- Sundaram Finance, conservative and diversified financial service play offers value
Asset financing companies have had a rough ride at the markets with a negative return in the past one year. But in this period business performance has improved as borne out by the quarterly earnings report. The funding crunch and the negative sentiment towards all NBFCs also impacted investor interest. While the funding constraint appears to be easing, their core market of commercial vehicle is slowing down. In light of these several cross currents, is it worth looking at asset financing NBFCs?The funding scenario
While there is an overall risk aversion towards NBFCs, especially from mutual funds who had been a big source of funding for NBFCs post demonetisation, that tap is drying up. Large NBFCs, especially the ones promoted by reputed corporate houses, will continue to find favour with mutual funds.
In addition, most of the larger NBFCs have a diversified funding sources with little reliance on the Commercial Paper (CP) market.
Hence, these entities are in a vantage position to capture market share from weaker NBFCs albeit the probably greater competition from banks in the emerging landscape.Q2 FY18 – good show
The asset financing companies reported a very decent performance in Q2FY19. The average growth in assets under management (AUM) stood in the twenties. For Shriram Transport, the growth was supported by non-used vehicle loans. Vehicle loans continued to dominate the growth for Cholamandalam. M&M Finance saw strong traction in construction equipment, commercial vehicles and small business loans. For Sundaram Finance, the growth drivers were construction equipment & tractors.
Given the recent slowdown in vehicle sales, near term growth could get impacted. However, long term growth dynamics remains intact and could derive some medium term support from decline in fuel cost and probable softening of rates few quarters down the line.Margin largely protected
Most of these entities are now reaping the benefits of a well-established network and the sweating of the assets should lead to further moderation in the cost to income ratio.
Another significant kicker for earnings growth in the quarter under review has been the decline in provision as the asset quality shows improvement.
Going forward, we expect the credit cost to stay subdued that should provide a major boost to earnings.Which stock to back?
Post the funding related turmoil in the NBFC space, we feel the larger entities with stronger promoter, robust business model stands to gain market share as the competitive landscape for these niche businesses remain weak although in recent times banks are eyeing this market as well.
While rural demand looks supportive on the back of pre-election spending, good monsoon and hike in MSP, the dream run in the auto segment is facing speed breaker. While rising funding cost and higher fuel prices were key dampeners in the past, fuel prices have come down and interest rates too appear to be peaking out now.
Of the companies under review, M&M Finance has a diversified portfolio and well entrenched in the rural geography.
The company has diversified funding base and a strong promoter, therefore a beneficiary of the risk averse environment. We see little risk to its double-digit growth given the reduced competitive intensity and the diversified portfolio. With the improvement in the end market, post the migration to 90-day NPA recognition norm, credit cost normalisation should support earnings despite a decline in interest margin on account of rising wholesale rates in recent times.
Cholamandalam too has a diversified portfolio of vehicle and home equity and has maintained pristine asset quality while registering profitable growth and is likely to continue on this path. However, the near term outlook looks challenged in the context of the valuation.
We are circumspect about the traction in second hand vehicle market of Shriram Transport as in recent times the non-second hand vehicle businesses have grown faster. This could impact profitability going forward as margins are much lowerSundaram Finance, with diversified business segments, will be the key beneficiary of the multiple growth drivers across various financial services business. We expect the company to grow lending book albeit at gradual and steady pace. Additionally, the other financial services business like AMC and general insurance are expected to grow in sync with India’s economic growth. The stock is still close to its 52-week low and offers value for low risk long-term investors.