SECTOR REPORT

AUTO FINANCE SECTOR- “BANKING THE UNBANKED”

03 May, 2010

Investment Thesis
After witnessing a slowdown in FY09, the revival in the Indian auto sector started FY10 onwards. And going forward, the auto
industry is expected to register strong volumes due to improvement in the economy and conducive financing environment. Within
the auto industry, the car segment is expected to register the highest growth mainly on account of the strong growth in the small
car segment and new model launches at competitive prices.
Conducive financing environment is one of the most important growth drivers of the auto industry. It is so as nearly 70-80%
vehicle sales are backed by loans extended by banks or financial institutions.
Auto finance industry was once dominated by the NBFCs. While banks dominated the low risk car-financing business, NBFCs
dominated the commercial vehicle segment as it was as perceived to be risky. Also, the banks enjoyed an edge over NBFC-funding
due to an easy access to low cost CASA funds (Current and savings account funds). The CASA advantage facilitated the banks
to eat into the market share of NBFCs.
While the auto finance companies are disadvantaged on the cost of funds, they score better in terms of credit assessment skills,
better operational efficiency, higher loan yields and lower regulatory requirements. This result in better return on assets for the
auto finance companies compared to banks.
Considering the growth expected in auto industry particularly in the non-urban areas and the need for finance we believe that
this would bode well for the auto finance companies. Inspite of the growing competition from banks, NBFC’s like Mahindra
Finance and Shriram Transport Finance continue to register robust growth due to their high penetration in unbanked areas, their
competence in understanding the local customer and their recovery capabilities.
We initiate coverage on Auto financing sector with a positive rating. Our top picks are Mahindra & Mahindra Financial
Services Ltd and Shriram Transport Finance Company Ltd. We have a “BUY at Declines” on Mahindra & Mahindra Financial
Services Ltd and “BUY” on Shriram Transport Finance Company Ltd.
Mahindra & Mahindra Financial Services Ltd: With improvement in the macro economic conditions and in the auto sales, we
believe that this is likely to have a positive impact on the disbursement of MMFSL. With improving macro economic conditions,
MMFSL will be a beneficiary of the rising rural demand. We expect the Net interest income to register a CAGR of 19.5% during
FY0-12 and the earnings to register a growth of 16.9% during the same period. Also due to nature of the business we expect the
gross NPA to continue to remain high. We recommend a “BUY at DECLINES” on Mahindra and Mahindra financial services
ltd for a target price of INR502. (2x it’s PBV of INR251 for FY12.)
Shriram Transport Finance Company Ltd: The demand for used CV is expected to increase mainly due to the rapid growth
expected in the new commercial vehicles segment. Shriram being a dominant player in the organised preowned CV market, we
believe that company will be a beneficiary of the rising demand. Further the ample amount of resources and the opportunities in
the construction equipment financing will support AUM growth in future. Improved fee income from new initiatives as well as
sustained asset quality are also factors that would support growth for the company. We initiate coverage on Shriram Transport
Finance Company Ltd with “BUY” recommendation for a target price of INR638 (2.5x its book value of INR255.1 of FY12).

Analyst
Deepti Chauhan
research@acm.co.in
Tel: (022) 2858 3408

Auto Finance Sector ACMIIL 

 SECTOR REPORT

Automobile Industry
The automobile Industry witnessed strong growth till 2007-08. However in 2008-
09, there was a drop in the overall volumes, attributed to the economic slowdown
that led to demand contraction in all the underlying segments. Thereafter the
government introduced various stimulus packages, which have helped in revival of
demand. Therefore after 2008-09, the economy started picking up and this resulted
in improvement in sales volume.
Particulars FY05 FY06 FY07 FY08 FY09 FY10 CAGR FY06-10
Passenger cars 819,922 882,094 1,076,408 1,203,102 1,219,384 1,526,787 14.7
7.6 22.0 11.8 1.4 25.2
Utility Vehicles 243,875 261,951 302,863 346,332 330,379 422,989 12.7
7.4 15.6 14.4 -4.6 28.0
Commercial vehicles 318,599 350,553 467,423 490,161 385,144 530,933 10.9
10.0 33.3 4.9 -21.4 37.9
Total 1,382,396 1,494,598 1,846,694 2,039,595 1,934,907 2,480,709 13.5
8.1 23.6 10.4 -5.1 28.2
Source: CRISIL

Cars and utility vehicles

After a year of slowdown, the domestic passenger cars and UV industry showed
a revival in 2009-10 supported by fiscal incentives and a revival in the underlying
economy. The key factors that bolstered the auto sales were reduction in car prices
due to excise duty cuts, various schemes cum discounts offered by the OEM’s and
softening of interest rates. Also, the sales got a fillip as new models were launched
at competitive prices.
Car and Utility vehicle-Domestic sales
2500
28.4
2000 22.0 2016
25.0 1753
1500 14.4 15.0
Expect car and UV sales to
In Thousands

1525 15.0
15.6
1219 11.0
register a CAGR o 14.1% during 1000 1076
1203
11.8 11.0
14.0
FY10-12. 500
471 523
346 424
303 -4.6 330
0
FY07 FY08 FY09 FY10E FY11E FY12E
Passenger car Domestic Sales Utility vehicle Domestic Sales
Growth in Passenger car sales Growth in UV sales
Source: CRISIL

Going forward as well, the growth momentum is expected to continue in the car and
the UV industry with growth in sales volume estimated at 13-15%. Factors like higher
affordability of people, improved business confidence, rise in disposable incomes
of taxpayers due to sops offered in the latest Union budget and new model launches
at competitive prices in FY10 as well as in FY11 are expected to aid the volume
growth of these segments.
The car and UV industry are dependent on the financing environment, which was
visible in FY09 where high-risk aversion amongst financiers curtailed the growth in
the Industry. However in FY10, there was significant improvement in the financing
environment where the rates of interest softened and the finance penetration (proportion
of vehicles financed) as well as the loan to value (LTV) improved for the segment.
Within the car and UV industry, the finance penetration ranges between 65-70%,
whereas the loan to value ranges between 72-77%.

Auto Finance Sector ACMIIL 

 SECTOR REPORT

Going forward with growth in volumes, increase in finance penetration and higher
LTV’s, the car and UV disbursement are expected to witness a CAGR of 21% and
19% respectively during the period FY10-12.
Car Disbursements UV Disbursements

1000 26.2% 30.0% 350 40.0%

31.2%
20.4%
800 20.0% 300 30.0%
20.3% 298
806 16.6% 250 17.7% 20.0%
701 268
600 10.0% 233
200 10.0%
INR Bn

579 198

%
INR Bn

%
501 150 0.0%
400 447 0.0% 148
384 126
304 100 -10.0%
105
200 253 -10.0% 80
50 -20.0%
-14.1% -25.0%
0 -20.0% 0 -30.0%
FY09 FY10E FY11E FY12E FY09 FY10E FY11E FY12E
Car market Car disbursements Growth UV market UV disbursements Growth

Source: CRISIL, ACMIIL Research

Commercial vehicles
As demand for commercial vehicles is driven by a number of factors such as growth
in industrial and agricultural production, freight movement, share of roadways in
freight movement, changes in freight rates and fuel prices and government policies
etc, the commercial vehicle industry too witnessed sharp contraction in 2008-09 due
to the economic crisis. Thus focus shifted towards increasing utilisation rather than
addition on new vehicles.
Commercial Vehicle Volume-Domestic
350 50%
38% 39% 329
300 40%
292
30%
250 252
246 236 243
221 20%
200
In Thousand

188 196 15% 10%

174

%
150 169 11%
149 0%
2%
100
-10%
-24%
50 -20%
0 -30%
FY07 FY08 FY09 FY10E FY11E FY12E
Commercial Vehicle sales LCV-Goods MHCV-Goods Overall Growth
direclty correlated to IIP. Source: CRISIL, ACMIIL Research

Correlation between CV sales and IIP

60.0

40.0

20.0

0.0
%

-20.0

-40.0

-60.0
Mar-08

May-08

Jul-08

Sep-08

Nov-08

Jan-08

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-09

-80.0

CV sales MoM Growth IIP MoM Growth

Source: CMIE, SIAM, ACMIIL research

Auto Finance Sector ACMIIL 

 SECTOR REPORT

LCV segment expected to
register higher growth
compared to MHCV segment.
However with revival of economy, the commercial vehicle industry has also started
to witness an increase in volumes. According to CRISIL, financing environment has
also been favourable for the CV industry with interest rate (currently around 10-12
% for MHCV and 15-18 % for LCV) and greater willingness of financiers to finance
CVs as compared to last year.
Going forward, the commercial vehicle volumes are expected to register a CAGR
of 13.1% during FY10-12. The LCV segment is expected to register higher growth
as compared to the MHCV segment mainly on account of increased movement of
non-bulk freight by road and launch of new lower tonnage vehicles.
Favourable financing environment is also one of the main growth drivers for the
commercial vehicle industry. CV disbursements fell in 2008-09 on account of fall in
the CV volumes and increase in defaults by the transporters. However with revival
in CV volumes, the CV disbursements are expected to register a CAGR of 13.9%
during FY10-12. Further decline in risk aversion has also resulted in improving the
finance penetration as well as the LTV ratio for the industry. In the CV industry, with
revival in economy and reduced uncertainty with respect to transporters earnings the
loan to value is expected to increase (75-77%). Finance penetration has historically
been high given the nature of the industry (97-98%) as Small Fleet Operators (SFO)
do not have cash to buy vehicles while the LFO (large fleet operators) require cash
reserves for working capital.

