opinion or

gold loan not affordable totrucker)

Mitigation factors

PSL classification driving

securitization demandAA rating and credit

check record

NCD NW 25% of book


Suppliers bargaining power is medium: The only force in the framework that is

not much of an area of strength for STFC is the sources of fund side of the business.

We have dealt in detail with this issue in the third section of the report but suffice to

say that being primarily wholesale-funded, availability of funds for STFC will always be

vulnerable to liquidity squeeze. However, there are multiple mitigating factors whichput STFC on a stable footing in this scenario.

As a dedicated commercial vehicle financier, all its assets have priority sectorclassification. This coupled with the excellent credit quality behavior that its

originated pools have exhibited over the long term has fuelled heavy demand for

securitised assets at pretty attractive spreads for the company. As wedemonstrate later that although new regulations may increase securitisation costs

over the next four years, the route will remain an attractive financing option.

The company is rated AA by Fitch and has now a long credit history, making it a

preferred borrower to most banks.

Retail NCDs are now almost 25% of the companys on-book liabilities, reducing its

institutional dependence.

Customers bargaining power is low: For its unbanked customer niche, even

STFCs high rate of interest of 18-22% presents itself as an extremely attractiveproposition (generating IRR of 123% annualised over the three year loan tenor). The

companys only alternative remains the unorganised money lender who charges aninterest rate of 36-40%. The biggest proof of the low bargaining power of customers is

the stickiness of yields at such high levels for a long period of time.

Threat of new entrants is low: The lure of a 20% yield has over the years attracted

financial companies across the spectrum to this segment, but none of them has made

any serious dent into STFCs market share. The key to this we feel is the difficulty in

replicating STFCs operating model (the only proven one in the segment).


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Threat of substitutes: The only product substitute for STFCs loan in its customer

segment is 100% equity or a gold loan, which will rule out first-time buyers on account

of inadequate resources.

In summary, the companys competitive position is exceptionally strong and the only

chink in the armor is dependence on institutional financing.

Market dominance in used CV is absolute and protects yields

The company with an old CV AUM of about Rs346bn in Q2FY13 has penetrated

about 43% of the total current opportunity size of Rs801bn. The only other players of

some consequence is IndusInd Bank with an old CV book of Rs0.9bn (the bank hasacquired Ashok Leyland Finance), M&M Financial Services (total old vehicle financing

book of Rs1.5bn, no separate data available for CVs) and Sundaram Finance (more

focused on new vehicle financing for large fleet operators). The company has

continued financing old vehicles at between 18-24%, through cycles, for as long as

we could go back in history. This is principally because there is no need to fight for

market share. We expect the basic yield levels to remain firm and under control of the

company barring regulatory intervention.

Used CV financing opportunity is Rs801bn growing at anestimated 15.6% over next 5 years

Change in tonnage profile of Medium and Heavy Commercial Vehicles (M&HCVs)

over FY04-12 coupled with robust growth in Light Commercial Vehicles (LCVs) over

FY09-12 will result in a large financing opportunity for used vehicles over FY14-18.

We feel that inflation of resale values will also have a crucial role to play.

Chart 14: Strong growth in MHCVs and LCVs over

FY09-12

Chart 15:coupled with steady shift tow ards

higher tonnage vehicles within MHCV

149

174202

253

275316

299

410

0

50

100

150

200

250

300

350

400

450

500

MHCVs LCVs

(%o

ftotal)

FY09 FY10 FY11 FY12

26% CAGR33% CAGR

11.6 18.0 17.6 21.6 22.4

45.1 34.026.0

24.1 20.4

43.245.8

50.1 49.5 51.4

0.2 2.3 6.3 4.8 5.9

0

20

40

60

80

100

120

FY04 FY06 FY08 FY10 FY12

(%o

ftotal)

>7.5T &


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new Commercial Vehicle (CV) sales that is available. The following table provides the

size and composition of the 5-12 year pool over the next five years.

Table 7: 5-12 year pool for next 5 years total vehicles

Number of vehicles

FY14E FY15E FY16E FY17E FY18E

MHCVs

>7.5T & 16.2T - Haulage Tractor (Tractor-Semi Trailer/Trailer)>16T 26T & 35.2T 36,034 41,283 50,977 66,944 83,987LCVs3.5T & 5T & 7.5T & 16.2T - Haulage Tractor (Tractor-Semi Trailer/Trailer)

>16T 26T & 35.2T 4.00

LCVs (per uni t)

3.5T & 5T &


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Assuming the representative vehicle of the 5-12 year old pool is an eight-year old

vehicle and that the above depreciation schedule holds true, we arrive at the following

average prices for the current members of the pool in each category.

Table 9: Current 8 year old vehic le price

FY13MHCVs: Goods Carriers (Rs mn /uni t)

>7.5T & 16.2T - Haulage Tractor (Tractor-Semi Trailer/Trailer)>16T 26T & 35.2T 1.44LCVs: Goods Carriers (Rs mn /unit)3.5T & 5T & 7.5T & 16.2T - Haulage Tractor (Tractor-Semi Trailer/Trailer)>16T 26T & 35.2T 55,018 66,814 87,453 121,736 161,892LCVs3.5T & 5T &


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Table 12: 5-12 year old CV financing opportun ity shows 15.6% CAGR in FY13-18

(Rs bn)

Market size FY13E FY14E FY15E FY16E FY17E FY18E5 yr

CAGR (%)

MHCV total 710.5 776.6 875.0 1,011.0 1,196.8 1,390.6 14.4

LCV total 90.0 110.8 132.9 166.3 208.3 263.6 24.0

Total CV 800.5 887.4 1,007.9 1,177.3 1,405.1 1,654.2 15.6


Chart 18:Addressable market opportuni tygrowing at 15.6% CAGR over next 5 years

Chart 19: LCV oppor tunity growing fastest givenstrong new vehicle sales in recent years

