Non Banking Finance Companies: Capital X Leverage Growth

Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.
December 19, 2005 FOR PRIVATE CIRCULATION

Jay Prakash Sinha
jay.sinha@kotak.com
+9122 56341207
Non Bank i ng Fi nanc e Compani es
Capital x Leverage = Growth
Sector Report
Non Banking Financial Institutions play a crucial role in broadening access to financial services, enhancing
competition and diversification of the financial sector.
RBI report on trends in banking, 2005
Non Banking Financial Companies (NBFCs) have come a long way from the era of concentrated
regional operations, lesser credibility and poor risk management practices to highly sophisticated
operations, pan-India presence and most importantly an alternate choice of financial
intermediation (not an alternate choice of banking as NBFCs still operate with lots of limiting
factors, which make them non-comparable to banks).
It is true that the difference between commercial banks and NBFCs is getting increasingly
blurred as NBFCs are today present in almost all the segments of financial sector save cheque
issuance and clearing facility. NBFCs are now recognized as complementary to the banking
system capable of absorbing shocks and spreading risks at times of financial distress. The
Reserve Bank of India (RBI) also recognises them as an integral part of the financial system
and is trying to improve the credibility of the entire sector.
Today, NBFCs are present in the competing fields of vehicle financing, hire purchase, lease,
personal loans, working capital loans, consumer loans, housing loans, loans against shares,
investments, distribution of financial products, etc. More often than not, NBFCs are present
where the risk is higher (and hence the returns), reach is required (strong last-mile network),
recovery has to be the focus area, loan-ticket size is small, appraisal & disbursement has to
be speedy and flexibility in terms of loan size and tenor is required.
The key differentiating factor working in favour of NBFCs is service. Today, a borrower is
looking for more convenience, quick appraisal & decision-making, higher amount of loan-to-
value and longer tenor. Though banks are not behind on the service aspect, they are largely
limited to urban centres. When it comes to semi-urban and rural centres, particularly where
the banking culture still not fully developed, NBFCs enjoy an edge over banks. However, even
in the urban areas, NBFCs have created niches for themselves, which are often neglected by
banks e.g. non-salaried individuals, traders, transporters, stock brokers, etc, and all these
categories are growing at a rapid pace.
New opportunities like home equity, credit cards, personal finance, etc, is expected to take
NBFCs to a new level. Growth in all these segments is sustainable at a higher rate than before
given the low penetration and changing demography in the country. Secondly, 100% cover for
public deposits would ensure higher credibility to the sector. Thirdly, capital had always been
a limiting factor for the sector. In a booming economy and the capital market, we expect that
these companies are now in a better position to raise capital at competitive rates to fuel their
future growth plans. Fourthly, better risk management and regulatory practices, NBFCs enjoy
a higher credibility today. Last but not the least, due to an established reach and network,
NBFCs could be the favourites of the foreign financial giants to make an inroad in the country.
The RBI has proposed to open the domestic market for foreign banks after FY2009 and some
of the foreign banks would not hesitate to shake hands with NBFCs to hit the ground running.
We believe that the sector is today at an inflection point and is likely to take a big leap in terms
of growth and profitability going forward.
NBFCs growth had been
constrained due to lack
of adequate capital.
Going forward, we believe
capital infusion and
leverage thereupon would
catapult NBFCs into a
different zone altogether.
We believe that the
sector has a lot more
potential to grow BIG
over the next 2 years.
Potential upside could be
much larger than our
estimates, if the
expanded capital base is
adequately leveraged
Companies covered
Shriram Transport Finance (STF)
Shriram City Union Finance (SCUF)
Cholamandalam Investment (CIFL)
Sundaram Finance (SFL)
Comparision of key parameters
CMP Reco RoE (%) RoAA (%) Spread (%) P/ABV (x) D/E (x) CAR (%)
(Rs) FY06E FY07E FY06E FY07E FY06E FY07E FY06E FY07E FY06E FY07E FY06E FY07E
Shriram Transport (merged) 119 HOLD 25.8 25.8 3.1 2.9 8.7 8.7 3.2 2.7 6.8 7.4 13.7 12.6
Shriram City Union Finance 149 BUY 38.2 38.5 3.9 4.1 11.9 11.8 5.5 4.0 7.1 7.1 12.1 12.8
Cholamandalam Investment 179 BUY 12.2 17.5 2.2 2.8 7.7 7.6 2.3 2.1 4.6 5.8 17.8 14.8
Sundaram Finance 396 BUY 11.8 12.5 1.8 1.8 4.9 4.8 1.5 1.4 5.7 5.9 14.6 14.4
Source: Kotak Securities - Private Client Research
December 19, 2005 Kot ak Sec ur i t i es - Pr i vat e Cl i ent Resear c h
Sector Report Please see the disclaimer on the last page For Private Circulation 2
SWOT analysis of NBFC
Strengths
High on service aspect
Strong last-mile approach
Focus on recovery
Easy and fast appraisal & disbursements
Regional kshatraps
Able to generate higher yield on assets
Attained critical mass in terms of size
Own employees vs DSAs
Opportunities
Augmentation of capital and leveraging for growth
Large untapped market, both rural & urban and also
geographically
Demographic changes and under-penetration
New opportunities in credit card, personal finance,
home equity, etc
Tie-up with global financial sector giants
Blurring gap with banks in terms of cost of funds
Securitisation, to liberate funds to fuel asset growth
Weakness
Weak in urban market
Weak credit history of most NBFCs
Largely restricted to the south India market
Weaker risk-management & technology systems
Too much of diversification from core business
Higher regulatory restrictions
Threats
Weak financial health of many of the NBFCs
High cost of funds
Asset quality deterioration may not only wipe out profits
but also networth
Entry of foreign players in post-2009 scenario
Growing retail thrust within banks
Growth path for NBFCs in future
Get the global expertise
& products
Larger NBFCs
with critical mass;
Focus on returns
& profits
Increase Reach,
Capital, Branding
Get innovative
products; Tie-ups
with global
financial giants
(preferably)
Multiply its size;
look to convert
into a bank
Consolidate their
positions; identify
various revenue
streams
Reduction in cost
of funds
Profile
NBFCs operations can largely be categorised into equipment leasing, hire purchase,
investments and loans. There are 13,261 NBFCs, of which 507 were public deposit accepting
companies. Though the number of registered NBFCs is pretty high, there are only 16 companies
with an asset size of above Rs.5.00bn and collectively they held nearly 4/5
th
of total assets of
all NBFCs.
