Auto Finance Sector Report

8/7/2019 Auto Finance Sector Report

1/31Auto Finance Sector ACMIIL

R E P O R TS E C T O R

AUTO FINANCE SECTOR- BANKING THE UNBANKED

Investment Thesis

After witnessing a slowdown in FY09, the revival in the Indian auto sector started FY10 onwards. And going forward, the auto

industry is expected to register strong volumes due to improvement in the economy and conducive nancing environment. Within

the auto industry, the car segment is expected to register the highest growth mainly on account of the strong growth in the small

car segment and new model launches at competitive prices.

Conducive nancing environment is one of the most important growth drivers of the auto industry. It is so as nearly 70-80%

vehicle sales are backed by loans extended by banks or nancial institutions.

Auto nance industry was once dominated by the NBFCs. While banks dominated the low risk car-nancing business, NBFCs

dominated the commercial vehicle segment as it was as perceived to be risky. Also, the banks enjoyed an edge over NBFC-funding

due to an easy access to low cost CASA funds (Current and savings account funds). The CASA advantage facilitated the banksto eat into the market share of NBFCs.

While the auto nance companies are disadvantaged on the cost of funds, they score better in terms of credit assessment skills,

better operational efciency, higher loan yields and lower regulatory requirements. This result in better return on assets for the

auto nance companies compared to banks.

Considering the growth expected in auto industry particularly in the non-urban areas and the need for nance we believe that

this would bode well for the auto nance companies. Inspite of the growing competition from banks, NBFCs like Mahindra

Finance and Shriram Transport Finance continue to register robust growth due to their high penetration in unbanked areas, their

competence in understanding the local customer and their recovery capabilities.

We initiate coverage on Auto nancing sector with a positive rating. Our top picks are Mahindra & Mahindra Financial

Services Ltd and Shriram Transport Finance Company Ltd. We have a BUY at Declines on Mahindra & Mahindra Financial

Services Ltd and BUY on Shriram Transport Finance Company Ltd.

Mahindra & Mahindra Financial Services Ltd: With improvement in the macro economic conditions and in the auto sales, we

believe that this is likely to have a positive impact on the disbursement of MMFSL. With improving macro economic conditions,

MMFSL will be a beneciary of the rising rural demand. We expect the Net interest income to register a CAGR of 19.5% during

FY0-12 and the earnings to register a growth of 16.9% during the same period. Also due to nature of the business we expect the

gross NPA to continue to remain high. We recommend a BUY at DECLINES on Mahindra and Mahindra nancial services

ltd for a target price of INR502. (2x its PBV of INR251 for FY12.)

Shriram Transport Finance Company Ltd: The demand for used CV is expected to increase mainly due to the rapid growth

expected in the new commercial vehicles segment. Shriram being a dominant player in the organised preowned CV market, webelieve that company will be a beneciary of the rising demand. Further the ample amount of resources and the opportunities in

the construction equipment nancing will support AUM growth in future. Improved fee income from new initiatives as well as

sustained asset quality are also factors that would support growth for the company. We initiate coverage on Shriram Transport

Finance Company Ltd with BUY recommendation for a target price of INR638 (2.5x its book value of INR255.1 of FY12).

AnalystDeepti Chauhan

[email protected]

Tel: (022) 2858 3408

03 May, 2010




Expect car and UV sales to

register a CAGR o 14.1% during

FY10-12.

Automobile Industry

The automobile Industry witnessed strong growth till 2007-08. However in 2008-

09, there was a drop in the overall volumes, attributed to the economic slowdown

that led to demand contraction in all the underlying segments. Thereafter the

government introduced various stimulus packages, which have helped in revival of

demand. Therefore after 2008-09, the economy started picking up and this resulted

in improvement in sales volume.

Particulars FY05 FY06 FY07 FY08 FY09 FY10 CAGR FY06-10

Passenger cars 819,922 882,094 1,076,408 1,203,102 1,219,384 1,526,787 14.7

7.6 22.0 11.8 1.4 25.2

Utility Vehicles 243,875 261,951 302,863 346,332 330,379 422,989 12.7

7.4 15.6 14.4 -4.6 28.0

Commercial vehicles 318,599 350,553 467,423 490,161 385,144 530,933 10.9

10.0 33.3 4.9 -21.4 37.9

Total 1,382,396 1,494,598 1,846,694 2,039,595 1,934,907 2,480,709 13.5

8.1 23.6 10.4 -5.1 28.2

Source: CRISIL

Cars and utility vehicles

After a year of slowdown, the domestic passenger cars and UV industry showed

a revival in 2009-10 supported by scal incentives and a revival in the underlying

economy. The key factors that bolstered the auto sales were reduction in car prices

due to excise duty cuts, various schemes cum discounts offered by the OEMs and

softening of interest rates. Also, the sales got a llip as new models were launched

at competitive prices.

Going forward as well, the growth momentum is expected to continue in the car and

the UV industry with growth in sales volume estimated at 13-15%. Factors like higher

affordability of people, improved business condence, rise in disposable incomes

of taxpayers due to sops offered in the latest Union budget and new model launches

at competitive prices in FY10 as well as in FY11 are expected to aid the volume

growth of these segments.

The car and UV industry are dependent on the nancing environment, which was

visible in FY09 where high-risk aversion amongst nanciers curtailed the growth in

the Industry. However in FY10, there was signicant improvement in the nancing

environment where the rates of interest softened and the nance penetration (proportion

of vehicles nanced) as well as the loan to value (LTV) improved for the segment.

Within the car and UV industry, the nance penetration ranges between 65-70%,

whereas the loan to value ranges between 72-77%.

In

Th

ousan

ds

Passenger car Domestic Sales Utility vehicle Domestic Sales

Growth in Passenger car sales Growth in UV sales

Car and Utility vehicle-Domestic sales

FY07 FY08 FY09 FY10E FY11E FY12E0

500

1000

1500

2000

2500

22.0

14.4

11.814.0

-4.6

15.6

28.4

25.015.0

11.011.0

15.0

523

2016

471330

424346303

10761203 1219

1525

1753

Source: CRISIL




Going forward with growth in volumes, increase in nance penetration and higher

LTVs, the car and UV disbursement are expected to witness a CAGR of 21% and

19% respectively during the period FY10-12.

Commercial vehicles

As demand for commercial vehicles is driven by a number of factors such as growth

in industrial and agricultural production, freight movement, share of roadways in

freight movement, changes in freight rates and fuel prices and government policies

etc, the commercial vehicle industry too witnessed sharp contraction in 2008-09 due

to the economic crisis. Thus focus shifted towards increasing utilisation rather than

addition on new vehicles.

%

Car market Car disbursements Growth

INR

Bn

0

200

400

600

800

1000

FY09 FY10E FY11E FY12E-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

501

253304

384447

579

701806

20.4%

26.2%

16.6%

-14.1%

Car Disbursements

%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

0

50

100

150

200

250

300

350

INR

Bn

FY09 FY10E FY11E FY12E

UV market UV disbursements Growth

298

268

233

198

148126

105

80

31.2%

20.3%

17.7%

-25.0%

UV Disbursements

Source: CRISIL, ACMIIL Research

FY07 FY08 FY09 FY10E FY11E FY12E-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0

50

100

150

200

250

300

350

In

Th

ousan

d

LCV-Goods MHCV-Goods Overall Growth

%

38%

2%

-24%

39%

15%11%

243

329

292

221

196

252

149

174

236

188

246

169

Commercial Vehicle Volume-Domestic

Source: CRISIL, ACMIIL Research

-80.0

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

%

Mar-08

May-08

Jul-08

Sep-0

8

Nov-08

Jan-08

Mar-09

May-09

Jul-09

Sep-0

9

Nov-09

Jan-09

CV sales MoM Growth IIP MoM Growth

Correlation between CV sales and IIP

Source: CMIE, SIAM, ACMIIL research

Commercial Vehicle sales

direclty correlated to IIP.




However with revival of economy, the commercial vehicle industry has also started

to witness an increase in volumes. According to CRISIL, nancing environment has

also been favourable for the CV industry with interest rate (currently around 10-12

% for MHCV and 15-18 % for LCV) and greater willingness of nanciers to nance

CVs as compared to last year.

Going forward, the commercial vehicle volumes are expected to register a CAGR

of 13.1% during FY10-12. The LCV segment is expected to register higher growth

as compared to the MHCV segment mainly on account of increased movement of

non-bulk freight by road and launch of new lower tonnage vehicles.