711 777875

1,011 1,197

1,391

90

111

133

166

208

264

300

500

700

900

1,100

1,300

1,500

1,700

1,900

FY13E FY14E FY15E FY16E FY17E FY18E

(Rsbn)

Overall valueCAGR - 15.6%

22.4

6.1

23.0

8.0

15.7

36.0

1.2

24.2

0

5

10

15

20

25

30

35

40

7.5-12T

25T

MHCV

(overall)

12yrs

Long haul

national

highway

Interstate

transport

Less than

300km intercity

transport

Local

transportation

Moderate

competitionLow competition No competition

Finance not

available

Shriram Transports expertise

0-5yrs 5-9yrs 9-12yrs >12yrs

Long haul

national

highway

Interstate

transport

Less than

300km intercity

transport

Local

transportation

Moderate

competitionLow competition No competition

Finance not

available

Shriram Transports expertise



22/47


22

Internal capacity for growth remains robust

The field officers are crucial for the companys growth, as they remain the only conduit

for both disbursement and subsequent collection. Two points are worth noting in the

following charts one, after a fall in the later quarters of FY12 (mostly on account of

reassignments), the strength of field officers picked up significantly in the last quarter.,

although the AUM and disbursement per field officer is much higher and have grownat a quarterly CAGR of 3-4% from FY10, at least half of the growth has come from

asset inflation. The company has added almost 35,000 new customers in the past

eight months by opening rural offices, which in some cases are one man offices.Rural ticket sizes are generally about 65-70% of urban ticket size. We feel that the

company is building capacity to ramp up growth (as evidenced in the field officerrecruitment spurt in this quarter) once it has gained confidence in the macroeconomic

situation.

Chart 21: Spike in field officers point to strong impending growth

7,715

8,412

9,001

9,830 9,439 9,339

8,716

8,155

7,546

8,212

6,000

6,500

7,000

7,500

8,000

8,500

9,000

9,500

10,000

10,500

Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12

(Nos)


Chart 22: Steady increase in business handled by field off icers

20

30

40

50

60

Jun-10

Sep-10

Dec-10

Mar-11

Jun-11

Sep-11

Dec-11

Mar-12

Jun-12

Sep-12

(Rsmn)

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

(Rsmn)

AUM per field off icer Disbursement per field off icer (RHS)

CAGR - 3.6%

CAGR - 4.3%



23/47


23

We assume a quarterly sequential growth run rate of 4% in CV AUM

We feel CV AUM could grow by about 5% QoQ in Q3FY13, followed by a sequentialgrowth run-rate of 4% till end FY15. A 4% QoQ growth generally means an annual

growth of around 17% in CV AUM. This is very close to our estimate for market

opportunity growth and will not require much market share gain. We feel there could

be some upside to these numbers if the macroeconomic condition improves.

Chart 23: CV AUM ramp-up

138174

222273 310

375439

514

57

59

70

8891

106

124

145

0

100

200

300

400

500

600

700

Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15

(Rs.bn)

New CVs Old CVs

CAGR-20%

CAGR-18%


Chart 24: 16% CV disbursement CAGR implied given loan repayment patterns

26 2431

4540

4552

6112

4

8

17

10

13

15

17

0

10

20

30

40

50

60

70

80

90


(Rsbn)

Old CVs New CVs

CAGR-16%



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25

The company always tries to operate in credit starved under-banked niches, which

allow it earn a handsome yield and build specialised capabilities rather than be a

me-too player in a competitive space where its cost of funds puts it at a natural

disadvantage against banks. Construction equipment finance qualifies on thisfront.

Unlike the used CV demand, business cycles have more pronounced effect on the CE

demand. Despite the current slowdown, long-term demand for new and used CEs isexpected to remain robust given the proposed infrastructure investment over 2012-17.

While some large construction and infrastructure companies remain under a cloud of

stress, the level of on-the-ground activity still remains healthy at semi-urban and rural

locations. STFC chooses to focus on single unit owners who provide the

subcontractors with their equipment against cash advances, and thus remain largely

insulated from any ballooning of receivables. The capital intensive nature of CEbusiness makes financing an essential part with about 85% of industry purchases

being financed. The used CE financing market is completely unorganised. Also,generally, the ticket sizes are larger in the CE finance business.

With domain specific management bandwidth created within the organisation, we feelSTFC is in a great position to penetrate yet another credit starved niche. We feel thebusiness will clock a QoQ growth rate of 10% for another four quarters and then 8%

QoQ till the end of FY15. Given this growth rate, we have assumed equity infusion

from the parent in two tranches of Rs1bn each over the next three years. We also feel

that the mix of AUM will increasingly shift towards used equipment, thereby pushing

up yields, though we have not built in the same.

Chart 26: CE AUM to post a robust growth over FY13-15E

6

19

29

41

55

0

10

20

30

40

50

60

70

Mar-11 Mar-12 Mar-13 Mar-14 Mar-15

(Rsbn)

CAGR - 37%


Business has some

key differences fromCV financing


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26

Automalls testimony to STFCs dominance of the asset class

The automall concept is a descendant of the Truck Bazaar event that the company

has been organising for long. The idea in this event was initially to organise a meeting

point for buyers and sellers of used CVs including those repossessed by the

company. This is a source of fee income for the company and an opportunity for both

fresh financing as well as a means to gain control of a large multitude of transactionsin its preferred asset class. Automalls have taken this concept forward by providing a

periodic opportunity for such transactions and by acting as a de-facto monopolyexchange for vehicle transactions in the malls catchment area. Vehicles are

auctioned on a regular basis in the central hall and the inaugural auction at its first

Chennai Automall sold 120 vehicles.

The concept has proved so successful that even other financing companies are

trading their repossessed commercial vehicles through these malls in lieu of payment

of a fee. STFC has already set up 10 automalls (including five mini automalls) and

plans to increase them to 20 by the end of FY13. The company is currently clocking

about 12,000 transactions per month through its automalls.

