Shriram Finance's business prospects remain healthy, pressure on NIM seen

Valuation targets, though, are close to current price; potential selling by large non-promoter shareholders also an overhang

Investors have see-sawed in their opinion of the merger of Shriram City Union Finance (SCUF) and Shriram Capital (SCL) into Shriram Transport Finance. The merged entity Shriram Finance has assets under management (AUM) up by 27 per cent with a more diversified portfolio. The equity base expands, and analysts believe AUM should grow at 15 per cent between FY23 to FY25 but there may be NIM (net interest margin) pressure. The CAGR in EPS (earnings per share) could be lower, estimated at 13 per cent over the same period. The higher free float could lead to more selling, putting a ceiling on the share price.

The merged entity is the second-largest NBFC, behind Bajaj Finance if we exclude mortgage financiers. The portfolio has around 77 per cent 4-wheeler auto loans, while SME, 2-wheeler loans, Personal loans and gold loans have shares of 9 per cent, 5 per cent, 3 per cent and 3 per cent of respectively post-merger. Asset quality at Shriram Transport Finance (STF) and SCUF has improved and is expected to stay stable. Credit costs have moderated in recent quarters and should be stable over the next two years. It’s estimated that synergies could lead to 10 per cent growth in PAT over the next two fiscals.

The Commercial Vehicle (CV) and used CV market could see an upswing, and stronger growth in SCUF should support overall loan growth. Growth in SME loans is muted and there may be an upside in northern 2-wheeler markets. Cross-selling to customers, especially to 2-wheeler customers, is another potential growth area. Indeed, cross-selling in general could be a growth area since erstwhile Shriram Transport branches may now offer gold loans, etc. Cost of finance may moderate a little overall since Shriram Transport is higher-rated than SCUF, SCL.

Shriram Transport loans are mostly fixed rate and this could create NIM compression given a rising interest rate regime. STF has raised lending rates on new loans by 25-100 basis points in different segments. NIMs would nevertheless moderate in FY24 since interest rates could continue rising.

There are 3 key non-promoter shareholders in Piramal Group, TPG and Apax Partners, who together hold approximately 15 per cent stake in Shriram Finance. If they decide to cash out some of their stakes, the equity overhang could force prices down.

STF plans to continue financing to unorganised small truck operators, and first time buyers, it has set eligibility criteria to determine if vehicles are environmentally friendly. It finances vehicles of less than 12 years with pollution certificates and promotes digital loan collection by offering cash backs.

The return on equity of the merged entity was around 15 per cent in H1, FY23, with 2.8 per cent Return on Assets, and NIM (as percentage of AUM) was around 8.8 per cent and credit cost was at 2.3 per cent. The Gross NPAs was around 6.7 per cent, while Net NPAs were at 3.3 per cent.

A focus on ESG is hard to assess but Shriram Finance has secured long-term funding of $100 million from the ADB under its social finance framework to service underserved customers. This will enable it to provide credit for new and used vehicles and BS VI-compliant and electric vehicles. It has also raised $250 million from the US Development Finance Corporation and $475 million through a 144A Bond from the international market in 2022, both against objectives for financial inclusion.

The market responded positively to the news of the ADB funding. But a 5 per cent spike only compensated for an earlier steep drop. It’s too early to judge technical trends. Valuation targets are close to the current price of Rs 1,380.