Favourable nancing environment is also one of the main growth drivers for the

commercial vehicle industry. CV disbursements fell in 2008-09 on account of fall in

the CV volumes and increase in defaults by the transporters. However with revival

in CV volumes, the CV disbursements are expected to register a CAGR of 13.9%

during FY10-12. Further decline in risk aversion has also resulted in improving the

nance penetration as well as the LTV ratio for the industry. In the CV industry, with

revival in economy and reduced uncertainty with respect to transporters earnings the

loan to value is expected to increase (75-77%). Finance penetration has historically

been high given the nature of the industry (97-98%) as Small Fleet Operators (SFO)

do not have cash to buy vehicles while the LFO (large eet operators) require cash

reserves for working capital.

Tractor Industry

Considering the importance accorded to the agricultural sector, the tractor industry

in India is very signicant. Tractors are an integral part of mechanization and have

got a crucial role to play in increasing the agricultural productivity. In India, tractors

are utilized for various purposes besides farming.

A farmers decision to buy a tractor depends on three factors

Value of crop output

Availability of nance

Rainfall

Commercial Vehicle MarketCommercial Vechicle disbursements Growth in Disbursements

%

FY09 FY10E FY11E FY12E-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

0

100

200

300

400

500

600

700

INR

Bn

334

518

261

357

418

463454

574

-36.9%

21.3%23.2% 24.2%

Commercial Vehicle Disbursements

Source: CRISIL. ACMIIL Research

LCV segment expected to

register higher growth

compared to MHCV segment.

CV disbursements expected toregister a CAGR of 13.9% during

FY10-12.




Tractor sales witnessed strong growth till FY07. Thereafter, the performance of

tractor industry became sluggish as sales declined by 5% in FY08 and registered at

growth of 0.7% in FY09. This was mainly on account of the economic crisis that

led to alarming levels of NPAs in the Indian banking system. The banks thus went

slow on fresh lending while adopting stringent lending norms. (Interest rates were

revised to double-digit gures, close to those charged on cars and SUVs,. whereas

their earlier average was under 9 %, Margin money, which used to be 10 %, was

revised to 20 %).

Mahindra & Mahindra dominates the tractor industry with 37% domestic marketshare (including Punjab Tractors Ltd), followed by Tractor and Farm Equipments

Ltd (TAFE) at the second place with 23 % market share. The other two main players

in the domestic market are Escorts Ltd and International Tractors Ltd (ITL).

Going forward the tractor volumes are expected to register growth of 8% for FY11

and FY12 due to rising farm income, improved nancing environment, government

initiatives towards rural development.

Tractor nancing plays an important role in the prospects of the tractor industry as out of

the total tractors sold in India, 85-90 % of the tractors are purchased on nance. Therefore

the nance penetration is 80% for tractors and the loan to value is 65-70%. The tractor

disbursements are expected to grow at a CAGR of 10.2% during FY10-12.

Tractor Sales

0

100

200

300

400

500

FY07 FY08 FY09 FY10E FY11E FY12E

21.4%

-5.0%

0.7%

28.0%

8.0% 8.0%

Tractor Sales Growth

%

In

Th

ousan

ds

Source: CRISIL

%

Tractor Volumes Agri GDP

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

FY

2001

FY

2002

FY

2003

FY

2004

FY

2005

FY

2006

FY

2007

FY

2008

FY

2009

Linkages with Agri GDP

Source: CRISIL

Tractors play a crucial role

in increasing agricultural

productivity.

Mahindra & Mahindra dominate

the tractor industry with 37%domestic market share.




Easy availability of Finance- An important growth driver for the auto

Industry

Apart from rising disposable incomes, Auto nancing has emerged as an important

driver for demand in the auto Industry. Funding is important part of the auto sales as

nearly 70% to 80% of the vehicle sales are backed by auto loans extended by banks

or nancial institution. The availability of vehicle nance at the point of purchase

can foster sales. Therefore in order to provide complete buying assistance to the

purchasers at the point of purchase, many of the Auto companies have set up their

own nancing companies or forged associations with banks.

Sources of Finance Auto Financing Industry

The auto nance Industry has both organised and unorganised players. The organised

players comprise of

Banks: Private, foreign, public and co-operative

NBFCs can be further categorised as standalone NBFCs and captive NBFCs.

Captive NBFCs are nancing arms of auto manufacturers set up with the objective

of primarily nancing the products of their parent manufacturer.

The unorganised players include local moneylenders, dealers etc.

The auto nance industry was once dominated by the NBFCs. While banks dominated

the low risk car-nancing segment, NBFCs dominated the commercial vehicle space,

which was perceived to be risky. However, the entry of banks in retail nance space

poised severe competition to NBFCs. The share of retail loans in total advances of

banks has gone up from 11% in FY2000 to almost 25% in FY08. However due tothe slowdown in the economy during FY09, the share of retail loans declined to

21%. Within the retail loans, auto loans constituted almost 15% share. Banks had an

edge over the NBFCs because of their access to low cost funds in the form of CASA

(Current and savings account). With the advantage of low-cost funds, banks have

eaten into the market share of NBFCs. The market share of NBFCs in car and CV

nance segments declined from 35% and 86% in 2001-02 to 20- 25% and 40-45%

in 2008-09 respectively. (Source: CRISIL).

Changing Dynamics of the Auto finance Sector- Market Share of Players.

Year Cars and utility Vehicles Commercial vehicles

NBFC Banks NBFC Banks

2001-02 35 65 86 14

2005-06 18 82 49 51

2008-09P* 20-25 75-80 45-50 50-55

Source: CRISIL Research, CRISIL Ratings, *P-Projected

Tractor Market Tractor disbursements Growth

%

FY09 FY10E FY11E FY12E0.0%

5.0%

10.0%

15.0%

20.0%

0

50

100

150

200

INR

Bn

165150

136118

9082

74

64

10.2%10.2%

15.6%

2.4%

Tractor Disbursements

Source: CRISIL. ACMIIL Research

Tractor disbursementsexpected to register a CAGR of

10.2% during FY10-12.

70%-80% of auto sales are

backed by auto loans.

Banks have eaten into the

market share of Auto Finance

companies.




Captive finance arm

During the nancial crisis, most banks and other lending institutions tightened their

lending portfolio. This trend therefore affected the volumes in the auto Industry. Many

automakers attributed this fall to the liquidity crunch in the industry and therefore totide over this problem they decided to set up their own nance arms. For Eg: TVS

Motor Company and Ashok Leyland are planning their captive nancing arms. Toyota

and Hero Honda are learnt to be moving in the same direction.

Role of captive financing firm

The auto industry worldwide has often faced the problem of nding the right funding

for its customers. These factors, coupled with the cyclical nature of the auto industry,

have induced several Indian automobile manufacturers to think of setting up captive

nancing arms to fund their products exclusively at all stages of the business cycle.

Captive units also offer both, the product and nance under one roof. The captive

nance companies enjoy the advantage of manufacturers brand equity, lowerestablishment costs and preferred nancier status.

Competitive advantage of NBFC over banks

Regulatory requirements are less stringent for Auto nance companies as

compared to banks

Like Banks, the Auto Finance companies are governed (NBFC norms) by RBI .

However the regulatory requirements for auto nance companies are less stringent

than those for banks as

Auto Finance companies dont need to maintain a cash reserve ratio (CRR),

No not need to make loans to priority sectors (whereas the banks have to lend

40% of their loan book to the priority sector)

Lower SLR requirements (15% vs 25% for banks).

Hence despite being disadvantaged on the cost of the funds (due to access to CASA),

the auto nance companies can compete with banks on pricing of loans. Moreover,

some portion of the loans of the auto nance companies is eligible for being classied

under priority sector lending. Therefore the auto nance companies securitise these

assets with banks. This not only frees cash ows for the auto nance companies but

also reduces the cost of funds, as these funds are available at relatively lower cost

when compared to direct borrowings from banks.

Auto Finance Companies Banks

Capital Adequacy Ratio 12% 9%

Cash Reserve Ratio 0% 5.75%

Statutory Liquidity Ratio 15% 25%

Priority Sector Lending 0% 40%

Source: ACMIIL Research

Class of consumers

NBFCs serve consumers, which are perceived to be risky and high NPA prone

as per the banking standards. For example Mahindra nance serves consumers

from the rural areas, which are unable to meet the documentation requirements of

the banks. Further companies like Shriram transport nance are into nancing of

preowned vehicle which although are high yielding segment but are consideredto be risky due to poor credit history of the customers. Therefore banks generally

stay away from this class of consumers, which acts as an advantage for these

NBFCs.

Captive units offer both, the

product and nance under one

roof.

Regulatory requirements are

less stringent for Auto nance

companies




NBFC have better operational efciency

Due to the advantage of low cost funds, banks enjoy higher spreads as compared

to Auto nance companies. However NBFC operate at better efciencies and

thats reected in their low cost to income ratios.