An extension of this idea is Shriram One Stop, which is an electronic kiosk system

that provides a touch screen platform at select branches where a potential buyer

could inspect the available inventory by getting all details on the individual vehicles

including their pictures from eight angles. By the end of Q2FY13 this has already

been launched at around 460 branches. The company expects this business to

generate Rs800mn in revenues in FY13 with Rs80-100mn contribution to PAT.

Multiple growth avenues remain open given captive customerbase

STFC has a customer base of more than 800,000 as of date. Most of these customershave a monthly disposable income of Rs12,000 (net of EMIs). Building in the fact that

this segment is virtually unbanked, STFCs franchise basically holds the solitary key to

access Rs9.6bn of monthly purchasing power. This provides an opportunity for

multiple business models to be layered on the basic operating architecture in future

years. The key businesses where the company can make serious forays are freightbill discounting (STFC has a 40:60 joint venture with Ashok Leyland called Ashley

Transport for this activity, addressable market size estimated at Rs60-70bn annually),credit card distribution and insurance distribution.

Automalls are a feeincome opportunity

Unique access to

Rs9.6bn of monthlypurchasing power


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27

Liability strategy crucial to margins and businessstability

When STFC started operating it had no access to institutional funding and relied

heavily on retail deposits (strengths developed in chit fund business). Even in 1999

bank funds constituted a tiny fraction of its total liability book. The advent of Citicorp in2000 and Axis Bank (UTI Bank then), to whom STFC offered portfolio management

services, went a long way to change STFCs credit perception in institutional financecircles. Subsequently, its long-term credit track record and behavior of securitised

pools made it fairly attractive borrowers for banks and financial institutions.

Diversifying the liability mix

History has however come full circle for STFC, as with increasing institutional profilethe company has started to reduce dependence on wholesale funding with

approximately a quarter of its liabilities now coming from NCDs which it has issued.

Although this route is costlier for the company by about 100bps than the bank

borrowings, the company is willing to bear the cost in order to build strategic strengthsin the retail NCD market.

Table 13: Details o f retail NCDs

(Rs bn) Coupon range Maturity range

Jun-09 10 10.75%-11.25% 3yrs-5yrsMay-10 5 9%-10.5% 3yrs-7yrsJun-11 10 11.0%-11.6% 3yrs-5yrsJul-12 6 10.25%-11.4% 3yrs-5yrs


Chart 27: Evolving liabil ity pro file reducing reliance on banks

59.8 59.8 59.252.9

43.8

21.4 24.1 26.3

23.635.7

6.77.7

11.2

16.3 14.1

5.6 5.0

30%

40%

50%

60%

70%

80%

90%

100%

FY08 FY09 FY10 FY11 FY12

Banks NCDs Sub-ordinate debt Fixed depos its Others



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28

Chart 28: Borrowing profil e large proportion ofunsecured borrow ing

Chart 29: Diversified liabili ty mix March 2012

Secured,

77.6

Un-secured,

22.4 Fixed

deposits,

5.0

Redeemable

NCD, 35.7

Loans from

corporates,

1.4Bank

borrowings,

30.5

Cash credit,

13.3

Sub debt,

14.1

Source: Company data, I-Sec research Source: Company data, I-Sec research

The companys debt schedule details reveal that about 37.2% of debt will expire in a

year. The average duration of its liabilities is about three years which is closelymatched with its asset duration. This low to almost no ALM mismatch gives us

confidence that the company is unlikely to face any payments issue.

Chart 30: Staggered maturit y across instruments March 2012

Chart 31: About a third of liabili ties mature in ayear March 2012

36.6

-

26.5

22.0 33.9

29.5

61.3

18.1

7.415.6

48.0

0%

10%

20%

30%

40%

50%60%

70%

80%

90%

100%

Sub-debt NCDs Banks

< 12 Months 12-36 Months 36-60 Months Over 60 months

Maturity < 1

year, 37.2

Matrutiy > 1

year, 62.8


STFC will be a beneficiary of softer interest rates

Most of STFCs bank borrowings are floating rate in nature. The principal fixed rate

component of liabilities is NCDs. In summation, about 70% of the companys liabilities

are floating rate in nature while all loan assets are fixed rate in nature, making the

company a beneficiary of any cut in headline rates. It should also be noted that

because of the companys dominance in the used CV market, its yields on assets will

remain firm even for incremental lending but yields will soften in the new CV financing

business (23% of AUM). However, banks are not immediate in passing on the benefitto borrowers and any improvement in borrowing costs of STFC will be gradual. We


29/47


30/47


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31

Chart 35: Illust ration of direct assignment route

STFC

borrower

STFC

STFC & other

banks

Bank

Sale of loans

Consideration

for loans

Credit enhancement, Liquiditysupport, 3rd party guarantee

Interest ofprincipal

Original loan

STFC

borrower

STFC

STFC & other

banks

Bank

Sale of loans

Consideration

for loans

Credit enhancement, Liquiditysupport, 3rd party guarantee

Interest ofprincipal

Original loan


The key differences between the structure of PTC and bilateral assignment are as

follows:

There is no SPV with a true sale based ownership of all assets for pooling of all

collections that issues the securities to the investors (banks in this case) and

routes the cash flow to them (banks).

In bilateral assignment, the whole pool goes to one buyer while in a PTC, since

securities are issued, there could be multiple investors with pari passu claims.

Chart 36: Break-up of annual amount securit ised by STFC

0

10

20

30

40

50

6070

80

90

100

Mar-08 Mar-09 Mar-10 Mar-11 Mar-12

(Rsbn)

Securitization (PTCs) Direct assignments


The companys accounting policies on securitisation are conservative and create anassured future revenue stream from deferring revenues even where cash flow has

actualised upfront.

Gains arising on securitisation / direct assignment of assets are recognised over

the tenure of securities issued by SPV / agreements as per guideline onsecuritisation of standard assets issued by the RBI, loss, if any is recognised

upfront. (Note that securitisation deferred consideration receivable comprises of


32/47


32

STFCs share of future interest strip receivables in case of a par structure

securitised / assigned deals.)

