Strong earnings growth to fuel Cholamandalam

Continued traction in the light commercial vehicle books along with diversification to help

Cholamandalam Investment and Finance Company (Cholamandalam)'s focus on the niche segment of light commercial vehicles or LCV lending has made it stand out among peers, and led to a 58 per cent rise in the share price in the past one year. Focus on big-ticket fleet operators as well as first mover advantage in this segment have aided its growth, profitability as well as asset quality. In fact, at 3.8 per cent, the company's gross non-performing assets (NPA) ratio is amongst the lowest in the NBFC space. Though not strictly comparable, other NBFCs operating in the vehicle finance space have higher gross NPA ratio of 6-11 per cent.

Given its higher exposure to the riskier segment of loan against property (LAP) or home equity as the company calls it, low asset quality ratios are a key positive. Cholamandalam's home equity segment (29 per cent of assets under management) has grown at a healthy clip in recent times and enabled it to diversify its lending portfolio. However, disbursements in this segment fell sequentially in the latest December quarter - partly on account of demonetisation. Notably, LAP segment as a whole has become less attractive given that higher competition has started pulling down yields for most players. This would remain a key monitorable especially on the asset quality front. Most analysts though believe the company can manage these pressures efficiently citing its earlier track record.

Its plans to tap growth in the under-penetrated segment of affordable home loans, coupled with its presence in the small and medium enterprises (SME) segment, will enable further diversification of Cholamandalam's loan book.

Given the prospects of achieving strong growth and profitability in the next couple of years on the back of continued traction in vehicle finance (68 per cent of assets under management) as well as other businesses, most analysts are positive on the stock.

At current levels of Rs 1,013, the scrip is trading at about 3 times FY18 estimated book value, which is higher as compared to its historical average one-year forward price to book ratio of about 1.8 times. However, the company could raise funds in FY18 which in turn could boost the book value and lead to normalisation of the price to book ratio. With the street building in healthy earnings CAGR of 20-22 per cent over the next couple of years as given the healthy expansion in return ratios, it could also aid valuations.

"A change in the borrowings mix, favourable interest rate regime, fixed-rate vehicle finance portfolio, improving leverage and provisions already as per 90 days norm will continue to drive return on average assets for Cholamandalam," says Darpin Shah of HDFC Securities. He has a target price of Rs 1,279 on the stock implying upside potential of 26 per cent from current levels. The consensus target price, as per Bloomberg, is Rs 1,141.23.