They operate at higher cost efciencies than banks. NBFCs enjoy higher leeway on

assets and liabilities when compared to that of tightly regulated banks. That gives

NBFCs better exibility in product selection as well as in pricing their services.

Reach into a number of non-metro locations;

In Billion FY2005 FY2006 FY2007 FY2008 FY2009

Total loans and advances 11250.6 14737.2 18937.8 23320.0 27935.7

Retail portfolio of banks 2666.1 3756.8 4878.6 5707.8 5938.2

Auto Loans 350.4 613.7 825.6 880.0 839.2

Retail loans/Total loans 23.7 25.5 25.8 24.5 21.3

Auto Loans/Total Loans 3.1 4.2 4.4 3.8 3.0

Source: RBI

HDFC Bank, SBI and ICICI bank together account of almost 50% of the auto

loan market within Banks

Bank Retail Loans as on March 2009 % to total

Total Auto Loans 839 100

HDFC Bank 180 21

ICICI Bank 150 18

SBI Bank 97 12

Kotak 81 10

Others 331 39

Source: Company Data, ACMIIL Research

Branch Network of these Banks

Branch presence Kotak ICICI bank HDFC Bank SBI MMFSL

Total Branches 180 1408 1400 11447 436

Rural 11 138 65 4353 343

Semi urban/Urban 70 860 792 5322 89

Metro 99 410 543 1772 4

Rural 6% 10% 5% 38% 79%Semi urban/Urban 39% 61% 57% 46% 20%

Metro 55% 29% 39% 15% 1%

Source: Company Data, RBI, ACMIIL Research

%

2008 2009

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

H

DFC

Ban

k

ICICI

Ban

k

KotakMa

h.

Ban

k

M&Ma

h.

Financia

l

Shr

iram

Trans.

StB

kOf

In

dia

Sundaram

Fina

nce

Cost to Income Ratio

49.952.5 50.8

45.7

63.366.4

32.830.5 29.329.2

50.246.6

38.9

45.1

Source: Company Data, RBI, ACMIIL Research

Auto nance companies have

low cost to income ratios.

Auto nance companies have

major presence in rural areas.




Although the share of banks in auto nancing segment is o rise, the share of auto loans

in total portfolio of banks has remained in the range of 3-4% as can be seen from

the above table. Also most banks, which have signicant exposure to the auto loan

market, have got their presence in metros. On the other hand, the NBFCs have got

major presence in the rural areas. Therefore, it works as an advantage to the NBFCs

as they are able to serve customers based in unbanked and remote areas. Also, future

growth from rural areas bodes well for the NBFCs.

Conclusion

Private Bank PSU Bank Standalone NBFC Captive NBFC

2009 HDFC SBI Shriram Transport Magma Shrachi Finance Mahindra Finance Bajaj Auto Finance

Yield 12.8* 11.3* 17.2 15.4 20.2 16

Cost of Funds 5.1 6.0 11.4 11.8 9.9 10.0

Spreads 7.7 5.2 5.9 3.6 10.3 6.6

ROA 1.4 1.0 3.0 1.3 3.3 1.2

Net NPA 0.6 1.8 0.8 0.0 2.6 0.0

Time to process loans 2 days 4 -7 days 2 days 2 days

Source: Company data, ACMIIL Research. *Yields on car loans

While the auto nance companies are disadvantaged on the cost of funds, they score

better in terms of credit assessment skills, better operational efciency, higher loan

yields and lower regulatory requirements. This result in return on assts for the auto

nance companies for auto nance companies in this segment compared to banks.

Considering the growth expected in auto industry particularly in the non-urban areas

and the need for auto nance, we believe that this would bode well for the auto nance

companies. Inspite of the growing competition from banks, NBFCs like Mahindra

Finance and Shriram Transport Finance continue to register robust growth due totheir high penetration in unbanked areas, their competence in understanding the local

customer and their recovery capabilities.

Auto nance companies

score in terms of better credit

assessment skills.


10/31Auto Finance Sector ACMIIL 0


Key Data (INR)

CMP 443

Target Price 502

Key Data

Bloomberg Code MMFS IN

Reuters Code MMFS.BO

BSE Code 532720

NSE Code M&MFIN

Face Value (INR) 10

Market Cap. (INR Bn.) 43

52 Week High (INR) 47352 Week Low (INR) 198

Avg. Daily Volume (6m) 176036

Shareholding %

Promoters 61.1

Mutual Funds / Bank/ FI 7.9

Foreign Institutional Investors 26.8

Bodies Corporate/Individuals/others 4.3

Total 100

INR mn FY10 FY11E FY12E

Net InterestIncome

10,290.4 12,383.6 14,699.2

Operat ing Income 10,670.7 12,811.4 15,213.4

Net Profit 3,427.1 4,012.8 4,682.7

Net interestmargins

12.9 12.9 12.9

EPS (INR.) 35.7 41.8 48.8

Book value (INR) 187.1 216.7 251.2

03 May, 2010

B U Y a t D E C L I N E S

Mahindra & Mahindra Financial Services LtdBackground

Mahindra & Mahindra Financial Services Ltd (MMFSL) a subsidiary of Mahindra &

Mahindra (M&M) is one of Indias leading non-banking nance companies focused

on providing nance for utility vehicles, tractors and cars in the rural and semi-urban

sector. Mahindra & Mahindra is a leading tractor and utility vehicle manufacturer.

MMFSL has a network of 459 branches spread across India. The company has assets

under management (AUM) worth INR 103 billion as on March 2010.

Investment Rationale

Revival in demand for auto Industry.

The automobile Industry witnessed strong growth till 2007-08. However in 2008-09,

there was a drop in the overall volumes, attributed to the economic slowdown that

led to demand contraction in all the underlying assets. Thereafter the governmentintroduced various stimulus packages, which have helped in revival of demand for the

auto segment. With revival in auto sector, we believe there will be an increasing need

for auto nancing which in turn will bode well for the auto nancing companies.

Rural areas to drive growth in future

Semi-urban and rural areas are emerging as a potentially lucrative market for auto sales.

Strong growth in middle-income population and higher farm incomes are driving the

demand in smaller cities and villages. For example, the contribution of rural sales for

Maruti has increased from mere 3.5% in FY08 to almost 16% in 2QFY10.This acts

as an advantage to MMFSL as it is well positioned in the rural markets. Further due to

this, many leading car manufacturers are looking to enter into tie ups with MMFSL.

Diversified Loan book

MMFSL has a well-diversied portfolio. The company nances utility vehicles,

tractors, cars, commercial vehicles and pre-owned vehicles. While MMFSL

predominantly nances M&M vehicles, the company has diversied its portfolio and

now nances non M&M vehicles as well. MMFSL maintains a policy of nancing

only 40% of the M&M sales. This has helped MMFSL in capping its risk in case of

a slow down in M&M sales. Going forward we expect the loan book to grow at a

CAGR of 17.9% during FY10-12 on the back of improving macroeconomic conditions

and robust auto sales.

Securitisation as a tool

Apart from bank borrowing securitization also helps meet funding needs of the

company. ~45% of the loan book of MMSL is eligible for being classied under

priority sector lending. Since banks have to meet their priority sector lending targets,

they readily purchase these securitized assets at a discount. With better cash ows

and reduced borrowings, securitization of assets helps contain cost of funds.

Strong Parentage

MMFSL was promoted in 1991 by Mahindra & Mahindra which currently holds ~60%

in the company. M&M being a leading auto manufacturer, MMFSL has capitalised on

its parents strong distributors and dealer network for nancing its UVs and tractors.

Further MMFSL credit rating is linked to M&M, which in turn enables MMFSL

raise funds at competitive rates. Due to the poor economic condition in FY09 andsubdued performance of the parent the credit rating agencies downgraded rating for

MMFSL. However we believe that with improvement in the economic conditions

and operating performance of M&M, there is a possibility of revision in the credit

rating for MMFSL.




Company

Well Positioned in the rural market

MMFSL has positioned itself between the organized banking sector and local

moneylenders, offering customers competitive, exible and speedy lending services.Banks and local moneylenders primarily provided credit in rural markets. However

due to the various documentation and other requirements, the banks are unable

to provide adequate credit to the rural consumers. And, the moneylenders charge

excessive rates. MMFSL identied this as an opportunity.

MMFSL adopted procedure, which were not as stringent as banks. Also the rates of

interest were xed between those charged by banks and moneylenders. The company

follows a subjective assessment for determining the repayment capability of the

borrower on the basis of his occupation, ownership of land, type of crops sold etc, for

disbursing the loans. A great deal of emphasis is placed on customizing the product

for the customers keeping in mind his expected cash ows and other consideration.The objective is to minimize the time take for approval without compromising on

the quality. The loans are processed within two days of application.