Expenditure in respect of securitisation / direct assignment (except bank

guarantee fees for credit enhancement) is recognised upfront.

Bank guarantee fees for credit enhancement are amortised over the tenure of the

agreements.Chart 37: Securitisation NIM is assumed to fall

(%)

8.59.0

9.09.59.5

10.010.5

11.011.511.511.8

12.3

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

15.0

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

Jun-14

Sep-14

Dec-14

Mar-15

Credit enhancement on direct

assignment not allowed


Chart 38: On book/ off book mix annual with projections

77 7762

55 5562 61 61

23 23

38 45 45 38 39 39

0

20

40

60

80

100

120


(%)

On-book AUM Off-book AUM



33/47


33

Chart 39: Annual securitisation to remain robust

88

102

83 79

131

149

0

20

40

60

80

100

120

140

160

Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15

(Rsbn)


Multiple regulatory developments may reduce profitability of this

route to some extent

In a bid to curb the regulatory arbitrage enjoyed by the NBFCs in the form of unlimited

access to low-cost funding from banks in return for originating and selling priority

sector loans, the regulator came out with a slew of regulations over the past eighteenmonths. Multiple committees were set up to deal with securitisation and the regulator

issued specific guidelines for securitisation on minimum holding period, minimumretention ratio and spread cap. Some other regulations that have been proposed but

not accepted include cap on off-book loans (MN Nair Committee).

Table 15: Regulatory developments and their impact

Old norm New norm Impact

Minimum holdingperiod

No such holdingperiod prescribed

6 months of holdingperiod (STFC's loansare have monthlyrepayment andduration of 3 years)

Minimum impact - large loan book toensure adequate availability of loans thatfulfill MHP criterion. ~65% of STFCsloans will generally qualify given assetduration profile.

Minimum retentionrate

No such retentionrequirement

10% of loan poolsecuritised

Minimal impact

Creditenhancements

Used to provideenhancementswith no capitalcharge

No creditenhancementsallowed on directassignment.No such rule for PTCroute.

Direct assignments: margins will declinesharply given the absence of creditenhancementsSecuritisation (PTC): volumes willincrease as this becomes the preferredroute over direct assignments

Interest rate cap onsecuritisation anddirect assignment

(eligibility aspriority sector)

No end userinterest rate cap

End-user interest ratecap on individualassets in the pool:

base rate + 800bps

Large proportion of new CV loans wouldbe securitised.

Source: RBI, I-Sec research

The upshot is that the only regulatory change that impacts STFC is that its assets

cannot get classified as priority sector (the driving force of securitisation demand) iftheir yields are more than 8% higher than the bank base rate. This, we feel, will have

the following impact and we have built the same into our model.


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35

Healthy financials and attractive valuations

Our financial assumptions and the rationale behind them are articulated in thefollowing table.

Table 16: Assumptions and rationale

Item Assumptions RationaleCV AUM growth Sequentially 5% in the coming

quarter and 4% thereafter tillMarch 2015

Old CV financing opportunity expected to grow at 16% every year. Ourimplied 17% YoY growth looks likely without much of a shift in marketpenetration. Also, ramp up in number of field officers is a clear indicationof acceleration.

Percentage of CV loans off book Fluctuates between 35% and38% depending on theparticular quarter

Even Nair Committees recommendations allow for 35% of loans to be offbook. Also remember that the percentage assumed is just on CV loanbook and does not include CE loans.

Percentage of old CV loans intotal CV loans

Maintained at 78% Historically has not fluctuated by much from this number. In fact, we feelthe number can be higher providing upside to yield estimates.

Yield on on-book CV loans Starts to go up by 10bps everyquarter

As more new vehicle loans are securitised on account of the 8% spreadcap on pool asset yields from base rate, in order for PSL classification

NIM on securitisation Going down from 11.8%currently to 8.5% by March2015

The spreads go down as lower yield assets are incrementally securitisedon account of the spread cap, and the increased costs of the bilateralassignment route on account of no scope for credit enhancement.

Growth in CE AUMs Growth of 10% QoQ for the

first 4 projected quarters and8% from there on till March2015

Portfolio currently growing at 11.8% QoQ and with a big ramp-up in

operations taking place our growth assumptions look fair barring amassive deterioration in macroeconomic outlook.

Yield on CE book 17% Marginally below current levels. Could see upside as proportion of oldCE loans increase with the company gaining more confidence in thebusiness.

Cost of debt 50bps improvement from FY12to FY15

Interest rate cuts expected at some stage. Numbers again could providefurther upside.

Non staff non-interest expenses Expected to continue at thesame levels as percentage ofoperating assets (AUM)

No efficiency gains factored in

Employee costs 1.5% QoQ salary inflation and2% QoQ manpower additionassumed

Employee ramp-up will continue in order to deliver the growth thecompany has guided for

P&L provisions and write-offs Assumed to rise from 0.45% ofAUM per quarter currently to

0.7% by end FY15

Higher provisioning on account of our assumption of maintaining 74%minimum coverage even when 90% norms come into place. The actual

number could be smaller given higher proportion of expected write-backsunderlying credit quality does not change.Source: I-Sec research

Margin outlook is robust

We believe STFCs margins are not going to erode much, but in fact could see some

upside from our projected numbers as

In the CV financing business, we believe that yields will remain firm in old CVfinancing while there may be some drop in new CV financing rates. On a blended

basis, impact on yields will be minimal.

Argued earlier, STFC is a beneficiary of any cut in headline interest rates on theborrowing cost side.

The impact on bilateral assignment costs on account of credit enhancementrestrictions will not be more than 100 bps on the total incremental securitisation,

with impact on total securitisation portfolio being even lower.

Although we have built in very slight deterioration of NIM, we believe there could be

some upside to our NIM assumptions.


