Sector Report PDF

Sector Report
December 19, 2005 FOR PRIVATE CIRCULATION
Jay Prakash Sinha

jay.sinha@kotak.com Non Banking Finance Companies
+9122 56341207
Capital x Leverage = Growth
Non Banking Financial Institutions play a crucial role in broadening access to financial services, enhancing
competition and diversification of the financial sector.
RBI report on trends in banking, 2005
Non Banking Financial Companies (NBFCs) have come a long way from the era of concentrated
NBFCs growth had been regional operations, lesser credibility and poor risk management practices to highly sophisticated
constrained due to lack operations, pan-India presence and most importantly an alternate choice of financial
of adequate capital. intermediation (not an alternate choice of banking as NBFCs still operate with lots of limiting
factors, which make them non-comparable to banks).
Going forward, we believe It is true that the difference between commercial banks and NBFCs is getting increasingly
capital infusion and blurred as NBFCs are today present in almost all the segments of financial sector save cheque
leverage thereupon would issuance and clearing facility. NBFCs are now recognized as complementary to the banking
catapult NBFCs into a system capable of absorbing shocks and spreading risks at times of financial distress. The
different zone altogether. Reserve Bank of India (RBI) also recognises them as an integral part of the financial system
and is trying to improve the credibility of the entire sector.
We believe that the
Today, NBFCs are present in the competing fields of vehicle financing, hire purchase, lease,
sector has a lot more
personal loans, working capital loans, consumer loans, housing loans, loans against shares,
potential to grow BIG investments, distribution of financial products, etc. More often than not, NBFCs are present
over the next 2 years. where the risk is higher (and hence the returns), reach is required (strong last-mile network),
recovery has to be the focus area, loan-ticket size is small, appraisal & disbursement has to
Potential upside could be be speedy and flexibility in terms of loan size and tenor is required.
much larger than our
estimates, if the The key differentiating factor working in favour of NBFCs is service. Today, a borrower is
expanded capital base is looking for more convenience, quick appraisal & decision-making, higher amount of loan-to-
value and longer tenor. Though banks are not behind on the service aspect, they are largely
adequately leveraged
limited to urban centres. When it comes to semi-urban and rural centres, particularly where
the banking culture still not fully developed, NBFCs enjoy an edge over banks. However, even
in the urban areas, NBFCs have created niches for themselves, which are often neglected by
banks e.g. non-salaried individuals, traders, transporters, stock brokers, etc, and all these
categories are growing at a rapid pace.
New opportunities like home equity, credit cards, personal finance, etc, is expected to take
Companies covered NBFCs to a new level. Growth in all these segments is sustainable at a higher rate than before
q Shriram Transport Finance (STF) given the low penetration and changing demography in the country. Secondly, 100% cover for
public deposits would ensure higher credibility to the sector. Thirdly, capital had always been
q Shriram City Union Finance (SCUF)
a limiting factor for the sector. In a booming economy and the capital market, we expect that
q Cholamandalam Investment (CIFL) these companies are now in a better position to raise capital at competitive rates to fuel their
q Sundaram Finance (SFL) future growth plans. Fourthly, better risk management and regulatory practices, NBFCs enjoy
a higher credibility today. Last but not the least, due to an established reach and network,
NBFCs could be the favourites of the foreign financial giants to make an inroad in the country.
The RBI has proposed to open the domestic market for foreign banks after FY2009 and some
of the foreign banks would not hesitate to shake hands with NBFCs to hit the ground running.
We believe that the sector is today at an inflection point and is likely to take a big leap in terms
of growth and profitability going forward.
Comparision of key parameters

CMP Reco RoE (%) RoAA (%) Spread (%) P/ABV (x) D/E (x) CAR (%)
(Rs) FY06E FY07E FY06E FY07E FY06E FY07E FY06E FY07E FY06E FY07E FY06E FY07E
Shriram Transport (merged) 119 HOLD 25.8 25.8 3.1 2.9 8.7 8.7 3.2 2.7 6.8 7.4 13.7 12.6
Shriram City Union Finance 149 BUY 38.2 38.5 3.9 4.1 11.9 11.8 5.5 4.0 7.1 7.1 12.1 12.8
Cholamandalam Investment 179 BUY 12.2 17.5 2.2 2.8 7.7 7.6 2.3 2.1 4.6 5.8 17.8 14.8
Sundaram Finance 396 BUY 11.8 12.5 1.8 1.8 4.9 4.8 1.5 1.4 5.7 5.9 14.6 14.4
Source: Kotak Securities - Private Client Research
Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.
December 19, 2005 Kotak Securities - Private Client Research
SWOT analysis of NBFC