Commercial Vehicle Disbursements

700 23.2% 24.2% 30.0%

21.3%
600 20.0%
574
CV disbursements expected to 500 518
463
10.0%
454
register a CAGR of 13.9% during 400 418 0.0%

%
INR Bn

357
FY10-12. 300 334 -10.0%
261
200 -20.0%
100 -36.9% -30.0%
0 -40.0%
FY09 FY10E FY11E FY12E
Commercial Vechicle disbursements Commercial Vehicle Market Growth in Disbursements
Source: CRISIL. ACMIIL Research

Tractor Industry
Considering the importance accorded to the agricultural sector, the tractor industry
in India is very significant. Tractors are an integral part of mechanization and have
got a crucial role to play in increasing the agricultural productivity. In India, tractors
are utilized for various purposes besides farming.
A farmer’s decision to buy a tractor depends on three factors –
● Value of crop output
● Availability of finance
● Rainfall

Auto Finance Sector ACMIIL 

 SECTOR REPORT

Tractor Sales
500 28.0%

21.4%
400

300

In Thousands
8.0% 8.0%

%
200

100 0.7%
-5.0%
0
FY07 FY08 FY09 FY10E FY11E FY12E
Tractor Sales Growth
Tractors play a crucial role
Source: CRISIL
in increasing agricultural
productivity. Linkages with Agri GDP
40.0%
30.0%
20.0%
10.0%
0.0%
%

-10.0%
-20.0%
-30.0%
FY 2001

FY 2005
FY 2003

FY 2008
FY 2006

FY 2009
FY 2002

FY 2004

FY 2007
-40.0%
Tractor Volumes Agri GDP
Source: CRISIL

Mahindra & Mahindra dominate
the tractor industry with 37%
domestic market share.
Tractor sales witnessed strong growth till FY07. Thereafter, the performance of
tractor industry became sluggish as sales declined by 5% in FY08 and registered flat
growth of 0.7% in FY09. This was mainly on account of the economic crisis that
led to alarming levels of NPAs in the Indian banking system. The banks thus went
slow on fresh lending while adopting stringent lending norms. (Interest rates were
revised to double-digit figures, close to those charged on cars and SUVs,. whereas
their earlier average was under 9 %, Margin money, which used to be 10 %, was
revised to 20 %).
Mahindra & Mahindra dominates the tractor industry with 37% domestic market
share (including Punjab Tractors Ltd), followed by Tractor and Farm Equipments
Ltd (TAFE) at the second place with 23 % market share. The other two main players
in the domestic market are Escorts Ltd and International Tractors Ltd (ITL).
Going forward the tractor volumes are expected to register growth of 8% for FY11
and FY12 due to rising farm income, improved financing environment, government
initiatives towards rural development.
Tractor financing plays an important role in the prospects of the tractor industry as out of
the total tractors sold in India, 85-90 % of the tractors are purchased on finance. Therefore
the finance penetration is 80% for tractors and the loan to value is 65-70%. The tractor
disbursements are expected to grow at a CAGR of 10.2% during FY10-12.

Auto Finance Sector ACMIIL 

 SECTOR REPORT

Tractor Disbursements

200 20.0%

15.6%
Tractor disbursements 150
150
165 15.0%
expected to register a CAGR of 10.2%
136 10.2%
10.2% during FY10-12. 100 118 10.0%

INR Bn
90

%
74 82
50 5.0%
64
2.4%
0 FY09 FY10E FY11E FY12E
0.0%

Tractor Market Tractor disbursements Growth

Source: CRISIL. ACMIIL Research

Easy availability of Finance- An important growth driver for the auto

70%-80% of auto sales are
backed by auto loans.
Banks have eaten into the
market share of Auto Finance
companies.
Industry
Apart from rising disposable incomes, Auto financing has emerged as an important
driver for demand in the auto Industry. Funding is important part of the auto sales as
nearly 70% to 80% of the vehicle sales are backed by auto loans extended by banks
or financial institution. The availability of vehicle finance at the point of purchase
can foster sales. Therefore in order to provide complete buying assistance to the
purchasers at the point of purchase, many of the Auto companies have set up their
own financing companies or forged associations with banks.
Sources of Finance –Auto Financing Industry
The auto finance Industry has both organised and unorganised players. The organised
players comprise of
● Banks: Private, foreign, public and co-operative
● NBFC’s can be further categorised as standalone NBFC’s and captive NBFC’s.
● Captive NBFC’s are financing arms of auto manufacturers set up with the objective
of primarily financing the products of their parent manufacturer.
● The unorganised players include local moneylenders, dealers etc.
The auto finance industry was once dominated by the NBFC’s. While banks dominated
the low risk car-financing segment, NBFCs dominated the commercial vehicle space,
which was perceived to be risky. However, the entry of banks in retail finance space
poised severe competition to NBFCs. The share of retail loans in total advances of
banks has gone up from 11% in FY2000 to almost 25% in FY08. However due to
the slowdown in the economy during FY09, the share of retail loans declined to
21%. Within the retail loans, auto loans constituted almost 15% share. Banks had an
edge over the NBFCs because of their access to low cost funds in the form of CASA
(Current and savings account). With the advantage of low-cost funds, banks have
eaten into the market share of NBFCs. The market share of NBFCs in car and CV
finance segments declined from 35% and 86% in 2001-02 to 20- 25% and 40-45%
in 2008-09 respectively. (Source: CRISIL).
Changing Dynamics of the Auto finance Sector- Market Share of Players.
Year Cars and utility Vehicles Commercial vehicles
NBFC Banks NBFC Banks
2001-02 35 65 86 14
2005-06 18 82 49 51
2008-09P* 20-25 75-80 45-50 50-55
Source: CRISIL Research, CRISIL Ratings, *P-Projected

Auto Finance Sector ACMIIL 


Captive units offer both, the
product and finance under one
roof.
Regulatory requirements are
less stringent for Auto finance
companies
SECTOR REPORT
Captive finance arm
During the financial crisis, most banks and other lending institutions tightened their
lending portfolio. This trend therefore affected the volumes in the auto Industry. Many
automakers attributed this fall to the liquidity crunch in the industry and therefore to
tide over this problem they decided to set up their own finance arms. For Eg: TVS
Motor Company and Ashok Leyland are planning their captive financing arms. Toyota
and Hero Honda are learnt to be moving in the same direction.
Role of captive financing firm
The auto industry worldwide has often faced the problem of finding the right funding
for its customers. These factors, coupled with the cyclical nature of the auto industry,
have induced several Indian automobile manufacturers to think of setting up captive
financing arms to fund their products exclusively at all stages of the business cycle.
Captive units also offer both, the product and finance under one roof. The captive
finance companies enjoy the advantage of manufacturer’s brand equity, lower
establishment costs and preferred financier status.
Competitive advantage of NBFC over banks
● Regulatory requirements are less stringent for Auto finance companies as
compared to banks
Like Banks, the Auto Finance companies are governed (NBFC norms) by RBI .
However the regulatory requirements for auto finance companies are less stringent
than those for banks as
● Auto Finance companies don’t need to maintain a cash reserve ratio (CRR),
● No not need to make loans to priority sectors (whereas the banks have to lend
40% of their loan book to the priority sector)
● Lower SLR requirements (15% vs 25% for banks).
Hence despite being disadvantaged on the cost of the funds (due to access to CASA),
the auto finance companies can compete with banks on pricing of loans. Moreover,
some portion of the loans of the auto finance companies is eligible for being classified
under priority sector lending. Therefore the auto finance companies securitise these
assets with banks. This not only frees cash flows for the auto finance companies but
also reduces the cost of funds, as these funds are available at relatively lower cost
when compared to direct borrowings from banks.
Auto Finance Companies Banks
Capital Adequacy Ratio 12% 9%
Cash Reserve Ratio 0% 5.75%
Statutory Liquidity Ratio 15% 25%
Priority Sector Lending 0% 40%
Source: ACMIIL Research
● Class of consumers
NBFC’s serve consumers, which are perceived to be risky and high NPA prone
as per the banking standards. For example Mahindra finance serves consumers
from the rural areas, which are unable to meet the documentation requirements of
the banks. Further companies like Shriram transport finance are into financing of
preowned vehicle which although are high yielding segment but are considered
to be risky due to poor credit history of the customers. Therefore banks generally
stay away from this class of consumers, which acts as an advantage for these
NBFC’s.
Auto Finance Sector ACMIIL 
 SECTOR REPORT

● NBFC have better operational efficiency

Due to the advantage of low cost funds, banks enjoy higher spreads as compared
to Auto finance companies. However NBFC operate at better efficiencies and
that’s reflected in their low cost to income ratios.
Cost to Income Ratio
70.0 66.4
63.3
60.0 2008 2009
50.0 49.9 52.5 50.8 50.2
45.7 46.6 45.1
Auto finance companies have 40.0
32.8 30.5
38.9

low cost to income ratios. 29.329.2

%
30.0
20.0
10.0
0.0

Shriram

Sundaram
Kotak Mah.