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36

Chart 40: Minimal impact on blended NIMs

7.16.3

5.6

4.7

5.86.16.5

8.69.8

10.7

12.812.4

9.5

8.4

7.67.57.4

7.88.2

7.06.9

2

4

6

8

10

12

14

Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15

(%)

On-book NIM Off-book NIM Blended NIM


Significant leverage headroom

A quick look at STFCs capital adequacy levels is enough to reveal that the company

is following an extremely conservative strategy on financial leverage and there is

significant scope for increasing leverage.

The companys tier 1 capital adequacy is 17.3% in FY12, which is the highest in past

10 years. The RBI stipulation for tier 1 capital is 12% for a deposit-taking NBFC like

STFC.

Table 17: Capital adequacy

(Rs mn)

FY07 FY08 FY09 FY10 FY11 FY12

CAR (%) 13.6 12.7 16.4 21.4 24.9 22.3Tier 1 CAR (%) 10.3 9.8 11.1 16.0 16.6 17.3Tier 2 CAR (%) 3.4 2.9 5.2 5.3 8.2 5.0Tier 1 capital (Rs m) 8,410 14,832 19,947 28,750 32,856 41,271Tier 2 capital (Rs m) 2,773 4,326 9,355 9,565 16,270 11,956Shareholders funds 10,864 18,164 23,166 38,441 48,934 60,326Credit enhancement and otherdeductions from tier 1 2,454 3,331 3,220 9,692 16,078 19,056CE and other deductions from tier 1 asa % of off book AUM 6.7 7.6 6.0 8.7 9.9 10.5


A look at the (following) chart on gross and net debt equity makes it clear that

company in its current balance sheet management strategy is continuing to

deleverage.


37/47


37

Chart 41: Gross and net debt to equity ind icatesignificant leveraging headroom

Chart 42: Leverage (loan assets to equity set toimprove over FY13-15E)

8.18.7

4.8

4.1 4.0 3.8 3.8 3.8

7.4

6.2

3.6 3.43.1 3.2 3.2 3.2

2

3

4

5

6

7

8

9

10

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

Mar-15

(%)

Gross Debt-Equity ratio Net Debt-Equity ratio

8.37.7

4.7

4.0 4.04.5 4.4 4.4

3

4

5

6

7

8

9

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

Mar-15

(%)


Cash levels remain high, a case for higher payouts remain

A look at FY12 balance sheet brings out that cash and liquid investments remain at

24.2% of the total balance sheet assets, its highest levels ever. Of this cash, if it is

assumed that the quantum maintained in current account is working capital on a

rolling basis and if margin money deposits that are used as credit enhancements are

excluded, there are still cash equivalents worth 14.5% of the balance sheet.

If we look at the past dividend payouts of the company, it used to be 30% of net profit

till FY08 in a phase of blistering asset growth. Currently, payout ratio has come down

to 12%. In our assumptions, in line with the management commentary, we have

maintained payouts at similar levels. However, when we look at the surplus cash onthe balance sheet and realise that the company has a lot of headroom for leverage,

the case for raising payouts and increasing leverage becomes very strong as a

means to adding shareholder value.

Table 18: Liquid assets remain plentiful

(Rs mn)

FY07 FY08 FY09 FY10 FY11 FY12

Cash in current account (X) 2,641 4,526 9,560 16,602 9 ,384 21,062Margin money deposit (enhancements) (Y) 3,664 6,479 11,537 20,596 18,225 14,500Other cash (Z) 11,801 903 35,303 6,935 9,505 17,656Total cash (A) = (X+Y+Z) 18,106 11,908 56,400 44,133 37,114 53,218Liquid investments (B) 2,121 13,736 6,270 18,064 33,415 36,045Cash and cash equivalents - C= (A+B) 20,227 25,644 62,670 62,198 70,530 89,263Total balance sheet assets 108,355 182,684 249,633 268,997 319,675 368,195



38/47


38

Chart 43: High proportion of discretionary liqu id assets on balance sheet

5.8 6.08.5

13.8

8.6 9.7

12.8 8.0

16.79.3

13.414.6

0

5

10

15

20

25

30

35

40

0

5

10

15

20

25

30

Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12

(%)

(%o

fBSasse

ts)

Other liquid assets Cash in current account and marg in money Payout ra tio (RHS)

Source: Company data, I-Sec researchNote: We assume current account cash and margin money deposits are operating in nature; other liquid assetsare discretionary.

Return ratios remain healthy despite heavier balance sheetEven with the extreme conservative stance that the company has taken on cash

preservation and leverage, RoE continues to stay above 20%. Decreasing tier 1 CAR

by 200bps, our estimation could provide at least 300bps boost to RoE. Another fact

that could boost RoE is that credit enhancements will no longer be required forbilateral assignments and thereby free up tier 1 capital.

Table 19: RoAE tree

(%)

FY07 FY08 FY09 FY10 FY11 FY12 FY13E FY14E FY15E

NII/ average assets (A) 7.7 8.2 7.9 8.4 10.3 10.0 9.6 9.9 10.1Net other income/ average assets (B) 0.2 0.1 0.2 0.2 0.5 0.6 0.7 0.7 0.7Cost to income ratio (C) 32.7 29.7 30.1 22.8 26.0 25.3 23.4 22.4 21.6

Provisions and writeoffs/ average assets (D) 2.0 1.7 1.4 1.6 1.8 2.2 2.3 2.8 3.2Tax rate (E) 34.2 35.7 33.5 34.1 33.8 33.1 33.0 33.0 33.0RoAA (F) = ((A+B)x(1-C) - D)*(1-E) 2.2 2.7 2.8 3.4 4.1 3.8 3.8 3.7 3.6Avg total assets/ avg net worth (G) 9.0 10.0 10.5 8.4 6.7 6.3 5.9 5.7 5.7RoAE = FxG 20.0 26.9 29.6 28.3 27.9 24.0 22.2 20.9 20.2

Source: I-Sec research, Company

Chart 44: Returns ratios remain healthy over FY13-15E

26.929.6 28.3

27.9

24.022.2

20.9 20.2

2.8

3.4

2.7

4.13.8

3.8 3.7 3.6

0

5

10

15

20

25

30

35

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

Mar-15

(%

)

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

(%)

RoE RoA (RHS)



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39

Valuations appear quite attractive

A quick look at STFCs historical trading bands shows it is trading at valuation levels

which have been worse only in the period of global credit squeeze. We feel that the

derating brought about by regulatory uncertainties and souring of asset quality makes

the valuations really attractive.

