Asset quality key monitorable going ahead for Cholamandalam Investment

The pre-provision operating profit or PPoP was up 14 per cent Q-o-Q, which led to a return on equity or RoE at about 19 per cent in Q1FY25 despite deterioration in asset quality

Cholamandalam Investment and Finance’s (Chola) share has yielded one of the best returns in the last month. The company has sustained assets under management (AUM) growth at 7 per cent quarter-on-quarter (Q-o-Q), and 35 per cent year-on-year (Y-o-Y) in Q1FY25. Scaling up of new businesses now contributes to 13 per cent of loans (vs 10 per cent in Q1FY24). The expense ratio has dropped to 3 per cent, down 50 basis points (bps) Q-o-Q. However, credit cost is up to 1.5 per cent (up 100 basis points Q-o-Q) and gross non-performing loans ratio is 2.6 per cent, up 10 bps Q-o-Q. 

The pre-provision operating profit (PPoP) was up 14 per cent  Q-o-Q, which led to a return on equity (RoE) at about 19 per cent in Q1FY25, despite the deterioration in asset quality.

Chola has reported over 25 per cent Y-o-Y growth in the last two financial years and management is confident of 25–30 per cent AUM growth while improving profitability. Return on assets (RoA) guidance is 3.8 per cent but the current valuation may reflect the outlook.

Q1FY25 saw 5 per cent Q-o-Q growth in NII, despite a 20bps Q-o-Q reduction in total net interest margin (NIM) to 7.6 per cent. The NIM contraction was impacted by a 10 bps Q-o-Q decline in total assets yields to 14.7 per cent and a 10 bps Q-o-Q increase in the cost of funds. Yield contraction was driven by a 90 bps Q-o-Q drop in home loans (HLs) (9 per cent of loans) yields to 16 per cent and a 30 bps Q-o-Q reduction in vehicle financing (VF) (57 per cent of loans) to 15.1 per cent during Q1FY25.

The expense ratio improvement was positive. Management expects the downward trend in expense ratio to continue and drive profit before tax/RoA expansion to 3.7–3.8 per cent (current 3.2 per cent).

Asset quality deterioration was partly seasonal, with GNPL rising to 2.6 per cent vs 2.5 per cent (Q4FY24). Chola also reduced its ECL (expected credit loss) coverage to 1.8 per cent from 2.2 per cent Y-o-Y. Management attributes the increase in GNPL to seasonality and maintains full-year FY25 credit cost guidance at 1–1.2 per cent.

The portfolio is diversifying and across geographies. Even within the core vehicle finance segment (which contributes 55 per cent of AUM), it has offered loans across all categories from CVs, PVs 3Ws, 2Ws, and tractors. In Q1FY25, while growth in the VF segment lagged prior growth, it remained robust at 5 per cent Q-o-Q and 25 per cent Y-o-Y.

The company is looking to expand its non-vehicle portfolio. It guides for 20 per cent growth for FY25E. Loans against property (LAP) and HL constitute 30 per cent of AUM, and are key growth drivers. The LAP and HL portfolios grew 41 per cent and 53 per cent Y-o-Y, respectively. Both these segments have been generating pre-tax RoA of over 3.5 per cent. The company is gradually increasing its micro-LAP portfolio with 9–10 per cent of the overall disbursements from this segment.

In FY23, Chola entered three new businesses, CSEL (Consumer & Small Enterprise), SME and Personal Loans. On low bases, these businesses have together grown at 77 per cent Y-o-Y, with aggregated share reaching 13 per cent of AUM in Q1FY25 vs 9 per cent in Q4FY23. All three segments were profitable in FY24. However, due to higher investments to grow these segments, profitability is somewhat constrained. But the cost-to-assets ratio is improving. Given the vulnerability of these unsecured segments, Chola plans to keep this book below 15 per cent of the total portfolio.  

The company has a track record of good execution and asset quality has held up, though this is a key monitorable. The stock trades at 5.5 times of expected FY25 book value. This is a premium valuation compared to other NBFCs and reflects outperformance.