The business is based on a cash collection model whereby the employees visit the

houses of the respective borrowers to collect repayments. This we believe can act as

an entry barrier in rural area with underdeveloped banking habits.

Network

MMFSL has a pan India network of 459 branches spread over 25 states and 2 union

territories in India covering almost 90% of the districts in India. Majority of its

branches are spread in rural and semi-urban areas.

Total Branches 459

Metro 4

Urban/Semi-urban 90

Rural 365

Source: Company

Efficient recovery mechanism

MMFSL has a policy of servicing customers with its own employees, who understand

the nuances of the market. MMFSL sources its executives locally and train them

periodically to understand the credit requirement of the customers and evolve a

nancial product based on the credibility of the borrowers. As MMFSL services a large

base of rural customers who lack the banking habits; all transactions are carried outin cash only. MMFSL has a strong cash collection system in place. Its cash collection

ofcers collect cash from the customer on a periodic basis, which is later deposited

at respective branches located in these rural areas.

To reduce the risk of frauds and leakages in its unique cash collection system,

MMFSL largely relies on its own employee rather than being dependent on DSA

and collection agents.

Diversified Loan Book

The loan book of MMFSL has witnessed a CAGR of 22% during FY06-08 on the

back of strong growth in auto sector. Due to the economic crisis, the loan book

registered a growth of mere 2.9% during FY09. While MMFSL predominantly

nances M&M vehicles, the company has diversied its portfolio and now nances

non M&M vehicles as well.

MMFSL positioned itself

between organized banking

sector and moneylenders.

MMFSL largely relies on its own

employees rather than beingdependent on DSA.




MMFSL has a got well-diversied portfolio. The company nances utility vehicles,

tractors, cars, commercial vehicles and pre-owned vehicles. Passenger vehicles (cars),

utility vehicles and tractors are the key segments for MMFSL, constituting 85%

share of the total disbursements. Initially, the company started with nancing UV

and tractor manufactured by M&M and thereafter entered into CV and car nancing.

The share of CV and car nancing in the disbursements has increased over the past

few quarters.

MMFSL maintains a policy of nancing only 40% of the M&M sales. This has helped

MMFSL in capping its risk in case of a slow down in M&M sales.

Disbursement Mix

Tractor nancing

MMFSL was predominantly engaged in providing nancial assistance to the

farmers for buying tractors and farm equipments. However, 2005 onwards MMFSL

diversied its lending portfolio and started nancing UVs, CVs and two-wheelers

as well. Tractors comprise of 23% of the total AUM as on March 2010.Tractor

nancing plays an important role in the tractor industry as out of the total tractors

sold in India, 85-90% of the tractors are purchased on Finance. MMFSL nances

tractor sold by M&M and PTL only.

M&M is a leading player in the tractor Industry. After acquisition of PTL, M&M

improved its market share to 42% in 2008-09. During FY09, M&M registered

tractor sales growth of 25.2% in the domestic market against at growth registeredby the Industry. In FY10, the companys YTD domestic sales have registered a

47% YoY growth at 165633 units. The acquisition of Punjab Tractors by M&M

is expected to increase disbursement for the tractor segment of MMFSL.

Due to seasonal nature of the business, delinquencies are higher in the tractor

segment being directly linked to agriculture. MMFSL maintains a lower LTV of

~68% and higher provision coverage to contain defaults. The tractor segment

has the highest average yields of 19-20%. Since tractor nancing is classied as

agricultural nance, banks buy these assets from MMFSL at a discount to meet

their priority sector lending targets. This in turn enables MMFSL to free cash

ows, reduce its borrowings and thereby its cost of funds.

MMFSL nances tractors only for its parent. Going forward we expect the tractor

segment of M&M to register a 9% CAGR in volumes during FY10-12. Further

since MMFSL nances ~30% of tractor sales of M&M and assuming a LTV of

68%, we expect the tractor loans to grow at a CAGR of 11 % during FY10-12.

Auto/Utility vehicles Tractors Cars Commercial Vehicles Refinance and Others

Dec-08 Jun-09 Dec-09 Mar-100%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

%

41%

22%

24%

7%

6%

40%

22%

25%

6%

7%

39%

22%

25%

6%

8%

35%

19%

29%

9%

8%

36%

20%

29%

8%

7%

35%

21%

29%

7%

8%

Disbursement Mix

Mar-09 Sep-09

Source: Company, ACMIIL Research

Tractors, Utility vehicles and

Cars are key segments for

MMFSL.

Tractors comprise 23% of the

total AUM of MMFSL.




Utility Vehicle Financing

MMFSL nances utility vehicles, SUVs and to some extent two-wheelers

manufactured by M&M. Post acquisition of two wheeler division of Firodia group

which manufactured Kinetic, the two Mahindra businesses drew more synergies

and further expanded its product offered. This segment comprises of close to 33%

of the total AUM as on March 2010.

In the utility vehicle segment, M&M, Maruti Suzuki and Tata Motors are the

largest players with ~80% market share. M&M is the leader in the utility space

with 36% market share as on March 2010.

The UV segment of M&M continue to post robust growth on account of the new

model Xylo and existing model Bolero which continue to witness good offtake.

M&M has further plans to launch new models over the next two years. It also plans

to launch a new SUV over the next two years as a successor to the Bolero. M&M

has also indicated that it would be launching a successor to the Scorpio over the

next two-three years. We believe that these initiatives by M&M are expected to

drive disbursement growth for UV segment of MMFSL.

MMFSL nances ~30% of sales on M&M. The loan to value in this segment is

73% and the average yields are ~17%. Going forward we expect the utility vehicle

volumes for M&M to register a CAGR of 13.5% during FY10-12. We expect the

loan growth of 17.8% during FY10-12 for the UV segment.

Car Financing

While MMFSL has been a preferred nancier for M&M, it has also entered into

tie-ups with leading passenger car manufactures including Maruti, Hyundai,

General Motors etc. Leading automobile manufactures leverage on MMFSLs

strong presence in the rural areas for providing nancial assistance to retail

customers. Car nancing comprises 30% share of the total AUM.

MMFSL enjoys the preferred nancier status of Maruti Suzuki. Maruti Suzuki is

the largest player in the passenger car segment with ~50% market share. Maruti

is increasingly focusing on the rural markets which is reected in the fact that

the rural sales for Maruti has increased from mere 3.5% in FY08 to almost 16%

in 2QFY10. The company is also planning to double its outlets into these areas.

This acts as an advantage for MMFSL and will help the company to improve its

disbursements in the car segment.

We expect the MMFSLs loan book for the car segment to grow at a CAGR of

19.9% during FY10-12.

Commercial vehicle nancing

MMFSL offers loans to commercial vehicles and construction equipment, which

includes trucks, buses, trippers, excavators, and light commercial vehicles. Within

this segment, the company is increasingly focusing to increase the portfolio of

construction equipment nancing. Further M&Ms foray into heavy commercial

vehicles segment in partnership with Navistar should also help improve

disbursements for this segment. Although this segment at present comprises

close to 8% of the total AUM at present, the company intends to increase the

composition of such loans to in the next 3 years.

Renancing

The management sees lot of potential in the nancing of preowned vehicles.

Consumer preference towards the pre owned vehicles is increasing at a rapid pace.

The market, which was earlier dominated by unorganised players, is expected to

Utility vehicles comprise 33%

of the total AUM of MMFSL.

MMFSL enjoys preferred

nancier status of Maruti

Suzuki.

MMFSL focusing to increase

the portfolio of construction

equipment nancing.




witness a change with many auto companies contemplating to enter the pre-owned

car market. Companies such as Mahindra First Choice, Popular Car World and

Maruti True Value are aggressively focusing on the franchising route to spread

across the country. Besides them, other car manufacturing companies such as

General Motors (GM), Hyundai Motors, Ford, Porche, and Carnation Auto have

also ventured into the pre-owned car industry to target the maximum share in

the market.

Renancing loans comprise 6% of the total AUM as on March 2010. Since the

valuation of the pre-owned vehicle is subjective, MMFSL lends in this segment

at premium yields of ~19%.

Outlook on Loan Book

Going forward we expect the loan book to grow at a CAGR of 17.9% during FY10-

12 on the back of improving macroeconomic conditions and robust auto sales. Car

nancing, CV nancing (including construction equipment nancing) and renance

segment are expected to be the major growth drivers. The company intends to increase

the composition of the CV nancing in the total AUM from 8% at present to 13% in

the next three years. The management also foresees lot of potential in the nancing

of preowned vehicles. The management has also indicated its plans of foraying into

a new segment of gold loan nancing.