Strengths Weakness
n High on service aspect n Weak in urban market
n Strong last-mile approach n Weak credit history of most NBFCs
n Focus on recovery n Largely restricted to the south India market
n Easy and fast appraisal & disbursements n Weaker risk-management & technology systems
n Regional kshatraps n Too much of diversification from core business
n Able to generate higher yield on assets n Higher regulatory restrictions
n Attained critical mass in terms of size
n Own employees vs DSAs
Opportunities Threats
n Augmentation of capital and leveraging for growth n Weak financial health of many of the NBFCs
n Large untapped market, both rural & urban and also n High cost of funds
geographically n Asset quality deterioration may not only wipe out profits
n Demographic changes and under-penetration but also networth
n New opportunities in credit card, personal finance, n Entry of foreign players in post-2009 scenario
home equity, etc n Growing retail thrust within banks
n Tie-up with global financial sector giants
n Blurring gap with banks in terms of cost of funds
n Securitisation, to liberate funds to fuel asset growth
Growth path for NBFCs in future
Get the global expertise

& products
Get innovative
Larger NBFCs
Increase Reach, products; Tie-ups Multiply its size;
with critical mass;
Capital, Branding with global look to convert
Focus on returns
financial giants into a bank
& profits
(preferably)
Consolidate their
positions; identify Reduction in cost
various revenue of funds
streams
Sector Report Please see the disclaimer on the last page For Private Circulation 2
Profile
NBFCs operations can largely be categorised into equipment leasing, hire purchase,
investments and loans. There are 13,261 NBFCs, of which 507 were public deposit accepting
companies. Though the number of registered NBFCs is pretty high, there are only 16 companies
with an asset size of above Rs.5.00bn and collectively they held nearly 4/5 th of total assets of
all NBFCs.
However, the size of NBFCs is very small compared to the banking industry. In June 2004,
NBFCs size was merely 5.7% of gross banking credit, which further deteriorated to 4.5% in
June 2005. There are two reasons for such decline- one, the banking credit growth has been
extremely good in FY05 i.e. at nearly 32.2% compared to 4.3% growth in NBFCs case. Secondly,
the number of NBFCs (deposit taking) is consistently declining over a period of time. It declined
from 875 in FY03 to 777 in FY04 and further to 573 in FY05. Nonetheless, we expect the
growth in larger NBFCs asset to be in the range of 25-30% over next two years.
# of NBFCs accepting public deposits NBFC assets as % of banks assets (%)
800
6.0
700
4.0
600
2.0
500
400 0.0
1999 2000 2001 2002 2003 2004 2005 FY 2004 FY 2005
Source: RBI, Trends & progress of Banking in India, 2004-05 Source: RBI, Trends & progress of Banking in India, 2004-05
Regional presence
NBFCs have typically grown in the southern part of the country. Most of the NBFCs have
started their journey as chit-funds and then largely catering to the growing needs of individuals,
forayed into much-better organized non-banking operations. Though there are no concrete
reasons why NBFCs are more deep-rooted in south India, we understand that it is largely
because of demographic patterns.
Geographical distribution of NBFCs Public deposit - Regionwise
South North Centre West East South North West East Centre
100% 100%
75% 75%
50% 50%
25% 25%
0% 0%
FY03 FY04 FY05 FY03 FY04 FY05
Though the number of NBFCs in north India is also high, average deposit is far lower compared
to south India. Other parts of the country do not have significant presence of NBFCs and are
also on declining trend.
Asset & liability mix

NBFCs have made a transient shift in their liability composition. Once largely dependent on
the public deposits, now borrowing in the form of non-convertible debentures, bank borrowings,
commercial papers, etc, are the largest form of liabilities.
On the asset side, leasing, hire purchase and loans & advances constitute the larger pie of
nearly 85%. This includes auto loans, hire-purchase, leased assets, personal finance, housing
loans, loans against shares, consumer durable loans, etc. Investments also add another 12%
of total asset size as some of the large NBFCs are purely engaged in the business of
investments. The diversified nature of asset mix gives stability to the NBFCs, which is important
for the stable and consistent growth of the sector.
Liability mix (FY05) Asset mix (FY05)
Paid up capital Bill business

