Cholamandalam Investment and Finance - Lower provisions a surprise; strong focus on sustainable cost efficiencies - ICICI Securities

Cholamandalam (Chola) delivered a comprehensive beat on PAT (Rs4.3bn vs I-Sec: Rs2.7bn) despite minor miss on operating profit. This was primarily because of lower credit costs of Rs562mn, down 49% YoY. Chola exuded confidence in the adequacy of its Covid/macro provisions and chose not to make additional accelerated provisions in Q1FY21. Cumulative Covid/macro provisions stood at ~87bps of AUM. Asset quality improved 50bps QoQ, primarily led by write-offs (>Rs1.2bn) of some fully provided assets. Moratorium was broadly unchanged (~74%) except that ~50% moratorium customers have made partial or full EMI payments. Chola reported massive market share gains as the momentum of new disbursements witnessed an improving trend especially in tractors, new passenger vehicles, two wheelers and used vehicles. We see an opportunity for Chola to deliver industry-leading asset quality and lower credit costs in an otherwise tough fiscal year. Maintain BUY with a target price of Rs262 (2.0x FY22E P/BV).

- Has Chola under provided/ adequately provided and is this a statement of confidence in its superior underwriting and collections? While one might think (we were no exceptions) Chola should have made aggressive provisioning even in Q1FY21 to build a higher cushion, we get comfort from the fact that Chola has historically always remained conservative and erred on the side of caution. While it is only natural to compare Chola's aggregate Covid/macro provisioning buffer (~87bps) with its close peers (Chart 4,5), it should be seen in the context of Chola's consistent delivery of superior asset quality and through-cycle lower credit costs (Chart 6). Management highlighted it had the benefit of knowing about extension of three-month moratorium before it arrived at Covid/macro provisions made in Q4FY20.

- Product mix changing in favour of higher-yielding assets but we still build in margin compression in FY21E and FY22E: While Chola was largely dependent on bank borrowings in the last five quarters, it has started seeing some traction in debt markets as evident in the higher quantum of debentures/CP in the borrowing mix. While incremental COB has come down, so have yields. Combined with negative from high levels of liquidity on the balance sheet, we build in NIM compression of ~40bps in the current and next fiscal.

- Asset quality and credit costs will be a function of collection efficiency post moratoriums: We give credit where it is due. Chola's moratorium disclosures were very comprehensive - it published details of collections and vintage of its moratorium customers (Chart 2,3). It effected write-offs of ~Rs330mn in its legacy agri-book and ~Rs800mn in its vehicle book (vehicles loans which were >36months old were fully written off). We anticipate asset quality to deteriorate to 4.7% by FY21-end and given the inherent uncertainties on collections in the face of localised lockdowns, we remain conservative and model elevated credit costs of 165bps/130bps in FY21E/FY22E.

- Massive market share gains in vehicle finance: Though it could be transitory but this vindicates its ability to turn adversity into opportunity. Share of vehicle finance improved YoY from 1.7% to 3.99% in Q1FY21. Likewise, market share doubled in passenger vehicles, two wheelers (on a small base), tractors and construction equipment. These market share gains would have come at the expense of smaller/weaker vehicle-finance NBFCs since its better credit-rated peers did not have any liquidity challenges and have suggested that they maintained (or slightly improved) their market share. Chola expanded across the country in tractor segment and new OEMs. In the quarter, Chola was on-boarded as a preferred financier for one of the top tractor OEMs.

- Outlook and our view on the stock remains intact: FY21 will unarguably be a tough fiscal for all vehicle financiers. Even Chola will not remain insulated and could witness sharp asset quality deterioration in H2FY21 and consequent high credit costs (we have built that in our estimates). It will tread cautiously in its LAP segment. However, any blip also offers an entry-point for long-term discerning investors in this strong franchise. Chola has navigated past credit cycles better than peers primarily due to its differentiated underwriting and strong collection focus. This will be strengthened further given Chola's strong focus on integrating data analytics to augment its physical underwriting skills (thrust on phygital). We even expect it to deliver sustainable cost efficiencies by cutting across discretionary expenses, rationalisation of branch network and emphasising productivity improvements.

- Valuations and risks: Valuation premium that Chola used to command over its peers has come off slightly. Current valuations at 1.5x FY22E P/BV still reflect its relatively superior asset quality and higher earnings predictability. Our target multiple of 2.0x FY22E P/BV leads to a revised target price of Rs262 (earlier: Rs273). Maintain BUY. Slippages in collection efficiency after moratorium period, higher competitive intensity from banks/SFBs and deterioration in asset quality, particularly in home equity portfolio, remain key risks.

Shares of Cholamandalam Investment and Finance Company Ltd was last trading in BSE at Rs.201.35 as compared to the previous close of Rs. 202.5. The total number of shares traded during the day was 324230 in over 5647 trades.

The stock hit an intraday high of Rs. 206.45 and intraday low of 196.95. The net turnover during the day was Rs. 65399825.

Source : Equity Bulls

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