Borrowing Profile

MMFSL borrows through diverse sources in the form of banks, bonds, commercial

papers and xed deposits. Borrowing prole is skewed towards bank borrowings.Apart from bank borrowing securitization also helps meet funding needs of the

company. Almost ~45% of the loan book of MMSL is eligible for being classied

under priority sector lending. Since banks have to meet their priority sector lending

targets, they readily purchase these securitized assets at a discount. MMFSL is able

to obtain discount of its borrowing cost from Banks on securitization of such assets.

With better cash ows and reduced borrowings, securitization of assets also helps

contain cost of funds.

With RBI hiking the rates, the banks are expected to increase their lending rates.

57% of its borrowings are from banks, however this is less likely to have an impact

on the cost of funds for the company as it has raised funds at lower cost during the

last year. Further the company intends to increase the share of xed deposits in the

total borrowings from 7% at present to 10% by FY12.

Loan Book Growth

0.0

20.0

40.0

60.0

80.0

100.0

140.0

FY08 FY09 FY10E FY11E FY12E

120.0

Loan Book

0%

20%

40%

60%

80%

100%


Auto/Utility vehicles Tractors Cars Commercial VehiclesRefinance and Others

38%

22%

26%

7%7%

36%

20%

28%

8%8%

36%

19%

29%

8%8%

36%

18%

29%

9%8%

Disbursement Mix


Expect MMFSL loan book togrow at a CAGR of 17.9% during

FY10-12.

Securitization as a tool to meet

funding needs of the company.




Credit ratingMMFSL has consistently enjoyed a good credit rating enabling it to borrow funds at

competitive rates. At present, FITCH has assigned AA (ind) rating and CRISIL has

assigned a AA- rating to the Companys long term debt, which is also linked to credit

rating of M&M. Due to the poor economic condition in FY09 and subdued performance

of the parent the credit rating agencies downgraded rating for MMFSL. However we

believe that with improvement in the economic conditions and operating performance

of M&M, there is a possibility of revision in the credit rating for MMFSL.

Margins to remain stable.

MMFSL has reported net interest margins of 12.9% in FY10 mainly led by lower

borrowing cost, lower level of NPAs and higher amount of securitisation towards theends of 4QFY10. With RBI hiking the rates, the banks are expected to increase their

lending rates. 57% of its borrowings are from banks, however this is less likely to

have an impact on the cost of funds for the company as it has raised funds at lower

cost during the last year. We expect our NIMs to remain stable at 12.9% over the

next two years.

Asset Quality

MMFSL follows a relatively stringent provisioning policy.

Duration (Months) RBI Norms Duration (Months) MMFSL norms

>5 and 5 and 18 and 11 and 30 and 24 months 100%

>54 months 50%

Source: Company

MMFSL operates in the rural and semi-urban areas where the population depends

on agriculture. The agricultural sector is highly seasonal mainly due to the abnormal

monsoons, which result in uncertainty in income levels. This results in delayed and

irregular payments. On important point to note that the NPAs are mainly seasonal

and are in the form of delayed payments. The nal credit write offs as per the

management has been ~2% of the loan book.

The gross NPA have declined from 7.6% in FY08 to 6.4% in FY10. The Net NPAs

have improved signicantly from 2.9% in FY08 to 0.9% in FY10. Over the period,MMFSL has improved its provision coverage from 63% in FY08 to 86% in FY10.

The improvement in gross NPA is on account of improved economic scenario which

coupled with a good rabi crop season have aided in containing incremental slippages

and also improving recoveries.

%

0%

20%

40%

60%

80%

100%

Mar-09 Jun-09 Sep-09 Dec-09

Bonds/NCD's Banks Others

51.4

43.7

4.9

50.4

46.0

3.7

45.9

49.0

5.1

43.4

50.0

6.6

33.7

57.0

9.4

Borrowing Profile

Mar-10

Source: Company

Borrowing Prole skewed

towards bank borrowings.

Margins to remain stable at12.9%

NPA expected to be high due to

the very nature of the business.




Further the management has indicated that one of the reasons for improved cash ows

has been usage of vehicles for commercial purposes rather than for farm purposes.

This we believe would bode well for the asset quality.

Due to the nature of the business, the gross NPAs are expected to be high, however

the company intends to maintain its Net NPA at 3% levels while maintaining higher

provisioning.

Capital adequacy

MMFSL has a capital adequacy ratio of 18.5% as on March 2010 against the

requirement of 12%. With improved prots and loan CAGR of 17.9%, we believe that

the company is well capitalised and will require to raise equity only post FY12.

Other initiatives

Insurance brokerage business - Mahindra Insurance Brokers (MIBL)

MIBL is the wholly owned insurance broking arm of MMFSL for both life and

non-life products. MMFSL is leveraging on its broad network of branches to offer

these nancial products in the rural markets. The non-life product segment largely

comprises of motor insurance primarily in the rural markets.

Rural housing loan business- Mahindra Rural Housing Finance (MRHFL)

Mahindra Rural Housing Finance is a wholly owned subsidiary of Mahindra &

Mahindra Financial Services Ltd (MMFSL), which was set up with the objective

of meeting the housing nance requirements of rural and semi urban customers.

MRHFL intends to capitalize on MMFSLs reach for creating a niche in the rural and

semi urban markets for housing nance. The company has launched operations in all

southern states on India in addition to states of Maharashtra and Gujarat.

Despite the difcult market condition in FY09, the company disbursed Loan worth

INR430 million in FY09 against INR30 million in FY08. Upto Dec 2009 the company

has sanctioned loans worth INR1118 million. Going forward, the management is

targeting a AUM of INR10, 000 million by FY13.

At present the contribution from these segments is insignicant, therefore we have

not factored any potential revenues from these segments in our future earnings

estimates.

Key Concerns

Dependency on Mahindra & Mahindra Ltd.

The company nances the acquisition of Mahindra utility vehicles and tractors. Henceany major reduction in sale of Mahindra utility vehicles and tractors will also affect

the business of the company.

High level of NPAs

MMFSL operates in the rural and semi-urban areas where the population depends

on agriculture. The agricultural sector is highly seasonal mainly due to the abnormal

monsoons, which result in uncertainty in income levels. This in turn may result in

high level of gross NPAs.

High revenue leakage

Since the business model of MMFSL is based on cash collection model wherein the

employees of MMFSL visit the respective borrowers house to collect repayments from

them. This exposes MMFSL to the risk of fraud and misappropriation of funds.

MMFSL well capitalized

MRHFL intends to capitalize on

MMFSLs reach.




Valuation and Recommendation

With improvement in the macro economic conditions and in the auto sales, we believe

that this is likely to have a positive impact on the disbursement of MMFSL. Since

M&M vehicles constitute a major portion of its disbursement, new launches by M&Min various segments would augur well for MMFSL.

Further the companys initiatives to foray into new areas of gold loan nancing,

housing nance etc is expected to add new revenue streams. MMFSL has also applied

for an AMC license and could look at expanding its line of business by launching

mutual fund schemes. However the contribution from these segments is insignicant

at present and will take some time to earn meaningful revenues for the company.

With improving macro economic conditions, MMFSL will be a beneciary of the

rising rural demand. We expect the Net interest income to register a CAGR of 19.5%

during FY0-12 and the earnings to register a growth of 16.9% during the same period.

Also due to nature of the business we expect the gross NPA to continue to remain

high. We recommend a BUY at DECLINES on Mahindra and Mahindra nancial

services ltd for a target price of INR502. (2x its PBV of INR251 for FY12E.).

Close Price 1.2PBV 1.5PBV 1.7PBV 2PBV

0

50

100

150

200

250

300

350

400

450

4/2/07

6/2/07

8/2/07

10/2/07

12/2/07

2/2/08

4/2/08

6/2/08

8/2/08

10/2/08

12/2/08

2/2/09

4/2/09

6/2/07

8/2/09

10/2/09

12/2/09

2/2/10

4/2/10


MMFSL to be a beneciary of

the rising rural demand.




Earnings Model (INR. Mn.)

Particulars FY09 FY10 FY11E FY12E

Interest Income 13648.2 15307.7 18598.9 22357.5

Interest expended 5098.6 5017.3 6215.3 7658.3

Net Interest Income 8549.6 10290.4 12383.6 14699.2

growth % 14.0 20.4 20.3 18.7

Other Income 198.4 380.3 427.8 514.2

Operating Income 8748.0 10670.7 12811.4 15213.4

Operating Expenses 2667.8 3249.8 4112.3 5034.8

Pre Provisioning Profits 6080.2 7420.9 8699.1 10178.6

Provisions & contingencies 2823.9 2215.2 2619.1 3083.6

Growth % 14.7 -21.6 18.2 17.7

Prior period items 0.0 -16.8 0.0 0.0

Profit before Taxes 3256.3 5188.9 6079.9 7095.0

Provisions for taxes 1111.1 1761.8 2067.2 2412.3

Net Profits 2145.2 3427.1 4012.8 4682.7

Growth % 21.2 59.8 17.1 16.7


Sources and Application of Funds (INR. Mn.)