Other liabilities 1%
6%
7% Investments
Equipment
Reserves & 10%
leasing assets
surpluses
6%
11%
Public
Loans &
deposits
Hire purchase advances
Borrowings 11%
assets 33%
65% 43%
Financial performance
NBFCs, despite their numbers declining, have done well in the recent past. The surge in retail
credit, particularly in vehicle and home financing, has helped the sector most. Besides, the gap
between the cost of funds between banks and NBFCs are also on the decline. The important
point in the picture is the growth in net owned funds of the NBFCs despite decline in number
of operational NBFCs indicates growing trend in financial health of the sector.
Spread between banks and NBFCs deposit rates Public deposit at less than 10% interest
5.50 80%
5.00 60%
4.50 40%
4.00 20%
3.50 0%
FY00 FY01 FY02 FY03 FY04 FY05 FY03 FY04 FY05
The general decline in the interest rates has also helped NBFCs to a large extent. In FY03,
there were merely 23% companies which were having public deposits (which is typically the
costliest outside liability) at a cost more than 10%. The same increased to over 70% in FY05.
But it is more important to note here that the gap between the cost of funds between banks
and NBFCs have declined from 5.5% to a more sustainable level of 4%. So, while the yield
on assets declined, spread has risen over the last two years.
Spread (%) Net owned funds (Rs bn)
Yield on assets (LHS) 56

Cost of funds (LHS)
Spread (RHS)
16 7.2 54
12 6.8 52
8 6.4 50
4 6.0 48
0 5.6 46
FY03 FY04 FY05 FY03 FY04 FY05
Despite rising competition from banks and within NBFCs itself, return on assets in the category
have been on a rising trend and is now stabilizing around 1.6%. This is primarily due to better
yield on assets, higher recovery and limited overhead costs structure of NBFCs.
Return on assets (%) Asset quality

Gross NPA (%) Net NPA (%)
2.0 12
1.6
9
1.2
6
0.8
3
0.4
0.0 0
FY03 FY04 FY05 FY01 FY02 FY03 FY04 FY05
In terms of asset quality, like banks, NBFCs also have seen commendable improvement in
their asset quality, both in terms of gross and net non-performing assets (NPA). In last five
years, gross NPA has declined secularly from 11.5% to 7.0%. In the same period net NPA also
improved from 5.6% to 3.4%.
Capital adequacy ratio

<12% 12-20% >20%
100%
75%
50%
25%
0%
FY03 FY04 FY05
Source: RBI
However, during FY05, number of companies having less than regulatory requirement of 12%
as capital adequacy is on rise. We expect the trend to reverse in FY06 onwards due to two
prime reasons: good profitability and capital raising programs.
Retail Finance
Retail finance is one of the major thrust areas for financial intermediaries due to the following
reasons:
n Low penetration and high growth opportunity
n Change in demography and lifestyle
n Higher disposable income and higher affordability
n Better margins and profitability
n Low loan-ticket size
n Lower delinquencies
Retail finance has grown up in size from Rs.272bn in FY99 to Rs.1,213bn in FY04 and is
expected to touch Rs.2,792bn by FY09 i.e. a CAGR of 18% over next five years. Banks have
become very much active in the retail space and their share also has gone up from less than
40% in FY99 to over 65% in FY04. As per a Cris Infac study it is slated to go up to 75% by
FY09.
Housing finance constitutes the largest pie of retail finance with a total market share of over
65%. The growth in housing finance is further expected to be in the range of 25-30% over next
couple of years given that the penetration level is still low and is catching up fast. Secondly,
the loan ticket size is also on rise.
Retail portfolio mix Retail finance portfolio, Rs bn

Housing Auto CV 2W
8000
100%
80% 6000
60%
4000
40%
2000
20%
0% 0
FY04 FY09P FY99 FY04E FY09P
Source: Cris Infac, Retail Finance Annual Review, March 2005 Source: Cris Infac, Retail Finance Annual Review, March 2005
Though housing finance today constitutes nearly 40% of total housing cost, it is still merely 3%
of GDP, which is much lower than the global average of nearly 8%.
Similarly, increase in borrowing capacity due to various reasons like decline in interest rate,
longer tenure and increase in income levels have led to the spurt in retail finance.
Units financed (%) - FY04 Increase in borrowing ability between FY99 & FY04 (%)
100 60
50
80
40
60
30
40
20
20
10
0 0
Housing Auto loan CV loan 2W loan Housing Auto loan CV loan 2W loan
Auto finance
Banks are slowly capturing the larger pie of the auto finance market; however, this has not
deterred the NBFC players too. Low loan ticket size, fabulous growth and rising finance
penetration besides lucrative margins are some of the reasons why all sorts of financial
intermediaries are fiercely competing for larger market share.
Market share in 2W segment Average yield (%)
Banks NBFCs Others

