Cholamandalam's investors should brace for higher asset quality pressure

Management expects further rise in already-high moratorium book

As is the case with most non-banking financial companies (NBFCs), the stock of Chola­mandalam Investment and Finance Company (Chola) has fallen sharply because of the Covid-19 outbreak and its expected implications on business. At 1.5 times FY21 estimated earnings, the stock is now trading at a 49 per cent discount to its long-term one-year forward valuation mean. Though low valuation offers comfort, turning many analysts positive on the stock, higher asset quality pain is a key downside risk that investors should not ignore.

Chola’s March 2020 quarter (Q4) results, announced last week, show 76 per cent of its customers (over 70 per cent of the loan book in value terms) have availed of a moratorium on their dues. This is, so far, the highest among peers. Worse, with the management expecting similar levels of moratorium in the second phase (June to August), it only adds to asset quality concerns.

“The management’s indication towards the likelihood of higher LGDs (loss given defaults) for Stage 3 assets (bad loans) and 76 per cent customers coming back to avail moratorium in Round 2 calls for lengthening of asset quality downcycle,” says Shweta Daptardar, analyst at Prabhudas Lilladher in her Q4 update on the company. Daptardar has downgraded the stock to ‘accumulate’.

 

 

Q4, which is typically a strong quarter in terms of collections, saw lower recoveries because of weak freight volumes and lockdown-led disruptions. A large part of Chola's book comprises loans to commercial and utility vehicles. Thanks to the higher moratorium, gross bad loans as a proportion of loan book rose just by 30 basis point sequentially to 3.8 per cent. So, investors may need to prepare for another round of asset quality pressure, which will reflect once the moratorium is lifted.

Analysts at Kotak Institutional Equities expect Chola's gross bad loans to increase by 380 basis point in FY21 to 7.6 per cent. Therefore, some analysts foresee a 50-70 basis point increase in credit cost (bad loan provisioning as a percentage of average loan book) in FY21, and hurt return ratios. This is despite Rs 534 crore Covid-19 provisioning created in Q4, which is one per cent of total loan assets as of March 2020.

Apart from elevated credit cost, weaker disbursement and lower fee income are expected to keep earnings under pressure. Therefore, many analysts have slashed their FY21 earnings estimate by 12-18 per cent for Chola. A satisfactory asset-liability management position, led by strong liquidity, though bodes well. Overall, investors may want to wait for further clarity on these counts.