M & Mah.
HDFC

Bank

St Bk Of
Financial
Bank

ICICI

Trans.

Finance
India
Bank
Source: Company Data, RBI, ACMIIL Research

They operate at higher cost efficiencies than banks. NBFCs enjoy higher leeway on
assets and liabilities when compared to that of tightly regulated banks. That gives
NBFCs better flexibility in product selection as well as in pricing their services.
● Reach into a number of non-metro locations;
In Billion FY2005 FY2006 FY2007 FY2008 FY2009
Total loans and advances 11250.6 14737.2 18937.8 23320.0 27935.7
Retail portfolio of banks 2666.1 3756.8 4878.6 5707.8 5938.2
Auto Loans 350.4 613.7 825.6 880.0 839.2
Retail loans/Total loans 23.7 25.5 25.8 24.5 21.3
Auto Loans/Total Loans 3.1 4.2 4.4 3.8 3.0
Source: RBI

HDFC Bank, SBI and ICICI bank together account of almost 50% of the auto
loan market within Banks
Bank Retail Loans as on March 2009 % to total
Total Auto Loans 839 100
HDFC Bank 180 21
ICICI Bank 150 18
SBI Bank 97 12
Kotak 81 10
Others 331 39
Auto finance companies have Source: Company Data, ACMIIL Research
major presence in rural areas.
Branch Network of these Banks
Branch presence Kotak ICICI bank HDFC Bank SBI MMFSL
Total Branches 180 1408 1400 11447 436
Rural 11 138 65 4353 343
Semi urban/Urban 70 860 792 5322 89
Metro 99 410 543 1772 4
Rural 6% 10% 5% 38% 79%
Semi urban/Urban 39% 61% 57% 46% 20%
Metro 55% 29% 39% 15% 1%
Source: Company Data, RBI, ACMIIL Research

Auto Finance Sector ACMIIL 

 SECTOR REPORT

Although the share of banks in auto financing segment is o rise, the share of auto loans
in total portfolio of banks has remained in the range of 3-4% as can be seen from
the above table. Also most banks, which have significant exposure to the auto loan
market, have got their presence in metros. On the other hand, the NBFCs have got
major presence in the rural areas. Therefore, it works as an advantage to the NBFCs
as they are able to serve customers based in unbanked and remote areas. Also, future
growth from rural areas bodes well for the NBFC’s.
Conclusion
Private Bank PSU Bank Standalone NBFC Captive NBFC
2009 HDFC SBI Shriram Transport Magma Shrachi Finance Mahindra Finance Bajaj Auto Finance
Yield 12.8* 11.3* 17.2 15.4 20.2 16.7
Cost of Funds 5.1 6.0 11.4 11.8 9.9 10.0
Spreads 7.7 5.2 5.9 3.6 10.3 6.6
ROA 1.4 1.0 3.0 1.3 3.3 1.2
Net NPA 0.6 1.8 0.8 0.0 2.6 0.0
Time to process loans 2 days 4 -7 days 2 days 2 days
Source: Company data, ACMIIL Research. *Yields on car loans

While the auto finance companies are disadvantaged on the cost of funds, they score
better in terms of credit assessment skills, better operational efficiency, higher loan
yields and lower regulatory requirements. This result in return on assts for the auto
finance companies for auto finance companies in this segment compared to banks.
Auto finance companies Considering the growth expected in auto industry particularly in the non-urban areas
score in terms of better credit and the need for auto finance, we believe that this would bode well for the auto finance
assessment skills. companies. Inspite of the growing competition from banks, NBFC’s like Mahindra
Finance and Shriram Transport Finance continue to register robust growth due to
their high penetration in unbanked areas, their competence in understanding the local
customer and their recovery capabilities.

Auto Finance Sector ACMIIL 

 SECTOR REPORT
B U Ya t D E C L I N E S
03 May, 2010 Mahindra & Mahindra Financial Services Ltd
Key Data (INR) Background
CMP 443 Mahindra & Mahindra Financial Services Ltd (MMFSL) a subsidiary of Mahindra &
Target Price 502 Mahindra (M&M) is one of India’s leading non-banking finance companies focused
on providing finance for utility vehicles, tractors and cars in the rural and semi-urban
Key Data sector. Mahindra & Mahindra is a leading tractor and utility vehicle manufacturer.
Bloomberg Code MMFS IN MMFSL has a network of 459 branches spread across India. The company has assets
Reuters Code MMFS.BO under management (AUM) worth INR 103 billion as on March 2010.
BSE Code 532720
Investment Rationale
NSE Code M&MFIN
Face Value (INR) 10
Revival in demand for auto Industry.
Market Cap. (INR Bn.) 43 The automobile Industry witnessed strong growth till 2007-08. However in 2008-09,
there was a drop in the overall volumes, attributed to the economic slowdown that
52 Week High (INR) 473
led to demand contraction in all the underlying assets. Thereafter the government
52 Week Low (INR) 198
introduced various stimulus packages, which have helped in revival of demand for the
Avg. Daily Volume (6m) 176036 auto segment. With revival in auto sector, we believe there will be an increasing need
for auto financing which in turn will bode well for the auto financing companies.
Shareholding %
Promoters 61.1
Rural areas to drive growth in future
Mutual Funds / Bank/ FI 7.9 Semi-urban and rural areas are emerging as a potentially lucrative market for auto sales.
Foreign Institutional Investors 26.8
Strong growth in middle-income population and higher farm incomes are driving the
demand in smaller cities and villages. For example, the contribution of rural sales for
Bodies Corporate/Individuals/others 4.3
Maruti has increased from mere 3.5% in FY08 to almost 16% in 2QFY10.This acts
Total 100
as an advantage to MMFSL as it is well positioned in the rural markets. Further due to
INR mn FY10 FY11E FY12E this, many leading car manufacturers are looking to enter into tie ups with MMFSL.
Net Interest
Income
10,290.4 12,383.6 14,699.2 Diversified Loan book
Operating Income 10,670.7 12,811.4 15,213.4 MMFSL has a well-diversified portfolio. The company finances utility vehicles,
Net Profit 3,427.1 4,012.8 4,682.7 tractors, cars, commercial vehicles and pre-owned vehicles. While MMFSL
Net interest 12.9 12.9 12.9 predominantly finances M&M vehicles, the company has diversified its portfolio and
margins now finances non M&M vehicles as well. MMFSL maintains a policy of financing
EPS (INR.) 35.7 41.8 48.8 only 40% of the M&M sales. This has helped MMFSL in capping its risk in case of
Book value (INR) 187.1 216.7 251.2 a slow down in M&M sales. Going forward we expect the loan book to grow at a
CAGR of 17.9% during FY10-12 on the back of improving macroeconomic conditions
and robust auto sales.
“Securitisation” as a tool
Apart from bank borrowing securitization also helps meet funding needs of the
company. ~45% of the loan book of MMSL is eligible for being classified under
priority sector lending. Since banks have to meet their priority sector lending targets,
they readily purchase these securitized assets at a discount. With better cash flows
and reduced borrowings, securitization of assets helps contain cost of funds.
Strong Parentage
MMFSL was promoted in 1991 by Mahindra & Mahindra which currently holds ~60%
in the company. M&M being a leading auto manufacturer, MMFSL has capitalised on
its parent’s strong distributors and dealer network for financing its UVs and tractors.
Further MMFSL credit rating is linked to M&M, which in turn enables MMFSL
raise funds at competitive rates. Due to the poor economic condition in FY09 and
subdued performance of the parent the credit rating agencies downgraded rating for
MMFSL. However we believe that with improvement in the economic conditions
and operating performance of M&M, there is a possibility of revision in the credit
rating for MMFSL.

Auto Finance Sector ACMIIL 10


MMFSL positioned itself
between organized banking
sector and moneylenders.
MMFSL largely relies on its own
employees rather than being
dependent on DSA.
SECTOR REPORT
Company
Well Positioned in the rural market
MMFSL has positioned itself between the organized banking sector and local
moneylenders, offering customers competitive, flexible and speedy lending services.
Banks and local moneylenders primarily provided credit in rural markets. However
due to the various documentation and other requirements, the banks are unable
to provide adequate credit to the rural consumers. And, the moneylenders charge
excessive rates. MMFSL identified this as an opportunity.
MMFSL adopted procedure, which were not as stringent as banks. Also the rates of
interest were fixed between those charged by banks and moneylenders. The company
follows a subjective assessment for determining the repayment capability of the
borrower on the basis of his occupation, ownership of land, type of crops sold etc, for
disbursing the loans. A great deal of emphasis is placed on customizing the product
for the customers keeping in mind his expected cash flows and other consideration.
The objective is to minimize the time take for approval without compromising on
the quality. The loans are processed within two days of application.
The business is based on a cash collection model whereby the employees visit the
houses of the respective borrowers to collect repayments. This we believe can act as
an entry barrier in rural area with underdeveloped banking habits.
Network
MMFSL has a pan India network of 459 branches spread over 25 states and 2 union
territories in India covering almost 90% of the districts in India. Majority of its
branches are spread in rural and semi-urban areas.
Total Branches 459
Metro 4
Urban/Semi-urban 90
Rural 365
Source: Company
Efficient recovery mechanism
MMFSL has a policy of servicing customers with its own employees, who understand
the nuances of the market. MMFSL sources its executives locally and train them
periodically to understand the credit requirement of the customers and evolve a
financial product based on the credibility of the borrowers. As MMFSL services a large
base of rural customers who lack the banking habits; all transactions are carried out
in cash only. MMFSL has a strong cash collection system in place. Its cash collection
officers collect cash from the customer on a periodic basis, which is later deposited
at respective branches located in these rural areas.
To reduce the risk of frauds and leakages in its unique cash collection system,
MMFSL largely relies on its own employee rather than being dependent on DSA
and collection agents.
Diversified Loan Book
The loan book of MMFSL has witnessed a CAGR of 22% during FY06-08 on the
back of strong growth in auto sector. Due to the economic crisis, the loan book
registered a growth of mere 2.9% during FY09. While MMFSL predominantly
finances M&M vehicles, the company has diversified its portfolio and now finances
non M&M vehicles as well.
Auto Finance Sector ACMIIL 11
 SECTOR REPORT