However, the size of NBFCs is very small compared to the banking industry. In June 2004,
NBFCs size was merely 5.7% of gross banking credit, which further deteriorated to 4.5% in
June 2005. There are two reasons for such decline- one, the banking credit growth has been
extremely good in FY05 i.e. at nearly 32.2% compared to 4.3% growth in NBFCs case. Secondly,
the number of NBFCs (deposit taking) is consistently declining over a period of time. It declined
from 875 in FY03 to 777 in FY04 and further to 573 in FY05. Nonetheless, we expect the
growth in larger NBFCs asset to be in the range of 25-30% over next two years.
Regional presence
NBFCs have typically grown in the southern part of the country. Most of the NBFCs have
started their journey as chit-funds and then largely catering to the growing needs of individuals,
forayed into much-better organized non-banking operations. Though there are no concrete
reasons why NBFCs are more deep-rooted in south India, we understand that it is largely
because of demographic patterns.
# of NBFCs accepting public deposits
Source: RBI, Trends & progress of Banking in India, 2004-05
NBFC assets as % of banks assets (%)
400
500
600
700
800
1999 2000 2001 2002 2003 2004 2005
0.0
2.0
4.0
6.0
FY 2004 FY 2005
Though the number of NBFCs in north India is also high, average deposit is far lower compared
to south India. Other parts of the country do not have significant presence of NBFCs and are
also on declining trend.
Geographical distribution of NBFCs
Public deposit - Regionwise
0%
25%
50%
75%
100%
FY03 FY04 FY05
South North Centre West East
0%
25%
50%
75%
100%
FY03 FY04 FY05
South North West East Centre
Asset & liability mix
NBFCs have made a transient shift in their liability composition. Once largely dependent on
the public deposits, now borrowing in the form of non-convertible debentures, bank borrowings,
commercial papers, etc, are the largest form of liabilities.
On the asset side, leasing, hire purchase and loans & advances constitute the larger pie of
nearly 85%. This includes auto loans, hire-purchase, leased assets, personal finance, housing
loans, loans against shares, consumer durable loans, etc. Investments also add another 12%
of total asset size as some of the large NBFCs are purely engaged in the business of
investments. The diversified nature of asset mix gives stability to the NBFCs, which is important
for the stable and consistent growth of the sector.
Financial performance
NBFCs, despite their numbers declining, have done well in the recent past. The surge in retail
credit, particularly in vehicle and home financing, has helped the sector most. Besides, the gap
between the cost of funds between banks and NBFCs are also on the decline. The important
point in the picture is the growth in net owned funds of the NBFCs despite decline in number
of operational NBFCs indicates growing trend in financial health of the sector.
Liability mix (FY05)
Asset mix (FY05)
Reserves &
surpluses
11%
Paid up capital
6%
Public
deposits
11%
Borrowings
65%
Other liabilities
7%
Bill business
1%
Equipment
leasing assets
6%
Hire purchase
assets
43%
Investments
10%
Loans &
advances
33%
Spread between banks and NBFCs deposit rates
Public deposit at less than 10% interest
3.50
4.00
4.50
5.00
5.50
FY00 FY01 FY02 FY03 FY04 FY05
0%
20%
40%
60%
80%
FY03 FY04 FY05
The general decline in the interest rates has also helped NBFCs to a large extent. In FY03,
there were merely 23% companies which were having public deposits (which is typically the
costliest outside liability) at a cost more than 10%. The same increased to over 70% in FY05.
But it is more important to note here that the gap between the cost of funds between banks
and NBFCs have declined from 5.5% to a more sustainable level of 4%. So, while the yield
on assets declined, spread has risen over the last two years.