26
100%
80% 22
60%
18
40%
14
20%
0% 10
2001-02 2002-03 2003-04 1998-99 2003-04 2004-05 2008-09
Finance penetration (%)

1998-99 2003-04 2004-05 2008-09
2W finance 12 32 37 49
Car/UV finance 45 64 66 75
New CV finance 49 63 79 78
New utility vehicle 38 56 58 66
Source: Cris Infac, Retail Finance Annual Review, March 2005
CAGR (%) (FY04-09)

30
25
20
15
10
0
2W finance Used CV finance Auto finance New utility New CV finance
vehicle
Source: Cris Infac, Retail Finance Annual Review, March 2005
There is a growing competition amongst the players to go for used vehicle financing. Though
the return is substantially higher, risks are higher too. Even after considering higher expected
losses in used vehicle finance, net margin is higher by nearly 175 to 250 bps. However, superior
returns are generated by way of focus on risk management and recovery.
Net margins
FY02 FY04 Remarks
New CVs 1.0-1.5 1.0-1.5 The decline in yield and cost of funds move more in
tandem compared to used vehicle financing.
Old CVs 1.5-2.25 2.5-3.25 Despite decline in yield, margins have improved.
Source: Cris Infac & Kotak Securities - Private Client Research
Though the overall market of used vehicle finance is small, competition is visibly growing.
Consumer durable finance

Consumer durable (CD) financing is also gaining momentum with the changing lifestyle and
increase in disposable income. As per Cris Infac, the market size is expected to grow from
Rs.141bn in FY04 to Rs.218bn in FY09 at a CAGR of 9.1%. Colour TVs, refrigerators, air
conditioners and washing machines contribute nearly 80-85% of total CD financing business.
In CD financing, NBFCs are more aggressive than banks primarily due to low-ticket items, low
tenure and secondly banks book it under their personal finance segment. Net spread in the
CD financing business is high at 4-6% compared to other segments of NBFCs.
Companies
Jay Prakash Sinha

jay.sinha@kotak.com
Shriram Transport Finance (STF)
+9122 56341207 (Rs.110, P/ABV: 3.2x, HOLD)
Price target: Rs.127 (18-month horizon)

STF is engaged in truck financing where the expertise lies in pre-owned
Stock details vehicles. It has a unique model in terms of pre-owned/ used truck financing,
BSE code : 511218 which gives STF an advantage over other auto financers, both NBFCs and
NSE code : SRTRANSFIN banks. Due to its niche operations, STF and other group companies have
Market cap (Rs bn) : 7.2*
been able to generate supernormal spreads over their asset book. STF
Free float (%) : 88.3
52-wk Hi/Lo (Rs) : 146/31
has plans to merge other group company namely, Shriram Investments
Wk Avg Qty : 132,812 and also Shriram Overseas. However, in our calculations we have taken
Shares o/s (mn) : 65.43* impact of Shriram Investments in terms of consolidation of accounts.
* Post merger equity shares o/s would be 126mn Given the growth expectation of 24.3% in used CV financing by Cris Infac
and market cap at Rs.13.86bn.
and also higher spread in used-vehicle financing, we believe that STF would
be able to sustain its high margins for the foreseeable future. STF also
Valuation table (merged)
manages portfolios for banks like UTI Bank and Citigroup for their used/
Rs mn FY05 FY06E FY07E FY08E new vehicle financing due to its natural advantage in the last-mile
Total income 6,896 8,321 9,914 11,958 (customer-centric) for both appraisal and recovery.
Gross profit 1677 1,913 2,249 2,655
Net profit 963 1,156 1,374 1,632
EPS (Rs) 7.6 9.2 10.9 12.9 Investment rationale
BVPS (Rs) 31.0 36.9 44.6 54.3
q Presence in high growth area of used-truck financing where margins are higher. SFL
Adj. BVPS (Rs) 28.9 34.1 41.0 49.8
had in the past margins over 10%, which post-merger we expect to sustain over 8%
Dividend yield (%) 2.3 2.3 2.3 2.3 albeit on a higher base.
Debt/ Equity (x) 7.2 6.8 7.4 7.9
RoAA (%) 3.5 3.1 2.9 2.7 q The group has a nationwide presence with dominance in south and west India.
RoE (%) 31.7 25.8 25.8 25.4
Spread (%) 8.8 8.7 8.7 8.3 q Merger would boost balance sheet; capital-raising to be easier to fuel asset growth
Net NPA (%) 0.9 0.9 0.9 0.9
q Group's foray into insurance and personal finance would help in cross-selling products
P/E (x) 14.4 12.0 10.1 8.5
as it is currently using its nidhi-clients
P/ABV (x) 3.8 3.2 2.7 2.2
CAR (%) 14.7 13.7 12.6 12.1 q Net interest income to grow at a CAGR of over 27% over next three years with profit
NPA (%) 0.9 0.9 0.9 0.9 to rise at a CAGR of 20%. Asset in the same period is expected to register a CAGR
Source: Company & Kotak Securities - Private of 30%. STF has one of the highest RoAA in the industry at 3%.
Client Research
Risks and concerns