MMFSL has a got well-diversified portfolio. The company finances utility vehicles,
tractors, cars, commercial vehicles and pre-owned vehicles. Passenger vehicles (cars),
utility vehicles and tractors are the key segments for MMFSL, constituting 85%
share of the total disbursements. Initially, the company started with financing UV
and tractor manufactured by M&M and thereafter entered into CV and car financing.
The share of CV and car financing in the disbursements has increased over the past
few quarters.
MMFSL maintains a policy of financing only 40% of the M&M sales. This has helped
MMFSL in capping its risk in case of a slow down in M&M sales.
Disbursement Mix

Tractors, Utility vehicles and 100% 6% 7% 8% 8% 7% 8%

Cars are key segments for 90% 7% 6% 6% 9% 8% 7%
80%
MMFSL. 70%
24% 25% 25%
29% 29% 29%

60%
22% 22%
% 50% 22%
20% 21%
19%
40%
30%
20% 41% 40% 39% 35% 36% 35%
10%
0%
Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10
Auto/Utility vehicles Tractors Cars Commercial Vehicles Refinance and Others
Source: Company, ACMIIL Research

Disbursement Mix
● Tractor financing
Tractors comprise 23% of the
total AUM of MMFSL.
MMFSL was predominantly engaged in providing financial assistance to the
farmers for buying tractors and farm equipments. However, 2005 onwards MMFSL
diversified its lending portfolio and started financing UVs, CVs and two-wheelers
as well. Tractors comprise of 23% of the total AUM as on March 2010.Tractor
financing plays an important role in the tractor industry as out of the total tractors
sold in India, 85-90% of the tractors are purchased on Finance. MMFSL finances
tractor sold by M&M and PTL only.
M&M is a leading player in the tractor Industry. After acquisition of PTL, M&M
improved its market share to 42% in 2008-09. During FY09, M&M registered
tractor sales growth of 25.2% in the domestic market against flat growth registered
by the Industry. In FY10, the company’s YTD domestic sales have registered a
47% YoY growth at 165633 units. The acquisition of Punjab Tractors by M&M
is expected to increase disbursement for the tractor segment of MMFSL.
Due to seasonal nature of the business, delinquencies are higher in the tractor
segment being directly linked to agriculture. MMFSL maintains a lower LTV of
~68% and higher provision coverage to contain defaults. The tractor segment
has the highest average yields of 19-20%. Since tractor financing is classified as
agricultural finance, banks buy these assets from MMFSL at a discount to meet
their priority sector lending targets. This in turn enables MMFSL to free cash
flows, reduce its borrowings and thereby it’s cost of funds.
MMFSL finances tractors only for its parent. Going forward we expect the tractor
segment of M&M to register a 9% CAGR in volumes during FY10-12. Further
since MMFSL finances ~30% of tractor sales of M&M and assuming a LTV of
68%, we expect the tractor loans to grow at a CAGR of 11 % during FY10-12.

Auto Finance Sector ACMIIL 12


● Utility Vehicle Financing
Utility vehicles comprise 33%
of the total AUM of MMFSL.
● Car Financing
MMFSL enjoys preferred
financier status of Maruti
Suzuki.
● Commercial vehicle financing
MMFSL focusing to increase
the portfolio of construction
equipment financing.
● Refinancing
SECTOR REPORT
MMFSL finances utility vehicles, SUVs and to some extent two-wheelers
manufactured by M&M. Post acquisition of two wheeler division of Firodia group
which manufactured Kinetic, the two Mahindra businesses drew more synergies
and further expanded its product offered. This segment comprises of close to 33%
of the total AUM as on March 2010.
In the utility vehicle segment, M&M, Maruti Suzuki and Tata Motors are the
largest players with ~80% market share. M&M is the leader in the utility space
with 36% market share as on March 2010.
The UV segment of M&M continue to post robust growth on account of the new
model Xylo and existing model Bolero which continue to witness good offtake.
M&M has further plans to launch new models over the next two years. It also plans
to launch a new SUV over the next two years as a successor to the Bolero. M&M
has also indicated that it would be launching a successor to the Scorpio over the
next two-three years. We believe that these initiatives by M&M are expected to
drive disbursement growth for UV segment of MMFSL.
MMFSL finances ~30% of sales on M&M. The loan to value in this segment is
73% and the average yields are ~17%. Going forward we expect the utility vehicle
volumes for M&M to register a CAGR of 13.5% during FY10-12. We expect the
loan growth of 17.8% during FY10-12 for the UV segment.
While MMFSL has been a preferred financier for M&M, it has also entered into
tie-ups with leading passenger car manufactures including Maruti, Hyundai,
General Motors etc. Leading automobile manufactures leverage on MMFSL’s
strong presence in the rural areas for providing financial assistance to retail
customers. Car financing comprises 30% share of the total AUM.
MMFSL enjoys the preferred financier status of Maruti Suzuki. Maruti Suzuki is
the largest player in the passenger car segment with ~50% market share. Maruti
is increasingly focusing on the rural markets which is reflected in the fact that
the rural sales for Maruti has increased from mere 3.5% in FY08 to almost 16%
in 2QFY10. The company is also planning to double its outlets into these areas.
This acts as an advantage for MMFSL and will help the company to improve its
disbursements in the car segment.
We expect the MMFSL’s loan book for the car segment to grow at a CAGR of
19.9% during FY10-12.
MMFSL offers loans to commercial vehicles and construction equipment, which
includes trucks, buses, trippers, excavators, and light commercial vehicles. Within
this segment, the company is increasingly focusing to increase the portfolio of
construction equipment financing. Further M&M’s foray into heavy commercial
vehicles segment in partnership with Navistar should also help improve
disbursements for this segment. Although this segment at present comprises
close to 8% of the total AUM at present, the company intends to increase the
composition of such loans to in the next 3 years.
The management sees lot of potential in the financing of preowned vehicles.
Consumer preference towards the pre owned vehicles is increasing at a rapid pace.
The market, which was earlier dominated by unorganised players, is expected to
Auto Finance Sector ACMIIL 13
 SECTOR REPORT

witness a change with many auto companies contemplating to enter the pre-owned
car market. Companies such as Mahindra First Choice, Popular Car World and
Maruti True Value are aggressively focusing on the franchising route to spread
across the country. Besides them, other car manufacturing companies such as
General Motors (GM), Hyundai Motors, Ford, Porche, and Carnation Auto have
also ventured into the pre-owned car industry to target the maximum share in
the market.
Refinancing loans comprise 6% of the total AUM as on March 2010. Since the
valuation of the pre-owned vehicle is subjective, MMFSL lends in this segment
at premium yields of ~19%.
Outlook on Loan Book
Going forward we expect the loan book to grow at a CAGR of 17.9% during FY10-
12 on the back of improving macroeconomic conditions and robust auto sales. Car
Expect MMFSL loan book to financing, CV financing (including construction equipment financing) and refinance
grow at a CAGR of 17.9% during segment are expected to be the major growth drivers. The company intends to increase
FY10-12. the composition of the CV financing in the total AUM from 8% at present to 13% in
the next three years. The management also foresees lot of potential in the financing
of preowned vehicles. The management has also indicated its plans of foraying into
a new segment of gold loan financing.

Loan Book Disbursement Mix

140.0
100% 7% 8% 8% 8%
120.0 7% 8% 8% 9%
100.0 80% 26% 28% 29% 29%
80.0 60%
22% 20% 19%
60.0 18%
40%
40.0
38% 36% 36% 36%
20%
20.0

0.0 0%
FY08 FY09 FY10E FY11E FY12E FY09 FY10E FY11E FY12E

Loan Book Growth Auto/Utility vehicles Tractors Cars Refinance and Others Commercial Vehicles
Source: Company, ACMIIL Research

Securitization as a tool to meet
funding needs of the company.
Borrowing Profile
MMFSL borrows through diverse sources in the form of banks, bonds, commercial
papers and fixed deposits. Borrowing profile is skewed towards bank borrowings.
Apart from bank borrowing securitization also helps meet funding needs of the
company. Almost ~45% of the loan book of MMSL is eligible for being classified
under priority sector lending. Since banks have to meet their priority sector lending
targets, they readily purchase these securitized assets at a discount. MMFSL is able
to obtain discount of its borrowing cost from Banks on securitization of such assets.
With better cash flows and reduced borrowings, securitization of assets also helps
contain cost of funds.
With RBI hiking the rates, the banks are expected to increase their lending rates.
57% of its borrowings are from banks, however this is less likely to have an impact
on the cost of funds for the company as it has raised funds at lower cost during the
last year. Further the company intends to increase the share of fixed deposits in the
total borrowings from 7% at present to 10% by FY12.

