Spirits of Shriram Transport Finance

Shriram Transport Finance (STFC), incorporated in 1979, is one of the largest assets financing non-banking financial companies (NBFC) with approximately 25 per cent market share in pre-owned and approximately 5-6 per cent market share in new truck financing. The company is a pure-play niche pre-owned commercial vehicle (CV) financier with its core customer base being under-banked small truck owner operators (low income group) who transact on a cash basis. It is the flagship company of the SHRIRAM Group—a diversified conglomerate play with interests in financial services, and non-financial services business such as property development, engineering projects and information technology, manufacturing, value-added services and pharmaceuticals.

As on June 2017, the company’s asset under management (AUM) stands at Rs 81,600 crore. It is strategically present in high yield pre-owned commercial vehicle financing with expertise in loan origination, valuation and collection. Over the past few years, the company has expanded its product portfolio to include financing of tractors, small commercial vehicles, three wheelers, passenger commercial vehicles and construction equipment. The split of AUM is heavy commercial vehicle (HCV), medium and large commercial vehicle (M&LCV), passenger vehicles and tractors accounting for 46.8 per cent, 20.4 per cent, 24.6 per cent and 4.3 per cent, respectively. It is also involved in ancillary services such as finance for working capital, engine replacement, bill discounting, credit cards and tyre loans as holistic financing support. The company has 962 branches and 857 rural centers with employee strength of 20,489 employees.

There have been staunch supporters of STFC’s sound business model, product niche and geographical depth. Over the last couple of years the company was impacted by cyclical growth trends; slower regulatory change; and asset quality twinges, tailwinds have been emerging across these parameters.

Wary of Merger with IDFC Group

Financial services conglomerates IDFC Group and Shriram Group are in talks to merge their businesses and have signed a 90-day confidentiality and exclusivity agreement for a potential merger of certain businesses and subsidiaries of the two groups.

The proposed merger of IDFC and the Shriram Group will create a financial colossal with a market value of at least Rs 72,000 crore that will have businesses as diverse as motorcycle credit and lending for power projects. In this amalgamation, Shriram Transport Finance Ltd will become a fully owned unit of IDFC ltd and get de-listed from the stock exchanges. It is announced to keep STFC as a separate entity under IDFC as a holding structure.

Both the groups have three months to structure the deal and will be subject to various regulatory approvals. The companies have yet to decide a share-swap ratio.

Uptick in growth

The Chennai-based lender showed initial signs of pick-up in disbursements during the quarter. The disbursements stood at Rs 10,800 crore comprising of Rs 9857 core in commercial vehicle segment and Rs 961 crore in new commercial vehicles. It showed positive signs post demonetisation.  During the first quarter of 2018, disbursements increased 1.5 per cent year on year whereas over the last two quarters, the disbursements de-grew.

While the impact of demonetisation seems to be waning, pre-buying of vehicles in last quarter of 2017 prior to Bharat Stage IV (BS-IV) transition and deferment of purchases before GST implementation limited the traction—AUM grew at sub-10 per cent YoY.

Notwithstanding this, the growth is expected to recover in second half of fiscal 2018 owing to pent-up demand post GST implementation, greater infrastructure activity post October and better monsoon. Consequently, management has maintained its assets under management growth guidance of more than 15 per cent for fiscal 2018.

Across segments

During the April-June’17 quarter, the domestic commercial vehicle business witnessed contraction with unit sales down by 9 per cent on year to year basis. This was primarily due to medium and heavy commercial vehicle (MHCV) segment, which saw sharp decline due to pre-buying in the months of February and March 2017 prior to BS-IV rollout and deferment of purchase prior to GST implementation.

On the other hand, the large commercial vehicle (LCV) segment has held up well due to uptick in consumption sector and good agriculture movement

While there has been some slowdown due to GST, management believes that things are settling down and should be normal by the end of the quarter

Stable asset quality

Asset quality remained stable with gross non-performing assets (GNPAs) declining sequentially to 8.0 per cent as aganist 8.2 per cent in 2017. The asset quality saw improvement, with 120 days past due (dpd) GNPAs. It is expected of the underlying asset quality to improve given improving cash flows; transition to 90dpd recognition norms is a key monitorable. These expected cyclical tailwinds will enable STFC to sustain an operationally strong performance.

The difference between GNPAs based on 90dpd and 120dpd recognition norms is 120-150 basis points (bps). The key aspects are that the management aims to bring credit costs to 2.5 per cent levels by end of the year 2018 and post the transition to 90dpd NPA recognition norms, provision coverage should come down to 60-65 per cent versus the present 71 per cent.

The net interest margins (NIMs) have improved on funding cost benefits and lower interest reversal. During the quarter, the margins enhanced to 7.5 per cent as against 6.9 per cent in last quarter of 2017, this is driven by replacement of maturing long-term borrowings and lower interest reversal vis-a-vis fourth quarter of fiscal 2017.

Stance for STFC- Growth levers in place

The truck operator’s cash flows are expected to improve with improving operational efficiency and better fleet utilisation post the GST transitioning phase. This, coupled with underlying demand, undisputed leadership and niche positioning, will enable STFC to deliver operationally strong performance. The first quarter of 2018 fiscal has reflected initial signs of pick up in performance.

The uncertainties surrounding this merger will be a key overhang. Though the details of the share swap will have to be worked out; valuations of 1.7 times the expected P/ABV of 2019 for greater than 19 per cent return of equity (RoE) potential leaves scope for swap ratio to be in STFC’s favour. 

Shriram Transport Finance posted strong performance during the quarter ended in June 2017. The company witnessed the highest Profit after tax (PAT) in the last six quarters; it stood at Rs 450 crore jumping 20 per cent versus previous sequential year.

The beat was on account of robust net interest income (NII) traction raised by 15 per cent YoY driven by margin expansion increased to 50 bps on quarter to quarter by 7.5 per cent on funding cost benefit and lower interest reversal.

Risks faced by Shriram Transport Finance

The major risks faced by the financier include impact of 90 days past due (dpd) in non-performing assets (NPA transition) and the recent merger announcement with IDFC involving the uncertainties around swap ratios, execution and regulatory approvals. The impact of BS-IV transition and GST implementation will be key monitorables. In addition to these, following risks also exist:

• Delayed pick up in economy: The vehicle sales and company’s asset quality are influenced by the utilisation in the commercial vehicle segment and freight rates, which depend on the economic cycle. Diversification of the loan book and growing emphasis on fee-based income should safeguard the company in case of a delay in recovery.

• High dependency on financed asset: The borrower’s small fleet operators (SFOs) and first time users (FTUs) ability to earn and his ability to repay rests solely on the asset pre-owned or new commercial vehicle financed. The well developed vehicle evaluation skills and conservative LTVs of the company should ensure adequate resale realisation in case of a default.

• Increased competition: Growing presence and expanding reach of NBFCs and commercial banks is also a cause for concern. However, structurally, operational difficulty in the pre-owned CV segment implies that crucial business intelligence developed by STFC over the years is difficult to replicate.

• Wholesale dependent nature: Currently, retail funding attributes to 18.5 per cent of the borrowings of Shriram Transport. This leaves the NBFC vulnerable to sharp spikes in interest rates in the wholesale markets. Considering that majority of its assets carry fixed interest rates, this may lead to NIM volatility.

neha.seth@outlookindia.com