Chart 45: Rolling 1-year forward P/E ratio Chart 46: Rolling 1-year forward P/ABV ratio

0

200

400

600

800

1,000

1,200

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

Oct-11

May-12

Nov-12

(Rs)

5x

8x

11x

14x

0

200

400

600

800

1,000

1,200

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

Oct-11

May-12

Nov-12

(Rs)

1.0x

1.75x

2.25x

3.0x

Source: Bloomberg, I-Sec research Source: Bloomberg, I-Sec research

We also see that STFC is trading at a 12% and 27% discount to its 5 year average

P/E and P/B multiples.

Chart 47: Historical P/E Chart 48: Historical P/ABV

0

2

4

6

8

10

12

14

16

18

Nov-07

Apr-08

Sep-08

Feb-09

Jul-09

Dec-09

May-10

Oct-10

Mar-11

Aug-11

Jan-12

Jun-12

Nov-12

(Rs)

Avg P/E - 9.7x

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Nov-07

Apr-08

Sep-08

Feb-09

Jul-09

Dec-09

May-10

Oct-10

Mar-11

Aug-11

Jan-12

Jun-12

Nov-12

(Rs)

Avg P/B - 2.2x

Source: Bloomberg, I-Sec research Source: Bloomberg, I-Sec research


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Comparative valuations make the picture clearer

A lot of STFCs peer companies have had strong stock price performance on the back

of reasons as diverse as expectation of banking licenses being granted, high growth

plans being disclosed, improvement in asset quality and emergence of new asset

class capabilities. A quick comparison of STFC with its peers in the context of hard

numbers shows why STFCs risk-return appears attractive to us.

Chart 49: Att ractively pr iced vis--vis NBFC peers

MMFSL

Shriram

Transport

Bajaj

Finance

Chola Invst

Sundaram

Finance

Shriram City

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

5 7 9 11 13 15 17 19 21 23 25

RoE (%)

P/BV(x)

MMFSL

Shriram

Transport

Bajaj

Finance

Chola Invst

Sundaram

Finance

Shriram City

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

4.0 9.0 14.0 19.0 24.0 29.0

EPS CAGR (%)

P/E(x)

Note: Prices as of Nov 26,12Source: Bloomberg, I-Sec research

Table 20: Comparative valuation summary

P/E (x) EPS CAGR (%) P/BV (x) RoE (%) Dividend yield (%)

(FY14E EPS) (FY13-15E) (FY14E BV) (FY14E) (cur rent )

MMFSL 11.3 18.8 2.3 22.8 1.4Shriram Transport 8.5 14.1 1.6 20.9 1.0

Bajaj Finance 8.7 21.6 1.8 22.1 0.9Chola Invst 8.2 26.4 1.5 20.5 1.1Sundaram Finance 11.6 7.6 2.1 20.1 1.6Shriram City 8.6 21.4 1.8 22.9 0.7

Source: Bloomberg, I-Sec research

Target price set at Rs 850, 35% upside in next 12 months

We think that given the RoE profile of the company and its long term valuation history,

a valid 12 month target P/B multiple for this company will be 2.2xFY14E BVPS. This

provides us with our target of Rs850 indicating a 12 month upside of 35%. We initiate

coverage on the stock with a BUY recommendation.


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Risks to our investment theses

Further deterioration of economic scenario

As we have argued earlier, freight volumes (key to trucker profitability) is the key

macroeconomic variable impacting STFCs business outlook. Indias economicdeceleration and industrial slowdown have had an impact on trucker economics

(though not as pronounced as it was in March 2009). However, if the economic

situation worsens further we see the following risks to our investment thesis.

Souring of underlying asset quality: The most direct impact that we see of sucha slowdown is utilisation of trucker fleets going down further, as freight volume

levels drop. When this happens, the spread between truckers monthly gross

income (net of fuel cost) and the EMI payable on the loan starts to dip. This

lowering of EMI affordability and attendant cash flow strains will immediately start

to show up in STFCs underlying asset quality (though the 180 day NPA norms

ensure a lagged impact on reported numbers).

Slower-than-expected growth: Loan asset growth for STFC is driven more by

internal preparedness and willingness than by competitive environment given the

companys niche dominance and still low levels of penetration. However, the

souring of asset quality generally rings the alarm bells in the psyche of managers

and inevitably slows down loan growth. This will put our earnings projections at

risk.

Deterioration of return ratios on account of excess balance sheet

conservatism: As we argued earlier, STFC currently is carrying a large chunk of

cash and cash equivalents on its balance sheet (24% of balance sheet assets).The tier 1 CAR of the company at the end of FY12 stood at 17.3% versus the 12%

it needs to conform to and the gross and net leverage is also at its lowest everlevels. This balance sheet conservatism is likely to increase further in a stressed

scenario, as the company will rightly choose prudence over bravado. In such a

scenario, the return ratios will look less attractive than it has in past and may lead

to a derating.

Execution risks in construction equipment finance business

STFC is not new to the construction equipment finance business but the scale of

operation has always been small relative to its size in CV financing. Dedicating

resources to the business (creation of an independent wholly-owned subsidiary with

its own management team) shows its ambition for a faster growth. (11.8% QoQ loan

growth being clocked currently). There is execution risk involved in this rapid ramp-upthat one needs to be cognizant of as the companys knowledge depth in this business

has to be lower than its core business. However, we drive comfort from the fact thatthe business does fit into the companys core competence of financing cash flow

generating assets, end-user financing, livelihood linked lending, use of its field officer

model for customer interaction depth and choice of small ticket size unbanked

customers who are trying to upgrade from being operator to owner.

