Too early to turn positive on M&M Finance, Chola, Shriram Transport stocks

Uptick in used CV sales helped in Q3, but new vehicle sales remain weak and operational challenges haven't eased

Shriram Transport Finance's stock took investors by storm last week when it gained 23 per cent, reacting to its December quarter (Q3) results. Even the stocks of its peers — Mahindra & Mahindra Financial Services (M&M Finance) and Cholamandalam Investment and Finance (Chola Finance) — had a good run after their Q3 results, prompting a section of investors to think if the tide had turned favourable for vehicle financiers. Shriram Transport’s 19 per cent year-on-year (YoY) growth in disbursements may have particularly nudged one to think so. But, the devil lies in the detail and some of the broader parameters, such as cost of funds, net interest margin (NIM; measures profitability of a lender), and asset quality suggest that there’s more room to cover before one could turn entirely positive on these stocks.

In the case of Shriram Transport, analysts at JM Financial note that on a YoY basis, calculated margins have compressed 22 basis points (bps) to 7.6 per cent as the cost of funds rose by 40 bps due to a rise in the share of high-cost funding sources, such as bank loans and retail deposits, in borrowing mix. For M&M Finance, NIMs contracted by 21 bps YoY to 7.17 per cent, despite the cost of funds getting a marginal 8 bps YoY respite to 8.36 per cent. This was on the back of greater reliance on securitisation contracts, the share of which in the overall funding mix rose to an all-time high of 14.7 per cent in Q3. That the firm’s yield on advances is still down by 6 basis points YoY indicates the competition in the sector and pricing constraints that lenders continue to work with as business remains patchy.

As for asset quality, Shriram Transport’s gross non-performing assets (NPA) remained near-about the September quarter level of 8.7 per cent, prompting some analysts to believe that its asset quality has more or less stabilised. M&M Finance, however, saw the number increase by 60 bps sequentially, prompting analysts at HDFC Securities to note that the extent of deterioration in asset quality was surprising, given the usual seasonal trends and the creditable progress made so far. One also needs to be mindful of the spike in the cost of provisioning and the write-off incurred by Chola Finance and M&M Finance in Q3 which went up 41.5 per cent and 78 per cent, respectively. For Chola, the issue was also with a marginal 10 bps sequential rise in its gross NPA ratio to 3.3 per cent. The credit cost guidance for these lenders remains higher YoY. Shriram Transport has guided for 2.1–2.2 per cent, while for Chola, it is anticipated to touch 1 per cent in FY20, a level not seen in recent years.

Amid these concerns, what’s helping these lenders beat the slowdown in the underlying sector is their ability to lend to the used-vehicle (including commercial vehicles or CVs) space. The underwriting strength that these companies have acquired over a period is giving analysts some confidence in their loan quality. But, here, too, barring Shriram Transport’s (which is primarily a used vehicle financier) strong disbursement trend, rest continue to see a shrinkage, indicating that the lenders are cautious on growth. For Chola Finance, in particular, which outpaced its peers on most parameters till Q3, analysts at Motilal Oswal Financial Services expect growth to slow down to 15 per cent over the medium term. “There could also be a 30-bps rise in credit costs (for Chola), unless the macro environment improves,” they add.

Another aspect not currently priced in for these firms is the potential risk of higher delinquencies in used vehicles segment. “Lending to the used-vehicles segment is presenting a growth opportunity in an otherwise tepid market. But, these loans carry near-zero recovery value and are dependent fully on the borrower’s cash flows to meet repayment obligation. If the slowdown is prolonged, how the asset quality of these loans will pan out is tough to call out now,” said a senior analyst from a domestic brokerage.

The question, therefore, is whether investors must be lured by the steep discount that these vehicle financiers trade at. While Shriram Transport trades at 1.1x estimated FY21 book, M&M Finance and Chola Finance trade higher at 1.8x–2.2x FY21 book. Majority of analysts have “buy” rating on the three stocks, though after the recent rally, investors could wait for better entry points.