Auto Finance Sector ACMIIL 14

 SECTOR REPORT

Borrowing Profile

100% 4.9 3.7 5.1 6.6 9.4

80%
Borrowing Profile skewed 43.7 46.0 49.0 50.0
towards bank borrowings. 60% 57.0
%
40%
51.4 50.4 45.9
20% 43.4
33.7

0%
Mar-09 Jun-09 Sep-09 Dec-09 Mar-10
Bonds/NCD's Banks Others
Source: Company

Credit rating
MMFSL has consistently enjoyed a good credit rating enabling it to borrow funds at
competitive rates. At present, FITCH has assigned AA (ind) rating and CRISIL has
assigned a AA- rating to the Company’s long term debt, which is also linked to credit
rating of M&M. Due to the poor economic condition in FY09 and subdued performance
of the parent the credit rating agencies downgraded rating for MMFSL. However we
believe that with improvement in the economic conditions and operating performance
of M&M, there is a possibility of revision in the credit rating for MMFSL.
Margins to remain stable.
MMFSL has reported net interest margins of 12.9% in FY10 mainly led by lower
Margins to remain stable at borrowing cost, lower level of NPAs and higher amount of securitisation towards the
12.9% ends of 4QFY10. With RBI hiking the rates, the banks are expected to increase their
lending rates. 57% of its borrowings are from banks, however this is less likely to
have an impact on the cost of funds for the company as it has raised funds at lower
cost during the last year. We expect our NIM’s to remain stable at 12.9% over the
next two years.
Asset Quality
MMFSL follows a relatively stringent provisioning policy.
Duration (Months) RBI Norms Duration (Months) MMFSL norms
>5 and <=18 10% >5 and <=11 10%
>18 and <=30 20% >11 and <=24 50%
>30 and <=54 30% >24 months 100%
>54 months 50%
Source: Company

NPA expected to be high due to
the very nature of the business.
MMFSL operates in the rural and semi-urban areas where the population depends
on agriculture. The agricultural sector is highly seasonal mainly due to the abnormal
monsoons, which result in uncertainty in income levels. This results in delayed and
irregular payments. On important point to note that the NPA’s are mainly seasonal
and are in the form of delayed payments. The final credit write off’s as per the
management has been ~2% of the loan book.
The gross NPA have declined from 7.6% in FY08 to 6.4% in FY10. The Net NPA’s
have improved significantly from 2.9% in FY08 to 0.9% in FY10. Over the period,
MMFSL has improved its provision coverage from 63% in FY08 to 86% in FY10.
The improvement in gross NPA is on account of improved economic scenario which
coupled with a good rabi crop season have aided in containing incremental slippages
and also improving recoveries.

Auto Finance Sector ACMIIL 15


MMFSL well capitalized
MRHFL intends to capitalize on
MMFSL’s reach.
SECTOR REPORT
Further the management has indicated that one of the reasons for improved cash flows
has been usage of vehicles for commercial purposes rather than for farm purposes.
This we believe would bode well for the asset quality.
Due to the nature of the business, the gross NPA’s are expected to be high, however
the company intends to maintain its Net NPA at 3% levels while maintaining higher
provisioning.
Capital adequacy
MMFSL has a capital adequacy ratio of 18.5% as on March 2010 against the
requirement of 12%. With improved profits and loan CAGR of 17.9%, we believe that
the company is well capitalised and will require to raise equity only post FY12.
Other initiatives
Insurance brokerage business - Mahindra Insurance Brokers (MIBL)
MIBL is the wholly owned insurance broking arm of MMFSL for both life and
non-life products. MMFSL is leveraging on its broad network of branches to offer
these financial products in the rural markets. The non-life product segment largely
comprises of motor insurance primarily in the rural markets.
Rural housing loan business- Mahindra Rural Housing Finance (MRHFL)
Mahindra Rural Housing Finance is a wholly owned subsidiary of Mahindra &
Mahindra Financial Services Ltd (MMFSL), which was set up with the objective
of meeting the housing finance requirements of rural and semi urban customers.
MRHFL intends to capitalize on MMFSL’s reach for creating a niche in the rural and
semi urban markets for housing finance. The company has launched operations in all
southern states on India in addition to states of Maharashtra and Gujarat.
Despite the difficult market condition in FY09, the company disbursed Loan worth
INR430 million in FY09 against INR30 million in FY08. Upto Dec 2009 the company
has sanctioned loans worth INR1118 million. Going forward, the management is
targeting a AUM of INR10, 000 million by FY13.
At present the contribution from these segments is insignificant, therefore we have
not factored any potential revenues from these segments in our future earnings
estimates.
Key Concerns
Dependency on Mahindra & Mahindra Ltd.
The company finances the acquisition of Mahindra utility vehicles and tractors. Hence
any major reduction in sale of Mahindra utility vehicles and tractors will also affect
the business of the company.
High level of NPA’s
MMFSL operates in the rural and semi-urban areas where the population depends
on agriculture. The agricultural sector is highly seasonal mainly due to the abnormal
monsoons, which result in uncertainty in income levels. This in turn may result in
high level of gross NPA’s.
High revenue leakage
Since the business model of MMFSL is based on cash collection model wherein the
employees of MMFSL visit the respective borrowers house to collect repayments from
them. This exposes MMFSL to the risk of fraud and misappropriation of funds.
Auto Finance Sector ACMIIL 16
 SECTOR REPORT

Valuation and Recommendation

MMFSL to be a beneficiary of
the rising rural demand.
With improvement in the macro economic conditions and in the auto sales, we believe
that this is likely to have a positive impact on the disbursement of MMFSL. Since
M&M vehicles constitute a major portion of its disbursement, new launches by M&M
in various segments would augur well for MMFSL.
Further the company’s initiatives to foray into new areas of gold loan financing,
housing finance etc is expected to add new revenue streams. MMFSL has also applied
for an AMC license and could look at expanding its line of business by launching
mutual fund schemes. However the contribution from these segments is insignificant
at present and will take some time to earn meaningful revenues for the company.
With improving macro economic conditions, MMFSL will be a beneficiary of the
rising rural demand. We expect the Net interest income to register a CAGR of 19.5%
during FY0-12 and the earnings to register a growth of 16.9% during the same period.
Also due to nature of the business we expect the gross NPA to continue to remain
high. We recommend a “BUY at DECLINES” on Mahindra and Mahindra financial
services ltd for a target price of INR502. (2x it’s PBV of INR251 for FY12E.).

450
400
350
300
250
200
150
100
50
0
2/2/08
4/2/08
6/2/08
8/2/08
10/2/08
12/2/08
2/2/09
4/2/09

8/2/09
10/2/09
12/2/09
2/2/10
4/2/10
4/2/07
6/2/07
8/2/07
10/2/07
12/2/07

6/2/07

Close Price 1.2PBV 1.5PBV 1.7PBV 2PBV

Source: ACMIIL Research

Auto Finance Sector ACMIIL 17

 SECTOR REPORT

Earnings Model (INR. Mn.)

Particulars FY09 FY10 FY11E FY12E
Interest Income 13648.2 15307.7 18598.9 22357.5
Interest expended 5098.6 5017.3 6215.3 7658.3
Net Interest Income 8549.6 10290.4 12383.6 14699.2
growth % 14.0 20.4 20.3 18.7
Other Income 198.4 380.3 427.8 514.2
Operating Income 8748.0 10670.7 12811.4 15213.4
Operating Expenses 2667.8 3249.8 4112.3 5034.8
Pre Provisioning Profits 6080.2 7420.9 8699.1 10178.6
Provisions & contingencies 2823.9 2215.2 2619.1 3083.6
Growth % 14.7 -21.6 18.2 17.7
Prior period items 0.0 -16.8 0.0 0.0
Profit before Taxes 3256.3 5188.9 6079.9 7095.0
Provisions for taxes 1111.1 1761.8 2067.2 2412.3
Net Profits 2145.2 3427.1 4012.8 4682.7
Growth % 21.2 59.8 17.1 16.7
Source: Company, ACMIIL Research

Sources and Application of Funds (INR. Mn.)