Despite rising competition from banks and within NBFCs itself, return on assets in the category
have been on a rising trend and is now stabilizing around 1.6%. This is primarily due to better
yield on assets, higher recovery and limited overhead costs structure of NBFCs.
Spread (%)
Net owned funds (Rs bn)
0
4
8
12
16
FY03 FY04 FY05
5.6
6.0
6.4
6.8
7.2
Yield on assets (LHS)
Cost of funds (LHS)
Spread (RHS)
46
48
50
52
54
56
FY03 FY04 FY05
In terms of asset quality, like banks, NBFCs also have seen commendable improvement in
their asset quality, both in terms of gross and net non-performing assets (NPA). In last five
years, gross NPA has declined secularly from 11.5% to 7.0%. In the same period net NPA also
improved from 5.6% to 3.4%.
Return on assets (%)
Asset quality
0.0
0.4
0.8
1.2
1.6
2.0
FY03 FY04 FY05
0
3
6
9
12
FY01 FY02 FY03 FY04 FY05
Gross NPA (%) Net NPA (%)
However, during FY05, number of companies having less than regulatory requirement of 12%
as capital adequacy is on rise. We expect the trend to reverse in FY06 onwards due to two
prime reasons: good profitability and capital raising programs.
Retail Finance
Retail finance is one of the major thrust areas for financial intermediaries due to the following
reasons:
Low penetration and high growth opportunity
Change in demography and lifestyle
Higher disposable income and higher affordability
Better margins and profitability
Low loan-ticket size
Lower delinquencies
Retail finance has grown up in size from Rs.272bn in FY99 to Rs.1,213bn in FY04 and is
expected to touch Rs.2,792bn by FY09 i.e. a CAGR of 18% over next five years. Banks have
become very much active in the retail space and their share also has gone up from less than
40% in FY99 to over 65% in FY04. As per a Cris Infac study it is slated to go up to 75% by
FY09.
Housing finance constitutes the largest pie of retail finance with a total market share of over
65%. The growth in housing finance is further expected to be in the range of 25-30% over next
couple of years given that the penetration level is still low and is catching up fast. Secondly,
the loan ticket size is also on rise.
Capital adequacy ratio
Source: RBI
Retail portfolio mix
Source: Cris Infac, Retail Finance Annual Review, March 2005
Retail finance portfolio, Rs bn
0%
20%
40%
60%
80%
100%
FY04 FY09P
Housing Auto CV 2W
0
2000
4000
6000
8000
FY99 FY04E FY09P
0%
25%
50%
75%
100%
FY03 FY04 FY05
<12% 12-20% >20%
Though housing finance today constitutes nearly 40% of total housing cost, it is still merely 3%
of GDP, which is much lower than the global average of nearly 8%.
Similarly, increase in borrowing capacity due to various reasons like decline in interest rate,
longer tenure and increase in income levels have led to the spurt in retail finance.
Auto finance
Banks are slowly capturing the larger pie of the auto finance market; however, this has not
deterred the NBFC players too. Low loan ticket size, fabulous growth and rising finance
penetration besides lucrative margins are some of the reasons why all sorts of financial
intermediaries are fiercely competing for larger market share.
Units financed (%) - FY04
Increase in borrowing ability between FY99 & FY04 (%)
0
20
40
60
80
100
Housing Auto loan CV loan 2W loan
0
10
20
30
40
50
60
Housing Auto loan CV loan 2W loan
Finance penetration (%)
1998-99 2003-04 2004-05 2008-09
2W finance 12 32 37 49
Car/UV finance 45 64 66 75
New CV finance 49 63 79 78
New utility vehicle 38 56 58 66
Market share in 2W segment
Average yield (%)
0%
20%
40%
60%
80%
100%
2001-02 2002-03 2003-04
Banks NBFCs Others
10
14
18
22
26
1998-99 2003-04 2004-05 2008-09
CAGR (%) (FY04-09)
There is a growing competition amongst the players to go for used vehicle financing. Though
the return is substantially higher, risks are higher too. Even after considering higher expected
losses in used vehicle finance, net margin is higher by nearly 175 to 250 bps. However, superior
returns are generated by way of focus on risk management and recovery.
Net margins
FY02 FY04 Remarks
New CVs 1.0-1.5 1.0-1.5 The decline in yield and cost of funds move more in
tandem compared to used vehicle financing.
Old CVs 1.5-2.25 2.5-3.25 Despite decline in yield, margins have improved.
Source: Cris Infac & Kotak Securities - Private Client Research
Though the overall market of used vehicle finance is small, competition is visibly growing.
Consumer durable finance
Consumer durable (CD) financing is also gaining momentum with the changing lifestyle and
increase in disposable income. As per Cris Infac, the market size is expected to grow from
Rs.141bn in FY04 to Rs.218bn in FY09 at a CAGR of 9.1%. Colour TVs, refrigerators, air
conditioners and washing machines contribute nearly 80-85% of total CD financing business.