Shareholding pattern
q General slowdown in the economy may reduce prospects of auto financing
Foreign
Public & 29% q Poor agricultural output/ poor monsoon can impact the business of the company
others q Stiff competition from the commercial banks entry into the auto-financing business
34% could negatively impact NBFCs business & margin in general.
Institutions
4% Valuation & recommendation
Promoters We expect that STF would post an EPS of Rs.9.2, 10.9 and Rs.12.9 in FY06E, FY07E
12% Corp. holding and FY08E respectively. In the same period adjusted book value is expected to be at
21% Rs.34, 41 and Rs.50 respectively.
Based on FY08 earning estimates, the company is expected to post an RoE of 25.4%,
One-year performance (Rel to Sensex)
which translates the fair value to be at 2.6x its adjusted book value. We believe that FY08
STF estimates would get factored in a 12 to 18 months timeframe, which is equal to Rs.127.
We recommend a HOLD on the stock with a price target of Rs.127 over 18-month horizon,
an upside of 16%.
Sensex
Source: Capitaline
Financials: Shriram Transport Finance - Merged entity

Profit & loss (Rs mn)
FY05 FY06E FY07E FY08E
Operating income 6,774 8,172 9,729 11,734
Other income 122 149 185 225
Total income 6,896 8,321 9,914 11,958
Interest expenditure 3,281 4,146 5,042 6,144
Employee expense 272 326 391 469
Operating expense 1,129 1,372 1,640 2,069
Other expense 537 564 592 622
Gross profit 1,677 1,913 2,249 2,655
Depreciation 158 188 199 219
Profit before tax 1,519 1,726 2,050 2,436
Provision for tax 557 569 677 804
Profit after tax 962 1,156 1,374 1,632
Extraordinary items (1) - - -
Net profit 963 1,156 1,374 1,632
Earning per share (Rs) 7.6 9.2 10.9 12.9
Book value per share (Rs) 31.0 36.9 44.6 54.3
Adjusted BVPS (Rs) 28.9 34.1 41.0 49.8
Source: Kotak Securities - Private client Research
Balance sheet (Rs mn)

Share capital 1,261 1,261 1,261 1,261
Preference capital 536 536 536 536
Reserves & surpluses 2,642 3,395 4,366 5,586
Total networth 4,439 5,192 6,163 7,383
Unsecured loans 3,057 3,973 5,271 6,662
Secured loans 25,376 32,684 42,101 53,256
Total loans 28,433 36,658 47,373 59,918
Total liability 32,872 41,850 53,536 67,301
Net block 1,300 1,284 1,275 1,264

Investments 89 98 108 119
Loans & advances 30,173 40,734 52,954 66,283
Cash 4,721 2,974 2,411 2,738
Other current assets 3,088 3,627 4,263 5,012
Current liabilities 3,951 4,544 5,243 5,498
Provision 1,358 1,134 1,269 1,426
Net current assets 32,673 41,658 53,116 67,108
Deferred tax assets (1,191) (1,191) (1,191) (1,191)
Total assets 32,871 41,850 53,308 67,301
Key financial ratios