Particulars FY09 FY10E FY11E FY12E
Liabilities
Capital 957.1 959.8 959.8 959.8
ESOP 12.9 12.0 12.0 12.0
Reserves & Surplus 13721.6 16984.8 19823.8 23136.8
Networth 14691.6 17956.6 20795.6 24108.7
Borrowings 52130.2 64577.4 75264.9 91489.8
Total 66821.8 82534.0 96060.5 115598.5
Assets
Fixed assets 356.9 456.5 508.7 561.0
Intangible assets 17.5 19.5 21.5 23.5
Investments 1097.1 2159.0 2359.0 2859.0
Deferred Tax assets 1787.5 2069.0 2178.7 2564.0
Loans and Advances 68383.4 83788.2 99032.8 116547.5
Net Current Assets -4820.6 -5958.2 -8040.2 -6956.6
Total 66821.8 82534.0 96060.5 115598.5
Source: Company, ACMIIL Research

Auto Finance Sector ACMIIL 18

 SECTOR REPORT

Ratios
FY09 FY10E FY11E FY12E
Spreads
Cost of Borrowings 9.9% 8.6% 8.9% 9.2%
Yield on Advances 19.4% 19.2% 19.3% 19.6%
Net Interest Income 9.5% 10.6% 10.4% 10.4%
Net interest margins 12.1% 12.9% 12.9% 12.9%
Profitability ratios
Return On Average Assets (ROAA) 3.3% 4.6% 4.6% 4.5%
Return On Average Net worth (ROANW) 15.4% 21.4% 22.2% 23.6%
Balance sheet ratios
Loan to borrowings ratio (%) 131.2 129.7 131.6 127.4
Debt/Equity Ratio (Times) 3.5 3.7 4.0 4.4
Growth Ratios
Borrowings 2.9% 23.9% 16.5% 21.6%
Loans 2.9% 22.5% 18.2% 17.7%
Networth 11.8% 22.2% 15.8% 15.9%
NII Growth 14.0% 20.4% 20.3% 18.7%
EPS 20.5% 59.3% 17.1% 16.7%
Valuation ratios
EPS (Rs.) 22.4 35.7 41.8 48.8
Book value (Rs.) 153.5 187.1 216.7 251.2
P/E (X) - - 12.0 10.3
P/BV (X) - - 2.3 2.0
Dividend per share 5.6 7.6 10.5 12.2
Source: Company, ACMIIL Research

Auto Finance Sector ACMIIL 19

 SECTOR REPORT

BUY
03 May, 2010
Shriram Transport Finance Company Ltd
Key Data (INR) Background
CMP 572 Shriram Transport Finance Company Ltd., a flagship company of the Shriram Group
Target Price 638 was established in 1979 and provides commercial vehicle finance to customers in
excess of 0.6 million across India. The company has niche presence in financing pre-
Key Data
owned trucks and small truck owners (STOs). On March 31, 2010 the company had
Bloomberg Code SHTF IN
a network of 484 branches and service centers across the country. Its main products
Reuters Code SRTR.BO
include financing of pre owned, commercial and passenger vehicles, along with three
BSE Code 511218
wheeler, tractor, construction and multi utility vehicles.
NSE Code SRTRANSFIN
It has around a 20-25% market share in pre-owned commercial vehicle (CV) financing
Face Value (INR) 10
and approximately 8% in new CV financing market.
Market Cap. (INR Bn.) 129

52 Week High (INR) 585

Investment Rationale
52 Week Low (INR) 224 Largest player in the Organised Preowned CV segment: Shriram is the largest
Avg. Daily Volume (6m) 340759 players in the organized pre-owned CV segment. According to the company, it has
20-25% market share in this segment. The company largely finances trucks in the 5-12
Shareholding % years old age profile where competition from organised players is non-existent. The
Promoters 41.4 pre-owned vehicle-financing segment highly fragmented, collections are usually done
Mutual Funds / Bank/ FI 4.3 in cash, and customers are mostly SFO and FTU and are perceived to be highly risky
Foreign Institutional Investors 32.6 in nature. The loan book has registered a 30% CAGR during the period from FY07-
Bodies Corporate/Individuals/others 21.7 10.The Assets Under Management (AUM) has grown from INR120 billion in FY07
Total 100 to INR291 billion in FY10 and it is largely dominated by the pre-owned vehicle.
Unique business model: The Company has developed strong competencies in the
INR mn FY10 FY11E FY12E
areas of loan origination, valuation of pre-owned trucks and collection. In the used
Net Interest 21,607.5 24,722.7 32,691.5
Income CV finance market the key success factors for the financiers would depend on their
Operating Income 22,528.4 25,943.1 33,900.5 knowledge about the asset class and the customer profile.
Net Profit 8,731.1 10,751.2 13,091.9 The financiers should have sufficient knowledge about borrowers profile with
Net interest 12.1 11.4 11.5 respect to their repayment capabilities. The banking habits of such borrowers are
margins
EPS (INR.) 38.7 47.7 58.0
underdeveloped, their incomes or cash flows are very irregular and they do not own
Book value (INR) 170.4 208.6 255.1
collaterals. These competencies have enabled STFCL to maintain high growth rates
and low NPA levels in a business that is perceived to be risky
Asset quality: STFCL has maintained its asset quality with gross NPA’s in the range
of 2-2.5%. This is mainly because exposure to the segment which is highly sensitive
to economic cycles in low for STFCL. Further the collections mechanism also aids
in maintaining the quality. STFCL has evolved a efficient system of cash collection
mechanism whereby 50% of the salary of its field officer is variable in nature and
linked to timely collection of receivables. This not only enabled the company to
maintain direct contact with customers but also enabled help reduce the maintain
NPA at very low levels.
Ample amount of resources: The company has ample liquidity with itself at present.
The company has completed a INR5.84bn QIP at a price of INR500.8, it has cash
of INR45 billion as on March 2010, and has also raised NCD worth INR10 billion
in FY10. The company has a capital adequacy ratio of 17% at present against the
minimum required by RBI of 12%. Therefore with all these cash inflows we believe
that the company has sufficient funds and would enable the company to fund its new
initiatives and also help reduce the debt equity.

Auto Finance Sector ACMIIL 20

 SECTOR REPORT

Valuation and Recommendation

The demand for used CV is expected to increase mainly due to the rapid growth
expected in the new commercial vehicles segment. New vehicles are mostly used for
plying on major routes with long haulage. It is inefficient to depute an old vehicle on
long haulages as if done so, the operating expenditures may rise and possibilities of
breakdown are maximum. Therefore after every 5 years, these vehicles are sold to
Small Fleet Operators who ply them on short routes. Higher CV sales also support
replacement demand, which stem from stricter regulations pertaining to overloading
and emissions.
Shriram being a dominant player in the organised preowned CV market, we believe
that company will be a beneficiary of the rising demand. Further the ample amount of
resources and the opportunities in the construction equipment financing will support
AUM growth in future. Improved fee income from new initiatives as well as sustained
asset quality are also factors that would support growth for the company.
We initiate coverage on Shriram Transport Finance Company Ltd with “BUY”
recommendation for a target price of INR638 (2.5x its book value of INR25.1 of
FY12).
Industry
In India, the goods transportation industry continues to be dominated by roadways
as a mode of transport with a 53 % share followed by railways with a 35.7 % share.
Further roads are increasingly being used for transportation of non-bulk commodities.
With the share of non-bulk commodities rising in the total domestic freight movement,
Crisil expect the share of roads in transportation industry also to increase.
The road transport operators are classified into single truck or small fleet operators-
SFO (those who own up to 1-5 trucks), First Time users (FTU) and large fleet
operators-LFO (owning over 20 trucks). The truck ownership pattern suggests that
the small fleet operators control around 75% of the total truck fleet.
Commercial vehicles demand
Demand for commercial vehicles is driven by a number of factors such as growth
in industrial and agricultural production, freight movement, share of roadways in
freight movement, changes in freight rates and fuel prices and government policies.
Due to slowdown in economy in FY09, the CV industry also witnessed slowdown
with volumes declining by 21%.
Commercial Vehicle Sales
CV industry sales improving. 600.0 33.3% 36.4%
40.0%

500.0
20.0%
10.0%
400.0
In Thousand

300.0 0.0%
%

4.9%
200.0
-20.0%
100.0 -21.4%
0.0 -40.0%
FY06 FY07 FY08 FY09 FY10
Commercial vehicles Sales Growth
Source: CRISIL

Auto Finance Sector ACMIIL 21

 SECTOR REPORT

With revival of economy, the commercial vehicle industry has started to witness an
increase in volumes. According to CRISIL, financing environment has also been
favourable for the CV industry with interest rate (currently around 10-12 % for
MHCV and 15-18 % for LCV) and greater willingness of financiers to finance CVs
as compared to last year. Further their interactions with industry players indicates
that CV industry has experienced some pre-ponement in purchases in the current
quarter due to the following reasons:
● Expected roll back of excise duty in the Union Budget 2010-11
● Expectation of hike in interest rates for vehicle purchases (the interest rates have
been hiked by around 50 basis points by majority of players recently).
● Increase in CV prices due to the implementation of new emission norms.
Within the CV market, Light commercial vehicle (LCV) grew by 36% YoY while
the Medium and Heavy commercial vehicles grew by 26%. The performance of the
LCV was better as compared to the MHCV segment.
Share of MHCV on Decline

LCV expected to perform better 100.0

compared to MHCV
80.0 54.0 47.0
60.9 56.4 56.8
60.0
%
40.0
46.0 53.0
39.1 43.6 43.2
20.0

0.0
FY05 FY06 FY07 FY08 FY09
LCV MHCV
Source: CRISIL

The share of LCV’s is on the rise in the commercial vehicle segment mainly due
to the hub and spoke model of transportation where the MHCV are used for long
distance hauls and pickups are used for the last mile logistics. Demand in the LCV
segment is expected to be robust and is expected to drive demand for the Commercial
vehicle segment mainly due to the increased movement of non-bulk cargo by road
and launch of lower tonnage vehicles (such as Mahindra Gio).
Commercial Vehicle Financing Industry
Commercial Vehicle finance industry has assumed significant importance since almost
90% of vehicles sold by vehicle manufacturers are financed. The CV financing industry
can be divided into two segments.
● New CV financing
● Pre Owned CV financing.
New CV market Used CV market
Age of the CV 0-5 years Above 5 years
Type of transport operator Large Fleet operator (LFO). Small Fleet Operator (SFO), First Time User (FTU)
Haulage Long haul, Metros, Major cities. Last mile, short haul routes, interstate
Loan Yields 12-13% 17-20%
Loan to Value 85-90% 65-70%
Major financiers Banks NBFC’s
Source: CRISIL.