In CD financing, NBFCs are more aggressive than banks primarily due to low-ticket items, low
tenure and secondly banks book it under their personal finance segment. Net spread in the
CD financing business is high at 4-6% compared to other segments of NBFCs.
0
5
10
15
20
25
30
2W finance Used CV finance Auto finance New utility
vehicle
New CV finance
Compani es
Stock details
BSE code : 511218
NSE code : SRTRANSFIN
Market cap (Rs bn) : 7.2*
Free float (%) : 88.3
52-wk Hi/Lo (Rs) : 146/31
Wk Avg Qty : 132,812
Shares o/s (mn) : 65.43*
* Post merger equity shares o/s would be 126mn
and market cap at Rs.13.86bn.
Valuation table (merged)
Rs mn FY05 FY06E FY07E FY08E
Total income 6,896 8,321 9,914 11,958
Gross profit 1677 1,913 2,249 2,655
Net profit 963 1,156 1,374 1,632
EPS (Rs) 7.6 9.2 10.9 12.9
BVPS (Rs) 31.0 36.9 44.6 54.3
Adj. BVPS (Rs) 28.9 34.1 41.0 49.8
Dividend yield (%) 2.3 2.3 2.3 2.3
Debt/ Equity (x) 7.2 6.8 7.4 7.9
RoAA (%) 3.5 3.1 2.9 2.7
RoE (%) 31.7 25.8 25.8 25.4
Spread (%) 8.8 8.7 8.7 8.3
Net NPA (%) 0.9 0.9 0.9 0.9
P/E (x) 14.4 12.0 10.1 8.5
P/ABV (x) 3.8 3.2 2.7 2.2
CAR (%) 14.7 13.7 12.6 12.1
NPA (%) 0.9 0.9 0.9 0.9
Source: Company & Kotak Securities - Private
Client Research
Shareholding pattern
One-year performance (Rel to Sensex)
Source: Capitaline
STF
Sensex
Shr i r am Tr anspor t Fi nanc e (STF)
(Rs.110, P/ABV: 3.2x , HOLD)
Price target: Rs.127 (18-month horizon)
STF is engaged in truck financing where the expertise lies in pre-owned
vehicles. It has a unique model in terms of pre-owned/ used truck financing,
which gives STF an advantage over other auto financers, both NBFCs and
banks. Due to its niche operations, STF and other group companies have
been able to generate supernormal spreads over their asset book. STF
has plans to merge other group company namely, Shriram Investments
and also Shriram Overseas. However, in our calculations we have taken
impact of Shriram Investments in terms of consolidation of accounts.
Given the growth expectation of 24.3% in used CV financing by Cris Infac
and also higher spread in used-vehicle financing, we believe that STF would
be able to sustain its high margins for the foreseeable future. STF also
manages portfolios for banks like UTI Bank and Citigroup for their used/
new vehicle financing due to its natural advantage in the last-mile
(customer-centric) for both appraisal and recovery.
Investment rationale
Presence in high growth area of used-truck financing where margins are higher. SFL
had in the past margins over 10%, which post-merger we expect to sustain over 8%
albeit on a higher base.
The group has a nationwide presence with dominance in south and west India.
Merger would boost balance sheet; capital-raising to be easier to fuel asset growth
Group's foray into insurance and personal finance would help in cross-selling products
as it is currently using its nidhi-clients
Net interest income to grow at a CAGR of over 27% over next three years with profit
to rise at a CAGR of 20%. Asset in the same period is expected to register a CAGR
of 30%. STF has one of the highest RoAA in the industry at 3%.
Risks and concerns
General slowdown in the economy may reduce prospects of auto financing
Poor agricultural output/ poor monsoon can impact the business of the company
Stiff competition from the commercial banks entry into the auto-financing business
could negatively impact NBFCs business & margin in general.
Valuation & recommendation
We expect that STF would post an EPS of Rs.9.2, 10.9 and Rs.12.9 in FY06E, FY07E
and FY08E respectively. In the same period adjusted book value is expected to be at
Rs.34, 41 and Rs.50 respectively.
Based on FY08 earning estimates, the company is expected to post an RoE of 25.4%,
which translates the fair value to be at 2.6x its adjusted book value. We believe that FY08
estimates would get factored in a 12 to 18 months timeframe, which is equal to Rs.127.
We recommend a HOLD on the stock with a price target of Rs.127 over 18-month horizon,
an upside of 16%.
