Sundaram Finance. Sundaram Finance: Lending momentum - Buy

Sundaram Finance, a leading non-banking finance company (NBFC) and predominantly a commercial vehicle (CV) financier, has always found favour with investors, given its steadfast focus on asset quality at all times and strong positioning in the automotive segment. The company has a very experienced management team and strong expertise on the market.

Over the past year, the value unlocking opportunity (as mentioned in our call last February) from the company’s decision to carve out its non-financial services business into a separate listed entity — Sundaram Finance Holdings Ltd (SFHL) — has also drawn investors. The stock price has gone up by 31 per cent since last February, when the board approved the demerger scheme.

In January this year, the company received the go-ahead for the demerger scheme by the National Company Law Tribunal. For every share held in Sundaram Finance, investors were to be allotted one share of SFHL. The record date was fixed at February 2, 2018.

While the demerger opened a value unlocking opportunity for existing investors, Sundaram Finance still has much to offer to long-term investors, thanks to its strong footprint in the CV financing space. The core business has been delivering healthy returns and maintaining good asset quality across industry cycles, despite the more stringent regulatory norms coming into play for NBFCs over the past few years. Besides its CV financing business, the company’s presence in other businesses such as home loans, mutual funds and non-life insurance, also adds value to the stock’s underlying price.

The Sundaram Finance stock trades at 3.9 times FY-19 book. This is at a premium to that of Shriram Transport and Mahindra and Mahindra Financial Services, which trade at 2.5-2.9 times. The ability of NBFCs such as Sundaram Finance and Bajaj Finance to maintain steady asset quality over the past two to three years, has driven their valuations.

The RBI had directed NBFCs to implement the more stringent NPA rules in a phased manner — from 150-day cut-off by end-March 2016 to 90 days by the end of March 2018. Mahindra and Mahindra Finance Services’ GNPA stood at 11.6 per cent as of December 2017 (90-day cut off) and that of Shriram Transport Finance at 7.89 per cent (120-day cut off). But Sundaram Finance has been well ahead of peers in complying with the norms. In 2015-16 itself, the company had moved to the 90-day norm — two years ahead of the regulatory stipulation. Sundaram Finance’s GNPAs stood at 1.74 per cent as of December 2017.

The expected pick-up in economic activity over the next one to two years and Sundaram Finance’s strong presence in the CV financing space, should continue to drive premium valuations. Investors with a long-term horizon of two to three years can buy the stock.

Focus on quality

Sundaram Finance’s focus has been in the new commercial vehicle segment. As of December 2017, CV accounts for 53 per cent of its assets under management (loan book). About 30 per cent of its loans is to the car segment and the balance to construction equipment, tractors, etc. Given that a chunk of the company’s lending is to the new CV segment, its fortunes depend on the growth in volumes within the segment, thus making it prone to the cyclicality in the underlying industry.

In FY-13 and FY-14, for instance, when industry sales volumes in MHCV shrunk by 23-25 per cent, Sundaram Finance’s growth in disbursements too moderated significantly. Nonetheless, the company managed to tide over the slowdown quite well, with disbursements growing by around 1.5 per cent CAGR during this period, through market share gains. Also, the company’s focus on quality (less risky new vehicle segment) has helped it keep a tab on delinquencies vis-à-vis peers such as Shriram Transport Finance that have a higher exposure to the used vehicle segment.

With the revival in CV sales, Sundaram Finance’s disbursements have also gathered pace since FY-16. After a 15 per cent growth in FY17, the company’s growth in disbursements have shot up 24 per cent Y-o-Y in the first nine months of FY-18, thanks to the pick-up in auto sales.

As per SIAM data, domestic sales of MHCVs have grown by 9 per cent in the first nine months and 12.5 per cent in FY-18. The sanguine industry growth numbers are expected to lead to healthy growth in disbursements in the March quarter as well.

Net profit for the nine months ended December 2017, after giving effect to the demerger, increased by 13 per cent to ₹403 crore compared with ₹356 crore in the same period last year.

Other businesses add value

Sundaram Finance also has stakes in other businesses such as home loans, mutual funds and non-life insurance, which add good value to the company’s underlying business. Going ahead, there could be substantial value unlocking for Sundaram Finance from these businesses.

In Royal Sundaram, the company holds 75.9 per cent stake. The non-life insurance player recorded a net profit of ₹67 crore in the first nine months of FY18 and a gross written premium of ₹1,944 crore. The company has a good distribution network and brand name thanks to its parent, Sundaram Finance. Valuing the insurance company on 1.1 times its one-year forward GWP (based on the additional 26 per cent stake Sundaram Finance acquired in RSA Group, UK in 2015), adds about ₹220 per share to Sundaram Finance’s core value.

Sundaram Finance also has a 100 per cent stake in Sundaram Asset Management Company (AMC). Given that Reliance Nippon Life Asset Management — the only listed AMC trades at about 6.5 per cent of its March 2018 AUM and is among the top five mutual funds — we have assigned a lower valuation (4 per cent) for Sundaram AMC. Sundaram Finance’s stake in the AMC thus works out to about ₹125 per share.

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