Auto Finance Sector ACMIIL 22


Banks increasingly finance
new commercial vehicles.
Unorganised players cater
to the bulk of used truck
financing.
5-12 year old truck financing-
STFCL key areas of focus.
SECTOR REPORT
New CV financing.
In the new CV finance Industry, operators are classified into single truck or small
fleet operators-SFO (those who own up to 1-5 trucks), First Time users (FTU) and
large fleet operators-LFO (owning over 20 trucks).
LFO’s usually prefer to have a large component of new CV’s in their owned truck
fleet. This is due to the fact that new CV’s despite high EMI’s have low maintenance
cost and thereby translates into higher profits.
According to CRISIL Research, while banks increasingly focus on the LFO, the SFO
and FTU segments are catered to by the NBFC’s. This is mainly because the SFO and
FTU have no proper documentation and are perceived to be risky in nature.
Preowned Commercial vehicle financing market
The pre-owned vehicle-financing segment highly fragmented, collections are usually
done in cash, customers are mostly SFO and FTU and is perceived to be higly risky
in nature. NBFC are the major financiers to the preowned segment as banks stay
away from these assets.
The buyers of the used CV are usually the SFOs and the FTUs. The trends in truck
ownership pattern suggest that the SFOs own more than 70 % of the truck fleet. One
typical characteristic of the SFO’s is their absolute dependence on brokers for business
on account of their small size of operations, lack of distribution network and necessary
infrastructure. SFO mostly depend on LFOs to get contracts. Their bargaining power
is relatively less. It thus reduces their affordability to purchase new CVs.
Unorganised players cater to the bulk of demand for used truck financing. Though
organised players are increasingly entering the market they have restricted their
operations to financing trucks aged between 0-4 years. In the 5-12 year old truck
financing, which is STFL’s key area of focus, competition from organised players
is non-existent.
Company
Business Model
CV Financing Business Model
Pre Owned (5-12 years Old CV’s) New Cv’s Market Share of 7-8 %.
Market Share of 20-25%. AUM-INR222 bn AUM-INR70 bn
Owned Funds Average core lending business
Owned Funds Average core lending business yields 15-16%.
yields 18-24%.
Securitization
Source: Company
Unique business model
STFCL has developed a strong understanding of the second hand truck market and
enjoys a market leadership position with a majority share in the organised sector.
STFCL command 20-25% market share of the used truck financing and 7-8% market
share of the new truck financing.
Auto Finance Sector ACMIIL 23

50% of salary of field officer
linked to timely collection of
receivables.
Preowned CV demand is non
cyclical.
SECTOR REPORT
The Company has developed strong competencies in the areas of loan origination,
valuation of pre-owned trucks and collection. In the used CV finance market the key
success factors for the financiers depend on their knowledge about the asset class
and the customer profile. The financiers should also posses sufficient knowledge
about repayment capabilities of borrowers. These customers possess underdeveloped
banking habits; their cash flows are higher irregular and lack collaterals. These
competencies have enabled STFCL to maintain high growth rates and adequate quality
(low NPA levels) in a business that is perceived to be risky.
Efficient Collection Mechanism
As mentioned above, the collection mechanism is also one of the important
competency to be developed by a used CV financier. Majority of the truck owners
STFCL finances have underdeveloped banking habits, therefore the business model
involves cash collection from its customers. STFCL has evolved a efficient system of
cash collection mechanism whereby 50% of the salary of its field officer is variable
in nature and linked to timely collection of receivables. This not only enabled the
company to maintain direct contact with customers but also enabled help reduce the
maintain NPA at very low levels.
Branch Network
Branch Network
Central North
11% 15%
West
18%
South
East 47%
9%
Source: Company
Disbursements in used CV finance immune to cyclicality in new CV sales- As
compared to the growth in new CVs, the pre-owned CV demand is non-cyclical, on
account of being low-ticket size and consistent demand. STFCL largely focused on
financing of used vehicles as more than 70% of the outstanding disbursements are
towards used vehicles. Further within these disbursements, majority are small-sized
commercial vehicles, which ply for short distances on state highways. During the
downturn, the category of truck operations that were hit were the ones that plied
on long distances on national highways, ferrying industrial goods. Since STFCL’s
exposure to this segment is relatively low, the company was able to maintain
disbursements in FY09. While the new CV disbursements declined by 44% during
FY09, the preowned CV disbursements registered a growth of 17%.
STFCL finances CV’s only for the goods segment. The demand for used CV is
expected to increase mainly due to the rapid growth expected in the new commercial
vehicles segment. The new vehicles are mostly used for plying on major routes with
long haulage and it is inefficient to hold an old vehicle on long haulages because of
increase in operating expenditure and possibility of breakdown. Therefore after 5 years
a resale of these vehicles is made to the Small Fleet Operators who ply them on short
routes. Higher CV sales would also be also supported by replacement demand, which
Auto Finance Sector ACMIIL 24
 SECTOR REPORT

will stem from stricter regulations on overloading and emissions. Going forward we
expect the new CV disbursements to grow at a CAGR of 10.1% during FY10-12.
We expect the preowned CV segment to register a CAGR of 19.5% during the same
period. We expect STFCL’s disbursements to grow at a CAGR of 17.7%.
Disbursement Mix

250

Expects STFCL disbursements 200

to register a CAGR of 17.7% 35
32
during FY10-12. In Bn 150
29
33 19
100 169
143
25 118
50 83 97
41
0
FY07 FY08 FY09 FY10E FY11E FY12E
Pre owned Vehicles New Vehicles
Source: Company and ACMIIL research

Loan Book Growth

Loan Book
400 100%

Loan Book Growth 317

80%
300
253
60%
200 179
In Bn

179

%
151 40%

100 82
20%

Expects STFCL loan book to 0

FY07 FY08 FY09 FY10E FY11E FY12E
0%
register a CAGR of 33% during
FY10-12. Source: Company and ACMIIL research

The loan book has registered a 30% CAGR during the period from FY07-10. The
loan book is expected to grow at a CAGR of 33% during FY10-12. Although the
pre-owned vehicles are expected to dominate the book, the construction equipment
financing is also expected to drive AUM growth n future. At present, the construction
equipment portfolio of INR25 billion constitute less than 10% of the AUM. However
with formation of a separate subsidiary, we expect ramp up in the construction
equipment portfolio and expect the size of the portfolio to increase to INR42 billion
by FY12.

Auto Finance Sector ACMIIL 25

 SECTOR REPORT

Borrowing Profile
Borrowing Profile

120.0

100.0 13.8 7.5 5.9

22.1 19.3
80.0
33.0 49.6
% 60.7
60.0 47.0 52.6
8.7
40.0 14.2
7.9 6.7 7.7
44.6
20.0 22.9 24.1 30.3
21.4
0.0
FY06 FY07 FY08 FY09 FY10
Debentures Subordinated debts Loans from banks Loans from institutions and others
STFCL taking proactive steps to Source: Company
reduce the floating liabilities. Majority of borrowing for STFCL is in the nature of bank borrowings (60% of total
borrowings). Apart from banks borrowings, debentures and securitization from an
important resource of funding. The borrowing profile of STFCL in more skewed
towards wholesale funding forming almost 85% of the total borrowings. Further 50%
of the borrowings are floating in nature. Since the assets are 100% fixed in nature,
this exposes the company to interest rate risk in a rising interest rate environment.
Therefore the company is taking proactive steps to reduce the floating liabilities. The
company has already raised NCD worth INR 10 billion in FY10. Going forward, the
company intends to increasingly use NCD and securitization to fund its disbursements.
The company has plans to raise NCD worth INR 10 billion in FY11 as well. With all
these measure we believe the company will be able to reduce the interest rate risk
on its floating liabilities.
Net Interest margins
With increase in interest rates, we expect the yields on advances to improve. However
since the company’s funding is largely wholesale and 50% of the borrowings are
Net interest margins to floating in nature, the cost of funds is likely to go increase. During FY10, the company
improve. had huge cash reserves on the balance sheet (~20% of the total assets) which was
built up to tide over the crisis, however with improvement in the economic situation
we believe that the cash balance will be utilized which in turn would improve the
net interest margins. We expect the net interest margins to improve 11.4% in FY11
and 11.5% in FY12.
Asset Quality
Asset Quality
5000 1.6% 2.0%

4000
1.2% 1.5%
Exposure to segment highly 3000
sensitive to economic cycles 0.9%
%
In Mn