Worsening macroremains biggest risk


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Financials

Table 21: Income statement summary

(Rs mn, year ending March 31)

FY10 FY11 FY12 FY13E FY14E FY15E

Fund based income 36,539 36,200 37,594 47,903 60,537 73,843Income from securitisation 7,838 17,003 22,153 19,449 19,788 20,413

Fee & trading income 305 892 1,155 1,650 2,269 2,784Income from operations 44,682 54,095 60,901 69,001 82,593 97,040Interest Expenses 22,519 22,928 25,317 29,439 34,905 39,759Net interest income 21,858 30,275 34,429 37,912 45,419 54,497Net Op Income 22,163 31,167 35,584 39,562 47,688 57,281Non operating income 277 675 914 1,009 1,110 1,212Gross Operating Profit 22,441 31,842 36,498 40,571 48,798 58,494Staff Expenses 2,251 3,711 4,076 4,429 4,800 4,975Depreciation 150 113 174 200 230 260Operating expenses 2,726 4,456 4,977 4,877 5,887 7,388Total Non-Interest Expenses 5,126 8,280 9,226 9,506 10,917 12,623Pre provision operating profits 17,314 23,563 27,271 31,064 37,881 45,871Provisions & write-offs 4,069 5,187 7,696 8,966 12,971 17,123Pre-Tax Profit 13,246 18,375 19,575 22,099 24,910 28,747Tax Rate (%) 34% 34% 33% 33% 33% 33%Net Profit 8,731 12,171 13,088 14,806 16,690 19,261

Share of profit/ (loss) of associate (1) (0) 1Minority interest 0 0 0PAT after minority interest and share of profit/ (loss) of associate 8,730 12,171 13,088 14,806 16,690 19,261Extraordinary Items 0 0 0 0 0 0Adjusted PAT 8,730 12,171 13,088 14,806 16,690 19,261


Table 22: Balance sheet summary

(Rs mn, year ending March 31)


Total equity capital 2,255 2,262 2,263 2,265 2,265 2,265Reserves & surplus 36,186 46,672 58,063 70,617 84,789 101,135

Shareholders funds 38,441 48,934 60,326 72,882 87,054 103,400Secured loans 151,725 151,694 187,182 214,131 260,903 312,457Unsecured loans 32,874 50,123 54,185 62,313 71,660 82,408

Total debt 184,599 201,817 241,367 276,443 332,562 394,866Net Deferred Tax liability (747) (1,542) (2,183) (3,018) (4,102) (5,512)Total sources of funds 222,293 249,209 299,510 346,307 415,514 492,753

Total fixed assets 465 435 537 772 942 1,182Loans & advances 179,792 146,965 165,287 227,282 264,199 307,209Investments 18,556 34,774 36,663 42,529 49,333 57,226

Inventories 0 129 9 20 30 40Sundry Debtors 0 0 3 0 0 0Cash & bank balance 45,395 37,114 53,218 45,110 58,150 66,190Loans 23,915 98,782 110,641 100,000 120,000 150,000Other current assets 502 1,475 1,838 2,298 2,872 3,590

Total current assets 69,813 137,501 165,709 147,428 181,052 219,820Current liabilities 38,246 58,510 53,039 63,647 76,376 91,651Provisions 8,458 11,956 15,646 20,437 26,770 37,443

Total current liabilities & provisions 46,704 70,466 68,685 71,703 80,011 92,684Net current assets 23,109 67,035 97,024 75,725 101,040 127,136Misc exp not written off 371 0 (0) 0 0 0Total uses of funds 222,293 249,209 299,510 346,307 415,514 492,753



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Table 23: Ratio summary

(%, year ending March 31)


Growth (%)New CV disbursement 59 74 -23 21 20 17Old CV disbursement 22 26 5 18 6 17CV Disbursement 28 35 -2 19 9 17CE disbursement 35 30

Net Op Income 29 41 14 11 21 20Net Interest Income 28 39 14 10 20 20Pre provisioning operating profits 41 36 16 14 22 21APAT 43 39 8 13 13 15EPS 29 39 7 13 13 15On book loan assets 0 10 21 37 17 19Securitised book 109 46 12 0 20 17Securitisation in the year 0 17 (18) (5) 66 13

Profitabilit y (%):NIM - on book 6.1 5.8 4.7 5.6 6.3 7.1NIM - securitised piece 9.5 12.4 12.8 10.7 9.8 8.6NIM - AUM 7.0 8.2 7.8 7.4 7.5 7.6Average cost of funds 11.7 11.9 11.4 11.4 11.5 10.9Non-interest income as % of total 0.6 1.2 1.5 1.4 1.3 1.2Cost to income ratio 22.8 26.0 25.3 23.4 22.4 21.6Op.costs/avg. earning assets (%) 1.5 2.4 2.3 1.7 1.7 1.8

Increase in unit staff costs (%) 7.8 23.7 23.4 11.1 0.1 -4.2Salaries as % of non-int.costs (%) 43.9 44.8 44.2 46.6 44.0 39.4Revenue/employee (Rs mn) 3.5 3.2 4.1 4.8 5.2 5.7Assets/employee (Rs mn) 17.5 14.7 19.9 23.5 26.1 28.5APAT margin 19.4 22.2 21.2 21.1 19.9 19.6Tax Rate 34.1 33.8 33.1 33.0 33.0 33.0

Leverage & Capital (%):Gross Debt-Equity ratio 4.8 4.1 4.0 3.8 3.8 3.8Net Debt-Equity ratio 3.6 3.4 3.1 3.2 3.2 3.2Loan assets/ shareholders funds 4.7 4.0 4.0 4.5 4.4 4.4CAR (%) 21.4 24.9 22.3 21.1 21.9 22.0Tier 1 CAR (%) 16.0 16.6 17.3 16.1 16.9 17.0Tier 2 CAR (%) 5.3 8.2 5.0 5.0 5.0 5.0

