Shriram Transport is a stock for the risk taker now

 We could see a sharp trading rally in Shriram Transport if the health scare abates or the risk on trade makes a comeback. So, this is a stock for the risk taker and best avoided by a conservative investor

Highlights
- Stock has underperformed the index year to date
- Growth in slow lane
- Moratorium picture has improved
- Higher provision for Covid mars profit and provision could remain high
- Asset quality improves in the quarter but future looks uncertain
- Diversified funding a positive, rights issue provided further capital buffer

- Valuation attractive, but inherent volatility makes it a stock for risk takers

Shriram Transport has been a big under- performer in the market despite the stock rallying from its nadir hit in March. The stock has risen 41 per cent from its March lows as against 48 per cent for the Nifty index. The insipid show by Shriram Transport is a bit surprising because the rural sector, which is a key market for the company, is looking up on the back of a good monsoon and lockdown restrictions are increasingly being eased. Moreover, the recent rights issue has given enough capital cushion to the company to face the probable rainy day. Then what ails this leader of second hand vehicle financing, despite the segment remaining relatively insulated compared to first hand CVs?

We see growth to be a challenge even beyond Covid

Growth was quite tepid in the last reported quarter. Used vehicles and working capital drove the overall year-on-year (YoY) growth in assets under management (AUM) to 5 per cent. Disbursements declined by close to 92 per cent YoY.

Source: Company

However, this is not a one-time decline as the pace of growth had been decelerating for the last several quarters. While the rural segment is doing better (40 per cent of AUM comes from rural), the overall sluggishness in the economy would be a key impediment to growing a relatively large book unless Shriram dilutes its underwriting standards.

Asset quality – good but not out of the woods yet

In the last reported quarter, asset quality was stable with gross and net stage 3 assets at 7.98 per cent and 5.06 per cent of total assets respectively as against 8.36 per cent and 5.62 per cent in the previous quarter. In fact, collection that had fallen during the lockdown — from 84 per cent in March to 23 per cent in April and rose to 52 per cent in May — recovered in July and stood at 73 per cent in terms of borrowers and 53 per cent in terms of value. While this means that the moratorium book has reduced from close to 70 per cent by value in May, it remains large enough to warrant caution.

 Credit cost to remain a drag on profit

The historic credit cost of Shriram Transport has been around 2 per cent of assets. In the quarter gone by, the reported profit was pulled down by a Covid provision of Rs 956 crore. The total Covid provision is close to Rs 1,866 crore, which is a little over 3 per cent of the moratorium book. We have factored in a very high level of credit cost in FY21e.

 Margins under pressure

The company has seen a steady decline in its margins thanks to more than adequate liquidity and competitive rates on yield on advances. The buffer liquidity and SLR investments as of August was Rs 9,687 crore and Rs 1,822 crore respectively. The company has also raised Rs 1500 crore by way of a rights issue that should shore up its capital adequacy ratio, which is already comfortable at 21.9 per cent.

Source: Company

 What are the redeeming features?

Shriram Transport Finance is a large deposit taking NBFC and a likely survivor post the mayhem that is sweeping the NBFC universe. It has a diversified funding base and could continue to garner funds from different sources, including foreign borrowings and banks. It may be noted here that on-lending to NBFCs is now considered a part of bank’s priority sector exposure. So we do not foresee a structural liquidity challenge.

Source: Company

While short-term asset quality hiccup cannot be ruled out, we draw comfort from the fact that for 70 per cent of the borrowers, the vehicles are back on the road. Moreover, with a distinctive preference for used vehicles by the rural population, the increase in farm income due to a good harvest and a normal monsoon should augur well for demand as well as asset quality. Should the much-awaited scrappage policy get implemented, it could breathe new life to the commercial vehicle segment.

However, for Shriram, in addition to the growth and asset quality worries, there is the looming risk of the merger with group companies. Such a merger will dilute the unique characteristics of its expertise in the used vehicle market. This isn’t imminent though owing to the ongoing pandemic. Earnings could remain volatile as nearly half of the loan by value goes to heavy commercial vehicles where economic slowdown could adversely impact freight rates and cash flow of borrowers.

Source: Company, Moneycontrol Research

We have assumed a subdued loan growth in FY21 and a much higher credit cost than what has been indicated by the management, thereby resulting in a substantial near-term earnings decline. However, a recovery is likely in FY22e. While valuation looks particularly attractive from the FY22e perspective, the stock might remain volatile. We could see a sharp trading rally if the health scare abates or if the risk on trade makes a comeback. So this is a stock for the risk taker best avoided by a conservative investor.