Institutions
4%
Corp. holding
21%
Foreign
29%
Promoters
12%
Public &
others
34%
Jay Prakash Sinha
jay.sinha@kotak.com
+9122 56341207
Financials: Shriram Transport Finance - Merged entity
Profit & loss (Rs mn)
FY05 FY06E FY07E FY08E
Operating income 6,774 8,172 9,729 11,734
Other income 122 149 185 225
Total income 6,896 8,321 9,914 11,958
Interest expenditure 3,281 4,146 5,042 6,144
Employee expense 272 326 391 469
Operating expense 1,129 1,372 1,640 2,069
Other expense 537 564 592 622
Gross profit 1,677 1,913 2,249 2,655
Depreciation 158 188 199 219
Profit before tax 1,519 1,726 2,050 2,436
Provision for tax 557 569 677 804
Profit after tax 962 1,156 1,374 1,632
Extraordinary items (1) - - -
Net profit 963 1,156 1,374 1,632
Earning per share (Rs) 7.6 9.2 10.9 12.9
Book value per share (Rs) 31.0 36.9 44.6 54.3
Adjusted BVPS (Rs) 28.9 34.1 41.0 49.8
Source: Kotak Securities - Private client Research
Balance sheet (Rs mn)
Share capital 1,261 1,261 1,261 1,261
Preference capital 536 536 536 536
Reserves & surpluses 2,642 3,395 4,366 5,586
Total networth 4,439 5,192 6,163 7,383
Unsecured loans 3,057 3,973 5,271 6,662
Secured loans 25,376 32,684 42,101 53,256
Total loans 28,433 36,658 47,373 59,918
Total liability 32,872 41,850 53,536 67,301
Net block 1,300 1,284 1,275 1,264
Investments 89 98 108 119
Loans & advances 30,173 40,734 52,954 66,283
Cash 4,721 2,974 2,411 2,738
Other current assets 3,088 3,627 4,263 5,012
Current liabilities 3,951 4,544 5,243 5,498
Provision 1,358 1,134 1,269 1,426
Net current assets 32,673 41,658 53,116 67,108
Deferred tax assets (1,191) (1,191) (1,191) (1,191)
Total assets 32,871 41,850 53,308 67,301
Key financial ratios
Debt-Equity Ratio 0.0 6.8 7.4 7.9
CAR (%) 14.7 13.7 12.6 12.1
Net NPA (%) 0.9 0.9 0.9 0.9
RONW (%) 31.7 25.8 25.8 25.4
RoAA (%) 3.2 3.1 2.9 2.7
Spread (%) 8.8 8.7 8.7 8.3
Stock details
BSE code : 532498
NSE code : SHRIRAMCIT
Market cap (Rs bn) : 3.8
52-wk Hi/Lo (Rs) : 159/28
Shares o/s (mn) : 27.10
Valuation table
Total income 1812 2081 2509 2955
Gross profit 414 554 732 830
Net profit 231 335 450 511
EPS (Rs) 7.3 12.3 16.6 18.9
BV/share (Rs) 25.9 30.3 41.2 55.3
Adj. BVPS (Rs) 22.6 25.7 35.4 48.2
Debt-equity ratio 7.2 7.1 7.1 6.9
APATM (%) 11.5 15.1 17.1 16.6
CAR (%) 11.8 12.1 12.8 13.7
Net NPA (%) 1.2 1.2 1.2 1.2
RONW (%) 32.7 38.2 38.5 32.7
RoAA (%) 3.2 3.9 4.1 3.7
Spread (%) 11.3 11.9 11.8 11.0
Dividend/share (Rs) 2.5 2.5 2.5 2.5
Dividend yield (%) 1.8 1.8 1.8 1.8
P/E (x) 19.6 11.5 8.5 7.5
P/ABV(x) 6.3 5.5 4.0 2.9
Client Research
Source: Capitaline
Shriram City Union Finance
Sensex
Shr i r am Ci t y Uni on Fi nanc e
(Rs.145, P/ABV: 5.5x , BUY)
Shriram City Union Finance (SCUF) is primarily engaged in the financing
of consumer durables and has made a disbursement of Rs.2.63bn in FY05.
The segment though low-ticket in size is picking up smartly and is expected
to grow at a CAGR of 9% over next four years as per Cris Infac report.
SCUF is keen on the segment and is looking to enhance its overall portfolio
substantially. It has also exited from truck financing, which is already
catered by other group companies.
We believe that the company is well positioned with its wide network, large
clientele base and strong track record to take the advantage of lifestyle
and demographic changes. We estimate companys growth at a CAGR of
28% over next three years. However, the growth could easily be catapulted
to next level with increase in its capital base and leveraging on the same.
Consistent track record of growth; strong parentage with ambitious growth plans
Focus on consumer durable & personal finance where the growth prospects are high;
given the talks of capital infusion, the asset could easily grow at a CAGR of 50% over
next three years.
Being low-ticket items and significantly lower tenure, capital turnover is high and
hence spreads are higher at 11.9% (one of the highest in the entire industry). This
also leads to high RoE for the company at 38% and hence demands for a premium
valuation.
Cross-selling and leveraging group strengths would help in sustaining growth
One of the highest EVA spread leading to higher valuation of the company. It is expected
to sustain at level of 16%, down from the current level of 20%.
Risks and concerns
General slowdown in the economy may reduce prospects of consumer durable
financing
Given the higher margins in the business, stiff competition going ahead cannot be
ruled out.
We expect that SCUF to post an EPS of Rs.12.3, 16.6 and Rs.18.9 in FY06E, FY07E
and FY08E respectively. In the same period adjusted book value is expected to be
at Rs.26, 35 and Rs.48 respectively.