Debt-Equity Ratio 0.0 6.8 7.4 7.9
CAR (%) 14.7 13.7 12.6 12.1
Net NPA (%) 0.9 0.9 0.9 0.9
RONW (%) 31.7 25.8 25.8 25.4
RoAA (%) 3.2 3.1 2.9 2.7
Spread (%) 8.8 8.7 8.7 8.3
Jay Prakash Sinha

jay.sinha@kotak.com
Shriram City Union Finance
+9122 56341207 (Rs.145, P/ABV: 5.5x, BUY)

Shriram City Union Finance (SCUF) is primarily engaged in the financing
Stock details of consumer durables and has made a disbursement of Rs.2.63bn in FY05.
BSE code : 532498 The segment though low-ticket in size is picking up smartly and is expected
NSE code : SHRIRAMCIT to grow at a CAGR of 9% over next four years as per Cris Infac report.
Market cap (Rs bn) : 3.8
SCUF is keen on the segment and is looking to enhance its overall portfolio
52-wk Hi/Lo (Rs) : 159/28
substantially. It has also exited from truck financing, which is already
Wk Avg Qty : 290,631 catered by other group companies.
Shares o/s (mn) : 27.10
We believe that the company is well positioned with its wide network, large
clientele base and strong track record to take the advantage of lifestyle
Valuation table and demographic changes. We estimate companys growth at a CAGR of
Rs mn FY05 FY06E FY07E FY08E 28% over next three years. However, the growth could easily be catapulted
Total income 1812 2081 2509 2955 to next level with increase in its capital base and leveraging on the same.
Gross profit 414 554 732 830
Net profit 231 335 450 511
EPS (Rs) 7.3 12.3 16.6 18.9
Investment rationale
BV/share (Rs) 25.9 30.3 41.2 55.3 q Consistent track record of growth; strong parentage with ambitious growth plans
Adj. BVPS (Rs) 22.6 25.7 35.4 48.2
Debt-equity ratio 7.2 7.1 7.1 6.9 q Focus on consumer durable & personal finance where the growth prospects are high;
APATM (%) 11.5 15.1 17.1 16.6 given the talks of capital infusion, the asset could easily grow at a CAGR of 50% over
CAR (%) 11.8 12.1 12.8 13.7 next three years.
Net NPA (%) 1.2 1.2 1.2 1.2
q Being low-ticket items and significantly lower tenure, capital turnover is high and
RONW (%) 32.7 38.2 38.5 32.7
hence spreads are higher at 11.9% (one of the highest in the entire industry). This
RoAA (%) 3.2 3.9 4.1 3.7
also leads to high RoE for the company at 38% and hence demands for a premium
Spread (%) 11.3 11.9 11.8 11.0
valuation.
Dividend/share (Rs) 2.5 2.5 2.5 2.5
Dividend yield (%) 1.8 1.8 1.8 1.8 q Cross-selling and leveraging group strengths would help in sustaining growth
P/E (x) 19.6 11.5 8.5 7.5
P/ABV(x) 6.3 5.5 4.0 2.9 q One of the highest EVA spread leading to higher valuation of the company. It is expected
to sustain at level of 16%, down from the current level of 20%.
Source: Company & Kotak Securities - Private
Client Research
Risks and concerns
q General slowdown in the economy may reduce prospects of consumer durable
financing
Institutions
q Given the higher margins in the business, stiff competition going ahead cannot be
Foreign 1.9%
ruled out.
0.1% Corp. holding
Public & 10.2%
others Valuation & recommendation
14.4%
q We expect that SCUF to post an EPS of Rs.12.3, 16.6 and Rs.18.9 in FY06E, FY07E
and FY08E respectively. In the same period adjusted book value is expected to be
at Rs.26, 35 and Rs.48 respectively.
Promoters
73.4% q Based on FY08 earning estimates, the company is expected to post an RoE of 38%,
which translates the fair value to be at 3.2x its adjusted book value. We believe that
FY08 estimates would get factored in a 12 to 18 months timeframe, which is equal
One-year performance (Rel to Sensex) to Rs.169. This is well supported by our residual income valuation of the stock at
Rs.183. Based on the average of the two, we arrive at a fair value of Rs.176 (again
Shriram City Union Finance based on FY08E estimates). We recommend a BUY on the stock with a price target
of Rs.176 over 18-month horizon, an upside of 24%.
Sensex
Source: Capitaline
Financials: Shriram City Union Finance