Particulars FY09 FY10E FY11E FY12E

Liabilities

Capital 957.1 959.8 959.8 959.8

ESOP 12.9 12.0 12.0 12.0

Reserves & Surplus 13721.6 16984.8 19823.8 23136.8Networth 14691.6 17956.6 20795.6 24108.7

Borrowings 52130.2 64577.4 75264.9 91489.8

Total 66821.8 82534.0 96060.5 115598.5

Assets

Fixed assets 356.9 456.5 508.7 561.0

Intangible assets 17.5 19.5 21.5 23.5

Investments 1097.1 2159.0 2359.0 2859.0

Deferred Tax assets 1787.5 2069.0 2178.7 2564.0

Loans and Advances 68383.4 83788.2 99032.8 116547.5

Net Current Assets -4820.6 -5958.2 -8040.2 -6956.6

Total 66821.8 82534.0 96060.5 115598.5





Ratios


Spreads

Cost of Borrowings 9.9% 8.6% 8.9% 9.2%

Yield on Advances 19.4% 19.2% 19.3% 19.6%

Net Interest Income 9.5% 10.6% 10.4% 10.4%

Net interest margins 12.1% 12.9% 12.9% 12.9%

Profitability ratios

Return On Average Assets (ROAA) 3.3% 4.6% 4.6% 4.5%

Return On Average Net worth (ROANW) 15.4% 21.4% 22.2% 23.6%

Balance sheet ratios

Loan to borrowings ratio (%) 131.2 129.7 131.6 127.4

Debt/Equity Ratio (Times) 3.5 3.7 4.0 4.4

Growth Ratios

Borrowings 2.9% 23.9% 16.5% 21.6%

Loans 2.9% 22.5% 18.2% 17.7%

Networth 11.8% 22.2% 15.8% 15.9%

NII Growth 14.0% 20.4% 20.3% 18.7%

EPS 20.5% 59.3% 17.1% 16.7%

Valuation ratios

EPS (Rs.) 22.4 35.7 41.8 48.8

Book value (Rs.) 153.5 187.1 216.7 251.2

P/E (X) - - 12.0 10.3

P/BV (X) - - 2.3 2.0

Dividend per share 5.6 7.6 10.5 12.2





Key Data (INR)

CMP 572

Target Price 638

Key Data

Bloomberg Code SHTF IN

Reuters Code SRTR.BO

BSE Code 511218

NSE Code SRTRANSFIN

Face Value (INR) 10

Market Cap. (INR Bn.) 12952 Week High (INR) 585

52 Week Low (INR) 224

Avg. Daily Volume (6m) 340759

Shareholding %

Promoters 41.4

Mutual Funds / Bank/ FI 4.3

Foreign Institutional Investors 32.6

Bodies Corporate/Individuals/others 21.7

Total 100

INR mn FY10 FY11E FY12E

Net InterestIncome

21,607.5 24,722.7 32,691.5

Operat ing Income 22,528.4 25,943.1 33,900.5

Net Profit 8,731.1 10,751.2 13,091.9

Net interestmargins

12.1 11.4 11.5

EPS (INR.) 38.7 47.7 58.0

Book value (INR) 170.4 208.6 255.1

03 May, 2010

B U Y

Shriram Transport Finance Company LtdBackground

Shriram Transport Finance Company Ltd., a agship company of the Shriram Group

was established in 1979 and provides commercial vehicle nance to customers in

excess of 0.6 million across India. The company has niche presence in nancing pre-

owned trucks and small truck owners (STOs). On March 31, 2010 the company had

a network of 484 branches and service centers across the country. Its main products

include nancing of pre owned, commercial and passenger vehicles, along with three

wheeler, tractor, construction and multi utility vehicles.

It has around a 20-25% market share in pre-owned commercial vehicle (CV) nancing

and approximately 8% in new CV nancing market.

Investment Rationale

Largest player in the Organised Preowned CV segment: Shriram is the largest

players in the organized pre-owned CV segment. According to the company, it has

20-25% market share in this segment. The company largely nances trucks in the 5-12

years old age prole where competition from organised players is non-existent. The

pre-owned vehicle-nancing segment highly fragmented, collections are usually done

in cash, and customers are mostly SFO and FTU and are perceived to be highly risky

in nature. The loan book has registered a 30% CAGR during the period from FY07-

10.The Assets Under Management (AUM) has grown from INR120 billion in FY07

to INR291 billion in FY10 and it is largely dominated by the pre-owned vehicle.

Unique business model: The Company has developed strong competencies in the

areas of loan origination, valuation of pre-owned trucks and collection. In the used

CV nance market the key success factors for the nanciers would depend on their

knowledge about the asset class and the customer prole.

The nanciers should have sufcient knowledge about borrowers prole with

respect to their repayment capabilities. The banking habits of such borrowers are

underdeveloped, their incomes or cash ows are very irregular and they do not own

collaterals. These competencies have enabled STFCL to maintain high growth rates

and low NPA levels in a business that is perceived to be risky

Asset quality: STFCL has maintained its asset quality with gross NPAs in the range

of 2-2.5%. This is mainly because exposure to the segment which is highly sensitiveto economic cycles in low for STFCL. Further the collections mechanism also aids

in maintaining the quality. STFCL has evolved a efcient system of cash collection

mechanism whereby 50% of the salary of its eld ofcer is variable in nature and

linked to timely collection of receivables. This not only enabled the company to

maintain direct contact with customers but also enabled help reduce the maintain

NPA at very low levels.

Ample amount of resources: The company has ample liquidity with itself at present.

The company has completed a INR5.84bn QIP at a price of INR500.8, it has cash

of INR45 billion as on March 2010, and has also raised NCD worth INR10 billion

in FY10. The company has a capital adequacy ratio of 17% at present against the

minimum required by RBI of 12%. Therefore with all these cash inows we believe

that the company has sufcient funds and would enable the company to fund its new

initiatives and also help reduce the debt equity.





The demand for used CV is expected to increase mainly due to the rapid growth

expected in the new commercial vehicles segment. New vehicles are mostly used for

plying on major routes with long haulage. It is inefcient to depute an old vehicle onlong haulages as if done so, the operating expenditures may rise and possibilities of

breakdown are maximum. Therefore after every 5 years, these vehicles are sold to

Small Fleet Operators who ply them on short routes. Higher CV sales also support

replacement demand, which stem from stricter regulations pertaining to overloading

and emissions.

Shriram being a dominant player in the organised preowned CV market, we believe

that company will be a beneciary of the rising demand. Further the ample amount of

resources and the opportunities in the construction equipment nancing will support

AUM growth in future. Improved fee income from new initiatives as well as sustained

asset quality are also factors that would support growth for the company.

We initiate coverage on Shriram Transport Finance Company Ltd with BUY

recommendation for a target price of INR638 (2.5x its book value of INR25.1 of

FY12).

Industry

In India, the goods transportation industry continues to be dominated by roadways

as a mode of transport with a 53 % share followed by railways with a 35.7 % share.

Further roads are increasingly being used for transportation of non-bulk commodities.

With the share of non-bulk commodities rising in the total domestic freight movement,

Crisil expect the share of roads in transportation industry also to increase.

The road transport operators are classied into single truck or small eet operators-

SFO (those who own up to 1-5 trucks), First Time users (FTU) and large eet

operators-LFO (owning over 20 trucks). The truck ownership pattern suggests that

the small eet operators control around 75% of the total truck eet.

Commercial vehicles demand

Demand for commercial vehicles is driven by a number of factors such as growth

in industrial and agricultural production, freight movement, share of roadways in

freight movement, changes in freight rates and fuel prices and government policies.

Due to slowdown in economy in FY09, the CV industry also witnessed slowdown

with volumes declining by 21%.

%

-40.0%

-20.0%

0.0%

20.0%

40.0%

0.0

100.0

200.0

300.0

400.0

500.0

600.0

In

Th

ousan

d

FY06 FY07 FY08 FY09

10.0%

Commercial vehicles Sales Growth

Commercial Vehicle Sales

-21.4%

4.9%

33.3%36.4%

FY10

Source: CRISIL

CV industry sales improving.




With revival of economy, the commercial vehicle industry has started to witness an

increase in volumes. According to CRISIL, nancing environment has also been

favourable for the CV industry with interest rate (currently around 10-12 % for

MHCV and 15-18 % for LCV) and greater willingness of nanciers to nance CVs

as compared to last year. Further their interactions with industry players indicates

that CV industry has experienced some pre-ponement in purchases in the current

quarter due to the following reasons:

Expected roll back of excise duty in the Union Budget 2010-11

Expectation of hike in interest rates for vehicle purchases (the interest rates have

been hiked by around 50 basis points by majority of players recently).