Based on FY08 earning estimates, the company is expected to post an RoE of 38%,
which translates the fair value to be at 3.2x its adjusted book value. We believe that
FY08 estimates would get factored in a 12 to 18 months timeframe, which is equal
to Rs.169. This is well supported by our residual income valuation of the stock at
Rs.183. Based on the average of the two, we arrive at a fair value of Rs.176 (again
based on FY08E estimates). We recommend a BUY on the stock with a price target
of Rs.176 over 18-month horizon, an upside of 24%.
Public &
others
14.4%
Promoters
73.4%
Foreign
0.1%
Corp. holding
10.2%
Institutions
1.9%
Jay Prakash Sinha
jay.sinha@kotak.com
+9122 56341207
Financials: Shriram City Union Finance
Other income 53 57 70 83
Total income 1,812 2,081 2,509 2,955
Interest expenditure 949 1,011 1,148 1,371
Operating expense 267 315 407 509
Gross profit 414 554 732 830
Profit before tax 364 499 672 763
Profit after tax 231 335 450 511
Extraordinary items 0 - - -
Net profit 231 335 450 511
Adjusted BVPS (Rs) 22.6 25.7 35.4 48.2
Share capital 271 271 271 271
Reserves & surpluses 431 668 1,021 1,436
Total networth 935 1,172 1,525 1,939
Unsecured loans 620 806 927 1,020
Secured loans 5,894 7,662 9,731 12,164
Total loans 6,514 8,468 10,658 13,184
Total liability 7,449 9,640 12,183 15,123
Net block 605 625 646 670
Investments 16 18 20 22
Loans & advances 7,666 10,349 12,936 16,170
Cash 945 581 677 537
Other current assets 14 16 20 24
Provision 324 356 392 431
Deferred tax assets (277) (277) (277) (277)
Total assets 7,449 9,640 12,183 15,123
CAR (%) 11.8 12.1 12.8 13.7
Net NPA (%) 1.2 1.2 1.2 1.2
RONW (%) 32.7 38.2 38.5 32.7
RoAA (%) 3.2 3.9 4.1 3.7
Spread (%) 11.3 11.9 11.8 11.0
Stock details
BSE code : 511243
NSE code : CHOLAINV
52-wk Hi/Lo (Rs) : 180/58
Valuation table
Total income 2147 2332 2979 4008
Gross profit 609 677 1000 1467
Net profit 341 394 614 929
EPS (Rs) 9.0 10.4 16.2 24.4
BVPS (Rs) 79.7 84.5 95.2 114.1
Adj. BVPS (Rs) 72.6 77.1 84.8 99.6
CAR (%) 19.5 17.8 14.8 12.9
Net NPA (%) 1.8 1.6 1.6 1.7
RONW (%) 12.2 12.2 17.5 22.8
RoAA (%) 2.1 2.2 2.8 3.1
Spread (%) 8.2 7.7 7.6 7.3
P/E (x) 19.5 17.0 10.9 7.2
P/ABV(x) 2.4 2.3 2.1 1.8
Client Research
Source: Capitaline
Cholamandalam
Sensex
Chol amandal am I nvest ment & Fi nanc e Co
(Rs.177, P/ABV: 2.3x , BUY)
Cholamandalam Investment & Finance Co (CIF), a Murugappa group
company, is primarily engaged into the business of vehicle financing and
Investments. It also has interests in asset management, capital market
and distribution of products. Its insurance arm is likely to be transferred
to other group company due to induction of DBS Bank as promoter.
With the induction of DBS Bank into the business, its retail finance business
is set to grow substantially. The expertise in product development, branding
& risk management of DBS Bank would allow the company to catapult into
a different league altogether.
Strong parentage and track record
Diversified financial business with a growth focus on high margin business
Thrust on retail financing is the key growth driver for the company
Induction of DBS Bank would allow the company to develop new products; growth is
expected to rise from a moderate level of 5% to a CAGR of 32% over next three
years. CIF has grown by 15-20% in the past against industry growth of 9-10%.
Eanings are also expected to post a CAGR of 33% over next three years and grow
by 2.7x by FY08E. Hence RoE is also slated to double from 12% to 23% by FY08E.
Asset management and the distribution business to get a big boost with the help of
DBS Bank association, presently neither of them is featuring in the top brackets. We
expect both to scale up in terms of business and valuation going forward.
Risks and concerns
Stiff competition from the commercial banks entry into the auto-financing/ retail
financing business could negatively impact NBFCs business & margin in general.
Reduction in DBS Banks commitment, if any, could reduce the growth.
Valuation and recommendation
We expect CIF to post an EPS of Rs.10.4, 16.2 and Rs.24.4 in FY06E, FY07E and
FY08E respectively. In the same period adjusted book value is expected to be at Rs.77,
85 and Rs.100 respectively.
Based on FY08 earning estimates, the company is expected to post a RoE of 23%, which
translates the fair value to be at 2x its adjusted book value. We believe that FY08 estimates
would get factored in a 12 to 18 months timeframe, which equals to Rs.201. We further
get Rs.31 as the value of its asset management and insurance business. We recommend
a BUY on the stock with a price target of Rs.232 over 18-month horizon, an upside of
32%.