Per share data

EPS (Rs) 38.7 53.8 57.8 65.4 73.7 85.0BVPS (Rs) 170.5 216.4 266.6 321.8 384.4 456.5DPS (Rs) 6.0 6.5 6.5 8.5 9.5 11.0

Asset quali ty data (%)GNPA 2.8 2.6 2.9 2.9 4.3 5.8NNPA 0.7 0.4 0.4 0.4 1.1 1.3Provision coverage 74.9 85.5 85.8 86.2 74.4 77.6

Return ratios (%)Return on average net worth 28.3 27.9 24.0 22.2 20.9 20.2Return on average assets 3.4 4.1 3.8 3.8 3.7 3.6Payout Ratio 17 15 12 11 13 13



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Index of Tables and Charts

Tables

Table 1: Trucker economics A typical single vehicle owner ..............................................4Table 2: Asset classification and minimum provisioning norms NBFCs............................6Table 3: Key NPA details for on-book assets .....................................................................10Table 4: Provisions on consolidated P&L ...........................................................................10Table 5: Provisions on consolidated balance sheet ...........................................................10Table 6: Stress test result summary ...................................................................................11Table 7: 5-12 year pool for next 5 years total vehicles ....................................................19Table 8: New CV prices ......................................................................................................19Table 9: Current 8 year old vehicle price ............................................................................20Table 10: Market sizing for FY13E .....................................................................................20Table 11: 5-12 year old CV financing opportunity category-wise .......................................20Table 12: 5-12 year old CV financing opportunity shows 15.6% CAGR in FY13-18..........21Table 13: Details of retail NCDs .........................................................................................27Table 14: Shortfall in priority lending by banks securitisation opportunity.......................30Table 15: Regulatory developments and their impact ........................................................33Table 16: Assumptions and rationale .................................................................................35Table 17: Capital adequacy ................................................................................................36Table 18: Liquid assets remain plentiful ............................................................................37Table 19: RoAE tree ...........................................................................................................38Table 20: Comparative valuation summary ........................................................................40Table 21: Income statement summary ...............................................................................43Table 22: Balance sheet summary .....................................................................................43Table 23: Ratio summary....................................................................................................44Charts

Chart 1: New vehicle loan book was consciously reduced since Sep-08.............................5Chart 2: Cash levels more than doubled in Mar-09, to stave any possible liquidity crunch

off ....................................................................................................................................5Chart 3: New CV disbursements consciously slowed down since June 2011 .....................6Chart 4: With major focus on old CVs, their proportion increased steadily ..........................6Chart 5: NPA bucketing for STFCs CV business.................................................................7Chart 6: GNPA trajectory, assuming phased migration to 90 day recognition .....................8Chart 7: Provisioning as proportion of assets to rise commensurately.................................9Chart 8: NPA progression base and stress case.............................................................11Chart 9: Freight index relatively sticky on downside & maintained upward trend ..............12Chart 10: Drop in freight utilisation leads to increase in NPA.............................................12Chart 11: Lagged impact of industrial activity (IIP) on NPA levels .....................................13Chart 12: Process flow Loan life cycle.............................................................................15Chart 13: Porters five forces analysis ................................................................................17Chart 14: Strong growth in MHCVs and LCVs over FY09-12.........................................18Chart 15:coupled with steady shift towards higher tonnage vehicles within MHCV .......18Chart 16: Residual value schedule MHCVs.....................................................................19Chart 17: Residual value schedule LCVs ........................................................................19Chart 18:Addressable market opportunity growing at 15.6% CAGR over next 5 years .....21Chart 19: LCV opportunity growing fastest given strong new vehicle sales in recent years

......................................................................................................................................21 Chart 20: Financing opportunities over life cycle of a typical 9 tonne truck........................21Chart 21: Spike in field officers point to strong impending growth......................................22Chart 22: Steady increase in business handled by field officers ........................................22Chart 23: CV AUM ramp-up................................................................................................23Chart 24: 16% CV disbursement CAGR implied given loan repayment patterns...............23


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Chart 25: Old / new CV mix expected to remain stable over FY13-15E ............................24Chart 26: CE AUM to post a robust growth over FY13-15E ...............................................25Chart 27: Evolving liability profile reducing reliance on banks.........................................27Chart 28: Borrowing profile large proportion of unsecured borrowing.............................28Chart 29: Diversified liability mix March 2012 ..................................................................28Chart 30: Staggered maturity across instruments March 2012 .......................................28Chart 31: About a third of liabilities mature in a year March 2012...................................28Chart 32: Declining interest rates to aid borrowing costs ...................................................29

Table 33: Credit ratings table..............................................................................................29Chart 34: A typical securitisation structure (PTC route) .....................................................30Chart 35: Illustration of direct assignment route .................................................................31Chart 36: Break-up of annual amount securitised by STFC ...............................................31Chart 37: Securitisation NIM is assumed to fall ..................................................................32Chart 38: On book/ off book mix annual with projections ...................................................32Chart 39: Annual securitisation to remain robust................................................................33Chart 40: Minimal impact on blended NIMs........................................................................36Chart 41: Gross and net debt to equity indicate significant leveraging headroom.............37Chart 42: Leverage (loan assets to equity set to improve over FY13-15E)........................37Chart 43: High proportion of discretionary liquid assets on balance sheet ........................38Chart 44: Returns ratios remain healthy over FY13-15E....................................................38Chart 45: Rolling 1-year forward P/E ratio ..........................................................................39Chart 46: Rolling 1-year forward P/ABV ratio .....................................................................39Chart 47: Historical P/E.......................................................................................................39Chart 48: Historical P/ABV..................................................................................................39Chart 49: Attractively priced vis--vis NBFC peers.............................................................40


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2012-11-28 511218=in (icici securit) shriram transport finance

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