Cholamandalam on firm ground aided by strong growth, decline in bad loans

Even as the stock markets are under pressure, shares of Cholamandalam Investment and Fincance Company have been outperforming, hitting a record high of Rs 1,475 on Wednesday. 

The Cholamandalam stock is up 14 per cent since January 30 after its good performance in the December quarter (Q3). In comparison, the Sensex was down 4 per cent in the same period. 

Strong show

In Q3, the company reported 53 per cent, year on year (y-o-y) growth in net profit, atRs 2.49 billion and a surge in net interest margin (NIM) to 9.6 per cent from 8.4 per cent in the year-ago period. Loan disbursements also grew 55 per cent y-o-y toRs 67.61 billion, while gross non-performing assets (NPAs) were down byRs 1.85 billion leading to an improvement in asset quality. The gross NPA ratio declined 80 basis points quarter on quarter, to 3.7 per cent. Assets under management (AUM) increased 20 per cent y-o-y toRs 400.56, the highest in the last 15 quarters. 

NIM, a profitability indicator, expanded for the seventh straight quarter because of a drop in funding costs, growth in the high-yielding vehicle finance book and improved asset quality. 

“Our disbursement, profit before tax, return on total assets and return on equity all grew. We maintained margins and, above all, NPAs came down. It is an all-round performance,” said N Srinivasan, executive vice-chairman and managing director, Cholamandalam Investment and Finance.

Umang Shah and Kushan Parikh, analysts at Emkay Global, said Cholamandalam delivered a robust performance on all counts with strong disbursement in the vehicle finance business. “We have upgraded our FY18/19 earnings estimate by an average 9 per cent to factor in better-than-expected growth and lower-than-expected credit costs. We believe that Cholamandalam is on a steady growth path, given the cyclical tailwind,” they said.

Vehicle finance, the key driver

The main growth driver for Cholamandalam was its vehicle finance business. The business saw disbursements growing 61 per cent y-o-y toRs 56.07 billion in Q3, while the NIM was higher at 8.9 per cent compared to 8.3 per cent in year-ago period. 

Vehicle finance accounted for 72 per cent of the company’s AUM, versus 68 per cent a year ago. On whether such a high loan book exposure to vehicle finance could be a risk, Srinivasan said there was no risk as Cholamandalam catered to all segments — commercial vehicles, two- and three-wheelers, cars, and agricultural and construction equipment.

The automobile industry is expected to grow 8-10 per cent annually in the coming years.

“We have a pan-Indian presence in the used vehicles space as well. The market is huge for this segment,” added Srinivasan. 

With the goods and services tax (GST) roll-out, the hub-and-spoke model was being pursued, which would help growth of the automobile industry, he added.  

While the pace of growth and diversification in vehicle finance is comforting, the company’s asset quality has also improved, which is the primary reason for improvement in overall gross NPAs.

Home finance

Disbursements in home equity, the second-largest contributor to AUMs rose toRs 7.99 billion in Q3 fromRs 6.19 billion in the year-ago period, up 29 per cent. The management and analysts, though, are cautious about this segment because of persisting asset quality issues and competition.

“We are pursuing the housing finance business through a wholly owned subsidiary right now. There is a long way ahead and we are structurally making differences so that the business can grow better. Even 30 per cent y-o-y growth is possible in housing finance,” said Srinivasan.

Outlook

Rising competition remains a challenge for the company. Likewise, rising interest rates could limit or weigh on margins. Against this backdrop, it could be a challenge for Cholamandalam to retain people. “We will try our best to maintain the margin at the gross and net levels,” said Srinivasan. 

According to analysts, Cholamandalam is a good bet because of its well-capitalised balance sheet, presence across geographies and diversifying portfolio. “It is expanding into newer segments such as home loans and MSME (micro, small and medium enterprises) financing. With strong branch expansion, focus on new products and improvement in the broader economy, we expect the company’s AUM to register double-digit compounded annual growth rate over the medium term,” analysts at Motilal Oswal Securities said.

HDFC Securities, too, raised its growth assumptions for Cholamandalam, after the Q3 results were announced, to 21 per cent from 20 per cent earlier over FY18-20. “Cost efficiencies and lower loan loss provisioning will lead to an expansion of 20 basis points in return on average assets over FY18-20. With return of equity of over 20 per cent, Cholamandalam deserves premium valuations,” it said. 

The stock is trading at 3.6 times its FY19 estimated book value. While a higher-than-expected increase in interest rates, a slowdown in economic growth and competitive landscape are key risk factors, long-term investors might see the stock decline, given the recent rally.