Increase in CV prices due to the implementation of new emission norms.

Within the CV market, Light commercial vehicle (LCV) grew by 36% YoY while

the Medium and Heavy commercial vehicles grew by 26%. The performance of the

LCV was better as compared to the MHCV segment.

The share of LCVs is on the rise in the commercial vehicle segment mainly due

to the hub and spoke model of transportation where the MHCV are used for long

distance hauls and pickups are used for the last mile logistics. Demand in the LCV

segment is expected to be robust and is expected to drive demand for the Commercial

vehicle segment mainly due to the increased movement of non-bulk cargo by road

and launch of lower tonnage vehicles (such as Mahindra Gio).

Commercial Vehicle Financing Industry

Commercial Vehicle nance industry has assumed signicant importance since almost90% of vehicles sold by vehicle manufacturers are nanced. The CV nancing industry

can be divided into two segments.

New CV nancing

Pre Owned CV nancing.

New CV market Used CV market

Age of the CV 0-5 years Above 5 years

Type of transport operator Large Fleet operator (LFO). Small Fleet Operator (SFO), First Time User (FTU)

Haulage Long haul, Metros, Major cities. Last mile, short haul routes, interstate

Loan Yields 12-13% 17-20%

Loan to Value 85-90% 65-70%Major financiers Banks NBFCs

Source: CRISIL.

Share of MHCV on Decline

0.0

20.0

40.0

60.0

80.0

100.0

%

FY05 FY06 FY07 FY08 FY09

39.1

60.9

43.6

56.4

43.2

56.8

46.0

54.0

53.0

47.0

LCV MHCV

Source: CRISIL

LCV expected to perform better

compared to MHCV




New CV financing.

In the new CV nance Industry, operators are classied into single truck or small

eet operators-SFO (those who own up to 1-5 trucks), First Time users (FTU) and

large eet operators-LFO (owning over 20 trucks).LFOs usually prefer to have a large component of new CVs in their owned truck

eet. This is due to the fact that new CVs despite high EMIs have low maintenance

cost and thereby translates into higher prots.

According to CRISIL Research, while banks increasingly focus on the LFO, the SFO

and FTU segments are catered to by the NBFCs. This is mainly because the SFO and

FTU have no proper documentation and are perceived to be risky in nature.

Preowned Commercial vehicle financing market

The pre-owned vehicle-nancing segment highly fragmented, collections are usually

done in cash, customers are mostly SFO and FTU and is perceived to be higly risky

in nature. NBFC are the major nanciers to the preowned segment as banks stayaway from these assets.

The buyers of the used CV are usually the SFOs and the FTUs. The trends in truck

ownership pattern suggest that the SFOs own more than 70 % of the truck eet. One

typical characteristic of the SFOs is their absolute dependence on brokers for business

on account of their small size of operations, lack of distribution network and necessary

infrastructure. SFO mostly depend on LFOs to get contracts. Their bargaining power

is relatively less. It thus reduces their affordability to purchase new CVs.

Unorganised players cater to the bulk of demand for used truck nancing. Though

organised players are increasingly entering the market they have restricted their

operations to nancing trucks aged between 0-4 years. In the 5-12 year old trucknancing, which is STFLs key area of focus, competition from organised players

is non-existent.

Company

Business Model

Unique business model

STFCL has developed a strong understanding of the second hand truck market and

enjoys a market leadership position with a majority share in the organised sector.STFCL command 20-25% market share of the used truck nancing and 7-8% market

share of the new truck nancing.

CV Financing Business Model

Pre Owned (5-12 years Old CVs)

Market Share of 20-25%. AUM-INR222 bn

Owned Funds Average core lending businessyields 15-16%.

Securitization

New Cvs Market Share of 7-8 %.

AUM-INR70 bn

Owned Funds Average core lending businessyields 18-24%.

Source: Company

Banks increasingly nance

new commercial vehicles.

Unorganised players cater

to the bulk of used truck

nancing.

5-12 year old truck nancing-

STFCL key areas of focus.




The Company has developed strong competencies in the areas of loan origination,

valuation of pre-owned trucks and collection. In the used CV nance market the key

success factors for the nanciers depend on their knowledge about the asset class

and the customer prole. The nanciers should also posses sufcient knowledge

about repayment capabilities of borrowers. These customers possess underdeveloped

banking habits; their cash ows are higher irregular and lack collaterals. These

competencies have enabled STFCL to maintain high growth rates and adequate quality

(low NPA levels) in a business that is perceived to be risky.

Efficient Collection Mechanism

As mentioned above, the collection mechanism is also one of the important

competency to be developed by a used CV nancier. Majority of the truck owners

STFCL nances have underdeveloped banking habits, therefore the business model

involves cash collection from its customers. STFCL has evolved a efcient system of

cash collection mechanism whereby 50% of the salary of its eld ofcer is variable

in nature and linked to timely collection of receivables. This not only enabled the

company to maintain direct contact with customers but also enabled help reduce the

maintain NPA at very low levels.

Branch Network

Disbursements in used CV nance immune to cyclicality in new CV sales- As

compared to the growth in new CVs, the pre-owned CV demand is non-cyclical, on

account of being low-ticket size and consistent demand. STFCL largely focused on

nancing of used vehicles as more than 70% of the outstanding disbursements are

towards used vehicles. Further within these disbursements, majority are small-sized

commercial vehicles, which ply for short distances on state highways. During the

downturn, the category of truck operations that were hit were the ones that plied

on long distances on national highways, ferrying industrial goods. Since STFCLs

exposure to this segment is relatively low, the company was able to maintain

disbursements in FY09. While the new CV disbursements declined by 44% during

FY09, the preowned CV disbursements registered a growth of 17%.

STFCL nances CVs only for the goods segment. The demand for used CV is

expected to increase mainly due to the rapid growth expected in the new commercial

vehicles segment. The new vehicles are mostly used for plying on major routes with

long haulage and it is inefcient to hold an old vehicle on long haulages because of

increase in operating expenditure and possibility of breakdown. Therefore after 5 years

a resale of these vehicles is made to the Small Fleet Operators who ply them on short

routes. Higher CV sales would also be also supported by replacement demand, which

North

15%

Central

11%

South

47%East

9%

West

18%

Branch Network

Source: Company

50% of salary of eld ofcer

linked to timely collection of

receivables.

Preowned CV demand is non

cyclical.




will stem from stricter regulations on overloading and emissions. Going forward we

expect the new CV disbursements to grow at a CAGR of 10.1% during FY10-12.

We expect the preowned CV segment to register a CAGR of 19.5% during the same

period. We expect STFCLs disbursements to grow at a CAGR of 17.7%.

Loan Book Growth

The loan book has registered a 30% CAGR during the period from FY07-10. The

loan book is expected to grow at a CAGR of 33% during FY10-12. Although the

pre-owned vehicles are expected to dominate the book, the construction equipment

nancing is also expected to drive AUM growth n future. At present, the construction

equipment portfolio of INR25 billion constitute less than 10% of the AUM. However

with formation of a separate subsidiary, we expect ramp up in the construction

equipment portfolio and expect the size of the portfolio to increase to INR42 billion

by FY12.

0

50

100

150

200

250


Pre owned Vehicles New Vehicles

In

Bn

41

2583

33

97

19

118

29

143

32

169

35

Disbursement Mix

Source: Company and ACMIIL research

%I

n

Bn

0

100

200

300

400

0%

20%

40%

60%

80%

100%

Loan Book Growth


82

151179

253

317

Loan Book

179

Source: Company and ACMIIL research

Expects STFCL disbursements

to register a CAGR of 17.7%

during FY10-12.

Expects STFCL loan book to

register a CAGR of 33% during

FY10-12.




Borrowing Profile

Majority of borrowing for STFCL is in the nature of bank borrowings (60% of totalborrowings). Apart from banks borrowings, debentures and securitization from an

important resource of funding. The borrowing prole of STFCL in more skewed

towards wholesale funding forming almost 85% of the total borrowings. Further 50%

of the borrowings are oating in nature. Since the assets are 100% xed in nature,

this exposes the company to interest rate risk in a rising interest rate environment.

Therefore the company is taking proactive steps to reduce the oating liabilities. The

company has already raised NCD worth INR 10 billion in FY10. Going forward, the

company intends to increasingly use NCD and securitization to fund its disbursements.