Sum of the part valuation
(FY 08E valuation)
Core business 201
AMC 20
Insurance 11
Total value 232
Public &
others
31%
Promoters
55%
Foreign
6%
Corp. holding
7%
Institutions
1%
Jay Prakash Sinha
jay.sinha@kotak.com
+9122 56341207
Financials: Cholamandalam Investment & Finance Co
Other income 1 50 100 100
Total income 2,147 2,332 2,979 4,008
Interest expenditure 845 930 1,212 1,723
Miscellaneous expenses 177 204 234 269
Provisions 230 207 186 168
Gross profit 609 677 1,000 1,467
Profit before tax 516 593 925 1,399
Net profit 341 394 614 929
Adjusted BVPS (Rs) 72.6 77.1 84.8 99.6
Total networth 3,128 3,312 3,717 4,437
Unsecured loans 6,033 6,938 9,713 13,599
Secured loans 7,276 8,368 11,715 16,401
Total loans 13,309 15,306 21,428 29,999
Total liability 16,437 18,618 25,145 34,437
Net block 160 161 178 213
Investments 1,288 1,288 1,288 1,288
Stock on hire 12,007 14,048 19,667 27,534
Cash 417 151 104 323
Loans & advances 3,306 3,829 4,857 6,180
Current liabilities 504 570 650 740
Provision 293 315 338 363
Deferred tax assets 56 26 39 2
Total assets 16,437 18,618 25,146 34,437
CAR (%) 19.5 17.8 14.8 12.9
Net NPA (%) 1.8 1.6 1.6 1.7
RONW (%) 12.2 12.2 17.5 22.8
RoAA (%) 2.1 2.2 2.8 3.1
Spread (%) 8.2 7.7 7.6 7.3
Stock details
BSE code : 521305
NSE code : SUNDARMFIN
52-wk Hi/Lo (Rs) : 409/240
Wk Avg Qty : 6,966
Valuation table
Total income 4591 5240 5905 6777
Gross profit 1446 1497 1672 1974
Net profit 760 843 985 1208
Earning/share (Rs) 27.4 30.4 35.4 43.5
BV/share (Rs) 245.9 268.8 296.7 332.7
Adj. BVPS (Rs) 235.1 258.0 285.9 321.9
Dividend/share (Rs) 7.5 7.5 7.5 7.5
APATM (%) 16.6 16.1 16.7 17.8
CAR (%) 14.7 14.6 14.4 14.2
Gross NPA (%) 1.5 1.8 2.0 2.0
Net NPA (%) 0.5 0.5 0.5 0.5
RONW (%) 12.6 11.8 12.5 13.8
RoAA (%) 2.0 1.8 1.8 1.9
Spread (%) 6.0 4.9 4.8 4.8
Dividend yield (%) 1.9 1.9 1.9 1.9
P/E (x) 14.7 13.2 11.3 9.2
P/ABV(x) 1.7 1.6 1.4 1.2
Client Research
Source: Capitaline
Sundaram Finance
Sensex
Sundar am Fi nanc e (SFL)
(Rs.395, P/ABV: 1.6x , BUY)
SFL is a major NBFC in financing automobiles with an asset base of over
Rs.44bn. The company has formidable presence in other financial sectors
like asset management, insurance, home finance and distribution of
financial products. Recently the company has also entered into software
services and BPO, though they are still in the nascent stage. The robust
growth in the medium & heavy commercial vehicles, cars, multi-axles, two-
wheelers, housing loans, personal loans and more importantly prospects
of insurance provide an investible opportunity in SFL.
We have valued the company using sum-of-the-parts valuation for its
various subsidiaries & divisions. Our estimate suggests a fair value of
Rs.518 based on FY08 estimates, which we expect to be factored in another
12-18months. We recommend a BUY with a price target of Rs.518, an upside
of 29% over an 18-month horizon.
Robust growth of automobile segment, which provides over 20% growth opportunity
for the company. Given the low leverage, SFL has potential to step up its asset growth
without having much capital concern.
The Sundaram group is associated with automobiles & related products and the global
phenomenon suggests that such a combination provides higher growth opportunity
for both the manufacturer and the finance company
Penetration level of General Insurance is still quite low at 0.56% of GDP against the
global average of 2.19%. We believe that huge growth potential is still untapped
SFL has amalgamated Lakshmi General Finance (LGF) with itself, which has further
boosted the business potential for the company
Software and services business, which are into nascent stage, are likely to grow at
a rapid pace
The company has a healthy capital adequacy of 14.6% besides net NPA of merely
0.45%
Sum of the parts valuation suggests that the stock is undervalued and would be re-
rated based on synergy of the group companies
Risks and concerns
Slowdown in the economy may impact the demand of automobiles and hence the
financing business
Poor agricultural output/ poor monsoon can impact the business of the company
Stiff competition from the commercial banks could negatively impact NBFCs business
& margins in particular
Low liquidity on bourses
We have valued the company using sum-of-the-parts valuation for its various subsidiaries
& divisions. Our estimate suggests a fair value of Rs.518 based on FY08 estimates,
which we expect to be factored in another 12-18months. We recommend a BUY with a
price target of Rs.518, an upside of 29% over an 18-month horizon.