1.0%
0.7%
low 2000
0.7%

0.5%
1000

0 0.0%
FY06 FY07 FY08 FY09 FY10
Gross NPA Net NPA Net NPA as % to Net advances

Source: Company

Auto Finance Sector ACMIIL 26


Ample amount of liquidity.
STFCL’s new ventures to
provide an avenue to earn fee
income.
Size of construction equipment
potfolio to increase.
SECTOR REPORT
STFCL has maintained its asset quality with gross NPA’s in the range of 2-2.5%. This
is mainly because exposure to the segment which is highly sensitive to economic
cycles in low for STFCL. Further the collections mechanism also aids in maintaining
the quality.
Capital Adequacy
The company has ample liquidity with itself at present. The company has completed
a INR5.84bn QIP at a price of INR500.8, it has cash of INR45 billion as on March
2010, and has also raised NCD worth INR10 billion in FY10. The company has a
capital adequacy ratio of 20.9% at present against the minimum required by RBI of
12%. Therefore with all these cash inflows we believe that the company has sufficient
funds and would enable the company to fund its new initiatives and also help reduce
the debt equity.
New Ventures
● Auto Malls &Electronic Touch Screen Kiosks.
Shriram plans to set up 50-60 Auto Malls over the next 12-15 months. Auto Malls
are being set up in the forms of hubs for selling of repossessed used CVs. STFCL
repossess on an average 7000-8000 vehicles annually. These would be sold
through these auto malls. The company would also sell repossessed vehicles of its
competitors in these malls on which it expect to earn a commission.
It also plans to buy some vehicles from other financiers and yard sales, and re-
brand them as “Shriram New Look” after retrofitting them.
STFCL has been holding a monthly Truck Bazaar, a marketplace for meeting of
potential buyers and sellers of CVs. It plans to replace the same by Electronic
Touch Screen Kiosks, which shall be stationed at these auto malls. There would
be an auction room in every auto mall that would accommodate about 200 people.
Each mall would have an electronic display screen displaying multiple–angle
photographs of vehicles, and an auction will take place. This could lead to a better
price search mechanism. Further it also provides an avenue for the company to
earn fee income.
● Partnering with private financiers
STFCL has tied up with about 500 other private financiers across the country.
These private financiers account for bulk of lending in the preowned vehicles
segment. As part of the arrangement, the private financier is responsible for
acquiring customers, collecting payments and pitching in with about 10-20 % of
the loan amount. The remaining part of the loan is extended by Shriram Transport
Finance. These private financiers are typically constrained for growth due to lack
of access to capital. This will enable Shriram to grow its AUM with the help of
the private financier. At present, these type of loans constitute ~10% of the loan
book of STFCL. The company has plans to increase this to 15-20% over the next
3 years and also would increase the tie ups to ~2500 financiers.
● Construction equipment Financing
The company is expanding its construction equipment-financing portfolio.
Management believes there is lot of potential in this segment. The company has
formed a 100% subsidiary for the same. At present the construction equipment
portfolio forms less than 10% of the total loan book. With pick up in the
infrastructure spends and also exit of some of banks from this space, we believe
demand for construction equipment financing to increase. We expect ramp up
in the construction equipment portfolio and expect the size of the portfolio to
increase to INR42 billion by FY12 from INR25 billion at present.
Auto Finance Sector ACMIIL 27
 SECTOR REPORT

Valuation and Recommendation

The demand for used CV is expected to increase mainly due to the rapid growth
expected in the new commercial vehicles segment. The new vehicles are mostly used
for plying on major routes of long haulage. It proves inefficient to run an old vehicle
on long haulages because of increase in operating expenditures and possibility of
breakdowns. Therefore, after 5 years, these vehicles are sold to Small Fleet Operators
who ply them on shorter routes. Higher CV sales also support by replacement demand,
STFCL being a dominant player
which will stem from stricter regulations on overloading and emissions.
in the pre-owned CV market is
Shriram being a dominant player in the organised preowned CV market, we believe
expected to benefit from the
that company will benefit from the rising demand. Also, ample amount of resources
rising demand
and the opportunities in the construction equipment financing will support AUM
growth in future. Improved fee income from new initiatives as well as sustained asset
quality are also factors that would support growth for the company.
We initiate coverage on Shriram Transport Finance Company Ltd with “BUY”
recommendation for a target price of INR638 (2.5x its book value of INR255.1 of
FY12).

600

500

400

300

200

100

0
2/2/08
4/2/08
6/2/08
8/2/08
10/2/08
12/2/08
2/2/09
4/2/09

8/2/09
10/2/09
12/2/09
2/2/10
4/2/10
4/2/07
6/2/07
8/2/07
10/2/07
12/2/07

6/2/07

Close Price 1PE 1.5PE 2PE 2.5PE

Source: ACMIIL Research

Auto Finance Sector ACMIIL 28

 SECTOR REPORT

Earnings Model (INR Mn)

Particulars FY09 FY10E FY11E FY12E
Interest Income 36597.8 44075.4 50849.7 67167.6
Interest expended 19776.7 22468.0 26127.0 34476.1
Net Interest Income 16821.1 21607.5 24722.7 32691.5
Growth % 45.4 28.5 14.4 32.2
Other Income 713.5 920.9 1220.4 1209.0
Operating Income 17534.6 22528.4 25943.1 33900.5
Operating Expenses 5202.1 5176.1 4946.7 7794.9
Pre Provisioning Profits 12332.5 17352.3 20996.4 26105.6
Provisions & contingencies 3057.5 4106.5 4829.2 6239.2
Profit before Taxes 9275.0 13245.8 16167.3 19866.4
Provisions for taxes 3082.3 4514.7 5416.0 6774.4
Net Profits 6192.7 8731.1 10751.2 13091.9
Growth % 57.8 41.0 23.1 21.8
Source: Company, ACMIIL Research

Sources and Application of Funds (INR. Mn.)

Particulars FY09 FY10E FY11E FY12E
Liabilities
Capital 2035.1 2255.4 2255.4 2255.4
Reserves & Surplus 21131.2 36168.4 44782.2 55271.1
Networth 23166.3 38423.8 47037.6 57526.5
Borrowings 201213.1 184599.1 260855.5 325902.6
Other Liabilities 25253.9 45727.4 31780.6 28049.5
Total 249633.3 268750.3 339673.7 411478.7
Assets
Fixed assets 1342.7 464.5 758.6 952.0
Investments 6547.6 18560.2 18560.2 18560.2
Loans 179043.8 179460.5 252857.0 317340.0
Other assets 62699.2 70265.2 67497.9 74626.4
Total 249633.3 268750.4 339673.7 411478.7
Source: Company, ACMIIL Research

Auto Finance Sector ACMIIL 29

 SECTOR REPORT

Key Ratios
FY09 FY10E FY11E FY12E
Spreads
Cost of Borrowings 11.3% 11.6% 11.7% 11.8%
Yield on Advances 22.2% 24.6% 23.5% 23.6%
Net Interest Income 10.9% 12.9% 11.8% 11.8%
Net interest margins 10.6% 12.1% 11.4% 11.5%
Profitability ratios
Return On Average Assets (ROAA) 3.1% 3.9% 4.1% 3.8%
Return On Average Net worth (ROANW) 29.6% 28.4% 25.2% 25.0%
Balance sheet ratios
Loan to borrowings ratio (%) 89.0 97.2 96.9 97.4
Debt/Equity Ratio (Times) 8.7 4.8 5.5 5.7
Growth Ratios
Borrowings 36.2% -8.3% 41.3% 24.9%
Loans 18.8% 0.2% 40.9% 25.5%
Networth 27.5% 65.9% 22.4% 22.3%
NII Growth 45.4% 28.5% 14.4% 32.2%
EPS 56.8% 28.6% 23.1% 21.8%
Valuation ratios
EPS (Rs.) 30.1 38.7 47.7 58.0
Book value (Rs.) 113.8 170.4 208.6 255.1
P/E (X) - - 13.4 11.0
P/BV (X) - - 3.1 2.5
Dividend per share 5.0 5.4 8.1 9.9
Source: Company, ACMIIL Research

Auto Finance Sector ACMIIL 30

 SECTOR REPORT

Notes:

Institutional Sales:
Ravindra Nath, Tel: +91 22 2858 3400
Kirti Bagri, Tel: +91 22 2858 3731
Himanshu Varia, Tel: +91 22 2858 3732
Email: instsales@acm.co.in
Institutional Dealing:
Email: instdealing@acm.co.in

Disclaimer:

This report is based on information that we consider reliable, but we do not represent that it is accurate or complete and it should not be relied upon such. ACMIIL or any of its affiliates or

employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in the report. ACMIIL and/or

its affiliates and/or employees may have interests/positions, financial or otherwise in the securities mentioned in this report. To enhance transparency we have incorporated a Disclosure of

Interest Statement in this document. This should however not be treated as endorsement of the views expressed in the report

Disclosure of Interest Mahindra & Mahindra Financial Services Ltd (MMFSL) Shriram Transport Finance Company Ltd

1. Analyst ownership of the stock NO NO

2. Broking Relationship with the company covered NO NO
3. Investment Banking relationship with the company covered NO NO
4. Discretionary Portfolio Management Services NO NO

This document has been prepared by the Research Desk of Asit C Mehta Investment Interrmediates Ltd. and is meant for use of the recipient only and is not for circulation. This document

is not to be reported or copied or made available to others. It should not be considered as an offer to sell or a solicitation to buy any security. The information contained herein is from

sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may from time to time have positions in and buy and sell securities

referred to herein.

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Auto Finance Sector ACMIIL 31