Shriram Transport Finance Corporation Rating: hold Improvement in core business continues

SHTF’s core used vehicle financing business is seeing m-o-m improvement in both fresh disbursements and collections. As highlighted in our Q2FY21 update, improving demand for used vehicles should reflect in higher disbursements in H2FY21 and collection behaviour post end of moratorium has been better than expected. Potential restructuring from loans under moratorium is likely to be in low single digits. All these factors should translate into lower cost of risk going forward.

Bank conversion or NBFC with stricter regulations? The RBI working group has recommended conversion of large NBFCs into banks and bringing scale-based bank-like regulations for large NBFCs that choose not to convert, to reduce systemic risks. SHTF mgmt has said it is not converting into a bank at this juncture, but stricter regulatory oversight for large NBFCs like SHTF is surely ahead.

While the RBI is yet to spell out what a tight regulatory framework would imply for large NBFCs, growth and profitability could feel an impact going forward. That in turn could impact the market perception towards large NBFCs in the medium to long term, and act as an overhang.

Time to evaluate group structure? The impending issue related to the merger with another group entity – Shriram City Union Finance—is already an overhang on SHTF. This could be an opportune time to re-assess issues related to group structure given the major changes the RBI plans to introduce for NBFC sector, and spell out its long-term direction, which may provide comfort to investors and act as a potential catalyst for valuation re-rating.

Downgrade to Hold: We tweak our FY21/23e earnings estimates on the back of lower than expected cost of risk, and we revise our TP to Rs 1,100 vs Rs 950 earlier based on a residual income model. With c3% upside to our new TP after a c50% rise in the stock price over the past month and with rising regulatory uncertainty, we downgrade to Hold from Buy. While core business trends are improving, the regulatory environment could become challenging, which could affect return ratios in the medium term. Lack of clarity on RBI’s regulatory proposals could act as an overhang in the near term.