Vehicle financing stocks: Rally doesn't price in flattening business growth

A rally of 45-57 per cent in the stocks of Shriram Transport and Cholamandalam Investments and Finance Company (Chola Finance), and over 35 per cent in the case of Mahindra and Mahindra Financial Services (M&M Finance) over the past month puts them almost back to the pre-Covid levels or prices seen in February.

Chola Finance made a new 52-week intraday high of Rs 394.30 on Friday, which is much higher than the Rs 340 level seen in February. The same is true for Sundaram Finance, which hit a 52-week high (Rs 1,831.75) last Tuesday and is up 23 per cent in a month. The rally has also tempted brokerages, including those at Motilal Oswal Financial Services (MOFL) and Kotak Instit­utional Equities, to renew their faith in these stocks.

It is pertinent to note that the stock prices may have run up significantly ahead of the fundamentals. In other words, the stock prices have moved up closer to/higher than pre-Covid levels, whereas their businesses are far from it.

Much of the rally may be attributed to an improvement in the collection efficiency trend. In a report dated November 24, analysts at MOFL have noted that for Shriram Transport and Chola Finance, less than 5 per cent of customers by value haven’t paid a single instalment, while for M&M Finance, the number stood at 13 per cent in Q2. Nonetheless, while the hope rally bodes well, investors shouldn’t lose sight of some key points.

Nomura’s proprietary index on business resumption touched an all-time high of 87.1 per cent for the week ended November 22, capturing the festive demand; it was 84.6 per cent a month ago. While this is encouraging, Sonal Verma, chief economist, Nomura, said one should wait for another week to get a better sense of the underlying picture. The report also points at the labour participation rate declining to 39.3 per cent from 39.5 per cent a week-ago and power demand growth declining 0.1 per cent week-on-week despite the festive rush, though better than the decline of 5.6 per cent a week ago.

“A key short-term risk is the revival of the pandemic threat as we transition out of the festive season. A few states have reverted to localised lockdown restrictions, which could slow the sequential pace of recovery in the next 2-3 months, following the sharp rebound thus far,” Verma noted.

Even those at S&P Global doubted the sustainability of collection trends and affirmed that if the asset quality of lenders looked better than expected in the September quarter, extended moratorium might have played a part. Moreover, analysts at Moody’s noted the collection efficiency for banks is better than that of non-banking financial companies for similar products.

Some of the recent management commentaries from Shriram Transport and Sundaram Finance were also in-sync with these cautious views. Both have indicated that while the collection efficiencies have been gradually getting better, the underlying demand was not very encouraging. For these four companies, 70-100 per cent of their business comes from vehicle financing. Among segments, the medium and heavy commercial vehicles (M&HCV) space, which accounts for 8-11 per cent of financiers' overall portfolios, continues to show signs of weakness both in collections and demand.

On the whole, while analysts at MOFL expected credit costs for vehicle financiers to ease a bit to 1.4-4.3 per cent in FY22, for FY21 their estimates remained unchanged at 1.7-4.4 per cent. Credit cost refers to the amount a lender could lose because of loans turning bad.

Despite some easing, it’s only in FY23 that credit costs would come near the level of FY20, which had been marred by slowdown and asset quality issues. Hence, a total normalisation to FY19 level remains distant.

This can also be gauged from the fact that some of the critical customer (bus services) segments, such as tourism, education institutions and offices, and state transport may take time to recover.

Seen in the context of heightened uncertainties, and the likelihood of brakes applied on the path of returning to normalcy, the stocks of vehicle financiers may have rallied too much and too soon. At the current levels, they are in the no-go zone for fresh investments. Existing investors, too, may want to book some profits.