Sundaram Finance, predominantly a commercial vehicles (CV) financier, recently approved the demerger of its non-financial services investments into a separate listed entity — Sundaram Finance Investments Ltd (SFIL).

By carving out the non-financial services business, the company has not only ring-fenced its financial services business, but also presented investors with an opportunity to unlock value from the company’s various investments, mainly in the automotive sector. For every share held in Sundaram Finance, investors will be allotted one share of SFIL. The record date is yet to be announced.

But, the demerger offering value unlocking opportunity is only the frosting on the cake. One of the leading lenders in the CV space, Sundaram Finance’s core business has been delivering healthy returns and maintaining good asset quality over the past couple of years. This, despite the slowdown in the economy and the more stringent regulatory norms coming into effect for non-banking finance companies (NBFCs).

Besides its CV financing business, the company’s presence in other businesses, such as home loan, mutual fund and non-life insurance, also adds value to the stock’s underlying price.

The Sundaram Finance stock trades at a premium to its peers. At around 3.9 times its one-year forward book, the stock trades much higher than Shriram Transport and Mahindra and Mahindra Financial Services, which are trading at 1.7-2 times. However, the stock trades cheaper than Bajaj Finance (five times) that has run up in recent times.

The ability of NBFCs such as Sundaram Finance and Bajaj Finance to maintain steady asset quality over the past two-three years, despite the RBI tightening NPA recognition norms for NBFCs in 2014, has driven their valuations.

For Sundaram Finance, the gradual pick-up in economic activity over the next one-two years and the inherent advantage that the company commands by complying with the NPA recognition norm ahead of time, should continue to drive premium valuations. Investors with a long-term horizon of two-three years can buy the stock.

Book value

In terms of book value, non-financial investments have grown from about ₹18 crore in 2005-06 to around ₹150 crore in 2015-16. Of the total investments, three are in listed companies — Sundaram Clayton (11.2 per cent holding), Wheels India (11 per cent) and India Motor Parts & Accessories (18.5 per cent), yielding a market value of about ₹1000 crore.

A back-of-the-envelope calculation of the possible market value of the other key investments based on their profit and net worth numbers works out to another ₹1,000 crore, based on peer valuations.

The per share value of these investments after a holding company discount of 30 per cent comes to about ₹150, 10 per cent of Sundaram Finance’s current market price.

While this may not appear significant now, with many of these businesses being dominant players in their space, the value unlocking potential could be substantial over the years.

Riding the recovery

Sundaram Finance is dependent on the fortunes of the CV industry. After two years of marked slowdown in domestic sales in the medium and heavy commercial vehicle (MHCV) segment, growth rebounded in fiscal 2015-16. After growing 16 per cent in 2014-15, MHCV sales closed FY16 with a strong 30 per cent growth. The comeback in CV sales augured well for Sundaram Finance, with loan disbursements growing 14 per cent in FY16 after three years of tepid growth.

But, CV sales have once again slowed in the current fiscal, leading to slower growth in disbursements for the company. However, over the next one-two years, as the economy picks up, disbursements should gather pace, thanks to the company’s strong business model.

Better placed

The RBI tightening the NPA recognition norms for NBFCs in 2014 has impacted earnings for many players. But Sundaram Finance has been well ahead of peers in complying with the norms. In 2015-16, the company moved to the 90-day norm, two years ahead of the regulatory stipulation. Despite this, Sundaram Finance’s gross NPAs are at 2 per cent of loans.

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. Royal Sundaram is among leading players in general insurance. Going ahead, there could be substantial value unlocking for Sundaram Finance.

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