A commercial success

PENNYWISE

With a unique business model, Shriram Transport Finance is set to witness unabated growth for the next few years.

Shriram Transport Finance is a good play on the commercial vehicle finance sector. Between 2002 and 2005, the commercial vehicle (CV) industry clocked a compounded annual growth rate (CAGR) of 29.4 per cent.

The year 2005-06 has not been so strong for CV sales, but the fourth quarter has again been solid. The industry is expected to continue its growth momentum over the next few years.

The credit for the improved CV sales mostly goes to the consistent GDP growth of over 7 per cent for the three years in a row, robust economic activity and easy financing and competitive rates offered by banks and financial institutions. Due to a larger base formed in the past few years, an increased number of vehicles is on the road.

This offers vast opportunities for financing of pre-owned (second-hand) vehicles. But financing does not come easy as there are private money lenders who charge interest at exhorbitant rates. But Shriram Transport Finance (STFL) has dared to enter the ring and has been changing the rules of the game. 
 

HIT NUMBERS
	FY04	FY05	Q3FY05	Q3FY06*
Net interest Income	131.73	183.14	36.46	105.16
Other income	14.49	2.47	0.89	2.40
Total Income	146.22	185.61	37.35	107.56
Operating profit	48.76	80.12	18.64	43.79
OPM (per cent)	33.35	43.17	49.91	40.71
Net Profit	36.84	49.32	11.77	28.84
NPM (Per cent )	25.19	26.57	31.51	26.81
* Shriram Investments merged with STFL

For more than 25 years, STFL has been the only organised player in financing pre-owned trucks to over 2.5 lakh small and mid-sized truck operators and fleet owners.

It provides a whole package of finance "� not only for purchase of the vehicles but also for the working capital. It is the market leader with an estimated share of about 16 per cent.

The company, over the years, has created strong entry barriers with its pan-India presence and a strong network of 250 branches, expertise in valuing pre-owned trucks and superior credit risk management.

There is still a lot of headroom left for the company to grow further, as the pre-owned truck financing industry estimated at over Rs 30,000 crore is almost twice the size of the new truck financing segment and, significantly, there is hardly any organised player.

A ban on overloading of trucks and a possible ban on trucks older than 15 years both act in favour of the company, as this will drive growth in demand for new trucks and, consequently, old trucks in future.

As STFL has clocked a CAGR of 51 per cent in its loan book and 35 per cent in its balance sheet size in the past five years, Parag Sharma, Vice-President (Finance), STFL, exudes confidence: "We expect the loan book to grow at over 30 per cent a year for the next three years. This is partly due to the higher growth rates of about 25-30 per cent in the last three years in the CV industry, which will enter the pre-owned market going ahead. We are more into financing vehicles ageing between four and twelve years."

He adds, "Even the size of the loan book is expected to be higher. Most of the vehicle sales in the past three years have been multi-axles, which command a higher value. So, just as the ticket size (value of the vehicle) will be higher, the same will be the case with the value of the loan."

What can add fuel to STFL's growth is its alliances with other financial institutions. The company does origination and collection activities for both Citycorp Finance and UTI Bank, and charges them a 2 per cent fee.

STFL also has a sound financial position. Its capital adequacy ratio stands at 26 per cent in March 2006, well above the limit of 12 per cent prescribed by the RBI for non-banking finance companies (NBFC).

This is partly due to the capital infusion of Rs 440 crore by Newbridge Capital owning 49 per cent stake in the holding company Shriram Holdings, which, in turn, has increased its investment in STFL through a preferential issue.

The company enjoys fat margins of about 10 per cent. "This (margin) is expected to remain stable as the decline in the cost of funds is in line with the decline in our lending rates," points out Sharma.

The company earns an yield of over 20 per cent on its loans. This is much higher than about 8 per cent that can be earned in the new vehicle financing business.

There is intense competition in the new vehicle financing business with many banks like ICICI Bank and HDFC Bank, and NBFCs such as GE Capital in a relatively small market of new financing. Going forward, as the company tries to capture a larger pie of the market, the lending rates may go down slightly.

Its cost of funds is also declining owing to its improving credit profile and replacement of high-cost retail deposits with wholesale debentures and term loans from banks. Cost of funds has gone down from about 18 per cent in FY03 to around 11 per cent in FY06. STFL has also brought down its NPA levels to less than 1 per cent.

However, there are certain worries for investors going in for the stock. STFL enjoys high margins primarily owing to the nature of its high risk business. About 77 per cent of truck owners hold up to five trucks. This could lead to overcapacity of trucks and under-cutting of freights, thereby impacting truck owners' profitability and their ability to repay loans.

Also, the probability of banks and other NBFCs entering the same business can intensify competition. If this happens, the company's margins will come under pressure as banks will have an edge over it because of their relatively low cost of funds.

But again, this does not seem a major threat for STFL as banks are unlikely to take exposure due to the high credit risk involved, and also incur the cost of building a network like STFL's.

In order to consolidate its related businesses and convert the company into a big truck financing conglomerate, the Shriram group is undertaking a merger of three group companies, strong in a different region.

STFL has traditionally had operations in western India. Shriram Investments, a company financing trucks in south India, was recently merged with STFL. Shriram Overseas Finance, which is based in north India, is also expected to merge with STFL.

The merged entity would have a balance sheet size of about Rs 4,000 crore in March 2005. It will also give the merged entity an edge over its potential competitors as it will have strong geographical coverage except the eastern region.

At Rs 134, the stock trades at a price-book value of 2.4 and 1.9 for FY07E and FY08E respectively. According to a banking analyst, this looks reasonable as STFL's return on equity at over 20 per cent is quite superior to other players.

Says Jay Prakash Sinha, Vice President and Head of Research at Kotak Private Client Group, "The outlook of the company is very positive. It has been able to manage the risky business of pre-owned truck financing quite well over so many years and has also developed a large client base and better reach."