The company has plans to raise NCD worth INR 10 billion in FY11 as well. With all

these measure we believe the company will be able to reduce the interest rate risk

on its oating liabilities.Net Interest margins

With increase in interest rates, we expect the yields on advances to improve. However

since the companys funding is largely wholesale and 50% of the borrowings are

oating in nature, the cost of funds is likely to go increase. During FY10, the company

had huge cash reserves on the balance sheet (~20% of the total assets) which was

built up to tide over the crisis, however with improvement in the economic situation

we believe that the cash balance will be utilized which in turn would improve the

net interest margins. We expect the net interest margins to improve 11.4% in FY11

and 11.5% in FY12.

Asset Quality

%

Borrowing Profile

Debentures Subordinated debts Loans from banks Loans from institutions and others

FY06 FY07 FY08 FY090.0

20.0

40.0

60.0

80.0

120.0

FY10

100.0

44.6

8.7

33.0

13.8

22.9

7.9

47.0

22.1

21.4

6.7

52.6

19.3

24.1

7.7

60.7

7.5

30.3

14.2

49.6

5.9

Source: Company

0.7%

1.6%

1.2%

FY06 FY07 FY08 FY09

0

1000

2000

3000

4000

5000

0.0%

0.5%

1.0%

1.5%

2.0%

%

InM

n

Gross NPA Net NPA Net NPA as % to Net advances

0.9%

Asset Quality

0.7%

FY10

Source: Company

STFCL taking proactive steps to

reduce the oating liabilities.

Net interest margins to

improve.

Exposure to segment highly

sensitive to economic cycles

low




STFCL has maintained its asset quality with gross NPAs in the range of 2-2.5%. This

is mainly because exposure to the segment which is highly sensitive to economic

cycles in low for STFCL. Further the collections mechanism also aids in maintaining

the quality.

Capital Adequacy

The company has ample liquidity with itself at present. The company has completed

a INR5.84bn QIP at a price of INR500.8, it has cash of INR45 billion as on March

2010, and has also raised NCD worth INR10 billion in FY10. The company has a

capital adequacy ratio of 20.9% at present against the minimum required by RBI of

12%. Therefore with all these cash inows we believe that the company has sufcient

funds and would enable the company to fund its new initiatives and also help reduce

the debt equity.

New Ventures

Auto Malls &Electronic Touch Screen Kiosks.Shriram plans to set up 50-60 Auto Malls over the next 12-15 months. Auto Malls

are being set up in the forms of hubs for selling of repossessed used CVs. STFCL

repossess on an average 7000-8000 vehicles annually. These would be sold

through these auto malls. The company would also sell repossessed vehicles of its

competitors in these malls on which it expect to earn a commission.

It also plans to buy some vehicles from other nanciers and yard sales, and re-

brand them as Shriram New Look after retrotting them.

STFCL has been holding a monthly Truck Bazaar, a marketplace for meeting of

potential buyers and sellers of CVs. It plans to replace the same by Electronic

Touch Screen Kiosks, which shall be stationed at these auto malls. There would

be an auction room in every auto mall that would accommodate about 200 people.

Each mall would have an electronic display screen displaying multipleangle

photographs of vehicles, and an auction will take place. This could lead to a better

price search mechanism. Further it also provides an avenue for the company to

earn fee income.

Partnering with private nanciers

STFCL has tied up with about 500 other private nanciers across the country.

These private nanciers account for bulk of lending in the preowned vehicles

segment. As part of the arrangement, the private nancier is responsible for

acquiring customers, collecting payments and pitching in with about 10-20 % of

the loan amount. The remaining part of the loan is extended by Shriram TransportFinance. These private nanciers are typically constrained for growth due to lack

of access to capital. This will enable Shriram to grow its AUM with the help of

the private nancier. At present, these type of loans constitute ~10% of the loan

book of STFCL. The company has plans to increase this to 15-20% over the next

3 years and also would increase the tie ups to ~2500 nanciers.

Construction equipment Financing

The company is expanding its construction equipment-nancing portfolio.

Management believes there is lot of potential in this segment. The company has

formed a 100% subsidiary for the same. At present the construction equipment

portfolio forms less than 10% of the total loan book. With pick up in the

infrastructure spends and also exit of some of banks from this space, we believe

demand for construction equipment nancing to increase. We expect ramp up

in the construction equipment portfolio and expect the size of the portfolio to

increase to INR42 billion by FY12 from INR25 billion at present.

Ample amount of liquidity.

STFCLs new ventures to

provide an avenue to earn fee

income.

Size of construction equipment

potfolio to increase.





The demand for used CV is expected to increase mainly due to the rapid growth

expected in the new commercial vehicles segment. The new vehicles are mostly used

for plying on major routes of long haulage. It proves inefcient to run an old vehicleon long haulages because of increase in operating expenditures and possibility of

breakdowns. Therefore, after 5 years, these vehicles are sold to Small Fleet Operators

who ply them on shorter routes. Higher CV sales also support by replacement demand,

which will stem from stricter regulations on overloading and emissions.

Shriram being a dominant player in the organised preowned CV market, we believe

that company will benet from the rising demand. Also, ample amount of resources

and the opportunities in the construction equipment nancing will support AUM

growth in future. Improved fee income from new initiatives as well as sustained asset

quality are also factors that would support growth for the company.

We initiate coverage on Shriram Transport Finance Company Ltd with BUY

recommendation for a target price of INR638 (2.5x its book value of INR255.1 of

FY12).

Close Price 1PE 1.5PE 2PE 2.5PE

0

100

200

300

400

4/2/07

6/2/07

8/2/07

10/2/07

12/2/07

2/2/08

4/2/08

6/2/08

8/2/08

10/2/08

12/2/08

2/2/09

4/2/09

6/2/07

8/2/09

10/2/09

12/2/09

2/2/10

4/2/10

500

600


STFCL being a dominant player

in the pre-owned CV market is

expected to benet from the

rising demand




Earnings Model (INR Mn)


Interest Income 36597.8 44075.4 50849.7 67167.6

Interest expended 19776.7 22468.0 26127.0 34476.1

Net Interest Income 16821.1 21607.5 24722.7 32691.5

Growth % 45.4 28.5 14.4 32.2

Other Income 713.5 920.9 1220.4 1209.0

Operating Income 17534.6 22528.4 25943.1 33900.5

Operating Expenses 5202.1 5176.1 4946.7 7794.9

Pre Provisioning Profits 12332.5 17352.3 20996.4 26105.6

Provisions & contingencies 3057.5 4106.5 4829.2 6239.2

Profit before Taxes 9275.0 13245.8 16167.3 19866.4

Provisions for taxes 3082.3 4514.7 5416.0 6774.4

Net Profits 6192.7 8731.1 10751.2 13091.9

Growth % 57.8 41.0 23.1 21.8


Sources and Application of Funds (INR. Mn.)


Liabilities

Capital 2035.1 2255.4 2255.4 2255.4

Reserves & Surplus 21131.2 36168.4 44782.2 55271.1

Networth 23166.3 38423.8 47037.6 57526.5

Borrowings 201213.1 184599.1 260855.5 325902.6

Other Liabilities 25253.9 45727.4 31780.6 28049.5Total 249633.3 268750.3 339673.7 411478.7

Assets

Fixed assets 1342.7 464.5 758.6 952.0

Investments 6547.6 18560.2 18560.2 18560.2

Loans 179043.8 179460.5 252857.0 317340.0

Other assets 62699.2 70265.2 67497.9 74626.4

Total 249633.3 268750.4 339673.7 411478.7





Key Ratios


Spreads

Cost of Borrowings 11.3% 11.6% 11.7% 11.8%

Yield on Advances 22.2% 24.6% 23.5% 23.6%

Net Interest Income 10.9% 12.9% 11.8% 11.8%

Net interest margins 10.6% 12.1% 11.4% 11.5%

Profitability ratios

Return On Average Assets (ROAA) 3.1% 3.9% 4.1% 3.8%

Return On Average Net worth (ROANW) 29.6% 28.4% 25.2% 25.0%

Balance sheet ratios

Loan to borrowings ratio (%) 89.0 97.2 96.9 97.4

Debt/Equity Ratio (Times) 8.7 4.8 5.5 5.7

Growth Ratios

Borrowings 36.2% -8.3% 41.3% 24.9%

Loans 18.8% 0.2% 40.9% 25.5%

Networth 27.5% 65.9% 22.4% 22.3%

NII Growth 45.4% 28.5% 14.4% 32.2%

EPS 56.8% 28.6% 23.1% 21.8%

Valuation ratios

EPS (Rs.) 30.1 38.7 47.7 58.0

Book value (Rs.) 113.8 170.4 208.6 255.1

P/E (X) - - 13.4 11.0

P/BV (X) - - 3.1 2.5

Dividend per share 5.0 5.4 8.1 9.9



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