Valuation
(Rs) Weight (%) Value for SFL
SFL, standalone 415 100 415
RSAICL, insurance 68 60 40
SHFL, housing finance 24 60 14
SAMCL, asset management 35 60 21
Cash in SFL 28 100 28
Total 518
Public &
others
42%
Promoters
37%
Foreign
11%
Corp. holding
1%
Institutions
9%
Jay Prakash Sinha
jay.sinha@kotak.com
+9122 56341207
Financials: Sundaram Finance
Other income 178 233 269 310
Total income 4,591 5,240 5,905 6,777
Interest expenditure 2,148 2,649 3,031 3,482
Gross profit 1,446 1,497 1,671 1,974
Profit before tax 1,224 1,259 1,469 1,803
Profit after tax 760 843 984 1,208
Net profit 760 843 984 1,208
Earning per share, Rs 27.4 30.4 35.4 43.5
Book value per share, Rs 245.9 268.8 296.7 332.7
Adjusted BVPS, Rs 235.1 258.0 285.9 321.9
Total networth 6,830 7,465 8,241 9,241
Unsecured loans 23,260 27,912 33,494 40,193
Secured loans 14,804 15,544 16,322 17,138
Total loans 38,064 43,456 49,815 57,330
Total liability 44,894 50,921 58,057 66,571
Net block 1,666 1,547 1,596 1,788
Lease 223 190 161 137
Investments 3,111 3,267 3,430 3,602
Stock on hire 4,189 3,561 3,027 2,573
Cash 1,004 774 582 159
Loans & advances 37,612 46,034 54,194 63,845
Provision 556 2,104 2,589 3,183
Deferred tax assets (20) 106 231 356
Total assets 44,894 50,921 58,056 66,571
CAR (%) 14.7 14.6 14.4 14.2
Net NPA (%) 0.5 0.5 0.5 0.5
RONW (%) 12.6 11.8 12.5 13.8
RoAA (%) 2.0 1.8 1.8 1.9
Spread (%) 6.0 4.9 4.8 4.8
RoE (%) - FY06E
Source:
P/E (x) - FY 06E
Source:
NPA (%) - FY 06E
Source:
D/E (x) - FY06E
Source:
ROAA (%) - FY 06E
Source:
Spread (%) - FY 06E
Source:
P/ABV (x) - FY 06E
Source:
CAR (%) - FY 06E
Source:
Asset size (Rs bn) - FY 06E
Source:
Compar at i ve anal ysi s: c har t s
RoE: Return on equity D/E: Debt equity P/ABV: Price to adjusted book value
P/E: Price earnings ROAA: Return on average assets CAR: Capital adequacy ratio
NPA: Non-performing assets NIM: Net interest margin
STF: Shriram Transport Finance SCUF: Shriram City Union Finance
CIFL: Cholamandalam Investment & Finance SFL: Sundaram Finance
0.0
10.0
20.0
30.0
40.0
STF SCUF CIFL SFL
0.0
2.0
4.0
6.0
8.0
STF SCUF CIFL SFL
0.0
1.0
2.0
3.0
4.0
5.0
6.0
STF SCUF CIFL SFL
10.0
11.0
12.0
13.0
14.0
STF SCUF CIFL SFL
0.0
1.5
3.0
4.5
6.0
STF SCUF CIFL SFL
0
5
10
15
20
25
STF SCUF CIFL SFL
0.0
0.3
0.6
0.9
1.2
1.5
STF SCUF CIFL SFL
0.0
3.0
6.0
9.0
12.0
STF SCUF CIFL SFL
0
15
30
45
60
STF SCUF CIFL SFL
Disclaimer
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of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It is for the general information of clients of Kotak Securities Ltd. It does not constitute
a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients.
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Kotak Securities Limited, nor any person connected with it, accepts any liability arising from the use of this document. The recipients of this material should rely on their own investigations
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Research Team
Name Sector Tel No E-mail id
Jay Prakash Sinha Economy, Banking, FMCG, Agro-Industry +91 22 5634 1207 jay.sinha@kotak.com
Avinash Gorakshakar Auto, Auto Ancillary +91 22 5634 1522 avinash.gorakshakar@kotak.com
Dipen Shah IT, Media, Telecom +91 22 5634 1376 dipen.shah@kotak.com
Sanjeev Zarbade Capital Goods, Engineering +91 22 5634 1258 sanjeev.zarbade@kotak.com
Teena Virmani Construction, Mid Cap, Power +91 22 5634 1237 teena.virmani@kotak.com
Shrikant Chouhan Technical analyst +91 22 5634 1439 shrikant.chouhan@kotak.com
Sunil Singh Editor +91 22 5634 1223 singh.sunil@kotak.com
K. Kathirvelu Production +91 22 5634 1567 k.kathirvelu@kotak.com

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Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.

December 19, 2005 FOR PRIVATE CIRCULATION

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