Other income 53 57 70 83
Total income 1,812 2,081 2,509 2,955
Interest expenditure 949 1,011 1,148 1,371
Operating expense 267 315 407 509
Gross profit 414 554 732 830
Profit before tax 364 499 672 763
Profit after tax 231 335 450 511
Extraordinary items 0 - - -
Net profit 231 335 450 511
Adjusted BVPS (Rs) 22.6 25.7 35.4 48.2

Share capital 271 271 271 271
Reserves & surpluses 431 668 1,021 1,436
Total networth 935 1,172 1,525 1,939
Unsecured loans 620 806 927 1,020
Secured loans 5,894 7,662 9,731 12,164
Total loans 6,514 8,468 10,658 13,184
Total liability 7,449 9,640 12,183 15,123
Net block 605 625 646 670

Investments 16 18 20 22
Loans & advances 7,666 10,349 12,936 16,170
Cash 945 581 677 537
Other current assets 14 16 20 24
Provision 324 356 392 431
Deferred tax assets (277) (277) (277) (277)
Total assets 7,449 9,640 12,183 15,123

CAR (%) 11.8 12.1 12.8 13.7
Net NPA (%) 1.2 1.2 1.2 1.2
RONW (%) 32.7 38.2 38.5 32.7
RoAA (%) 3.2 3.9 4.1 3.7
Spread (%) 11.3 11.9 11.8 11.0
Jay Prakash Sinha

jay.sinha@kotak.com
Cholamandalam Investment & Finance Co
+9122 56341207 (Rs.177, P/ABV: 2.3x, BUY)

Cholamandalam Investment & Finance Co (CIF), a Murugappa group
Stock details company, is primarily engaged into the business of vehicle financing and
BSE code : 511243 Investments. It also has interests in asset management, capital market
NSE code : CHOLAINV and distribution of products. Its insurance arm is likely to be transferred
Market cap (Rs bn) : 6.8
to other group company due to induction of DBS Bank as promoter.
52-wk Hi/Lo (Rs) : 180/58
With the induction of DBS Bank into the business, its retail finance business
Wk Avg Qty : 107,018
Shares o/s (mn) : 38.25
is set to grow substantially. The expertise in product development, branding
& risk management of DBS Bank would allow the company to catapult into
a different league altogether.
Valuation table
Rs mn FY05 FY06E FY07E FY08E

Investment rationale
Total income 2147 2332 2979 4008
Gross profit 609 677 1000 1467 q Strong parentage and track record
Net profit 341 394 614 929
q Diversified financial business with a growth focus on high margin business
EPS (Rs) 9.0 10.4 16.2 24.4
BVPS (Rs) 79.7 84.5 95.2 114.1 q Thrust on retail financing is the key growth driver for the company
Adj. BVPS (Rs) 72.6 77.1 84.8 99.6
Debt-equity ratio 4.3 4.6 5.8 6.8 q Induction of DBS Bank would allow the company to develop new products; growth is
CAR (%) 19.5 17.8 14.8 12.9 expected to rise from a moderate level of 5% to a CAGR of 32% over next three
Net NPA (%) 1.8 1.6 1.6 1.7 years. CIF has grown by 15-20% in the past against industry growth of 9-10%.
RONW (%) 12.2 12.2 17.5 22.8
q Eanings are also expected to post a CAGR of 33% over next three years and grow
RoAA (%) 2.1 2.2 2.8 3.1
Spread (%) 8.2 7.7 7.6 7.3
by 2.7x by FY08E. Hence RoE is also slated to double from 12% to 23% by FY08E.
P/E (x) 19.5 17.0 10.9 7.2
q Asset management and the distribution business to get a big boost with the help of
P/ABV(x) 2.4 2.3 2.1 1.8 DBS Bank association, presently neither of them is featuring in the top brackets. We
Source: Company & Kotak Securities - Private expect both to scale up in terms of business and valuation going forward.
Client Research
Risks and concerns

q Stiff competition from the commercial banks entry into the auto-financing/ retail
financing business could negatively impact NBFCs business & margin in general.
Foreign Institutions q Reduction in DBS Banks commitment, if any, could reduce the growth.
6% 1%
Public & Valuation and recommendation
others Corp. holding
31% 7% We expect CIF to post an EPS of Rs.10.4, 16.2 and Rs.24.4 in FY06E, FY07E and
FY08E respectively. In the same period adjusted book value is expected to be at Rs.77,
85 and Rs.100 respectively.
Promoters
Based on FY08 earning estimates, the company is expected to post a RoE of 23%, which
55%
translates the fair value to be at 2x its adjusted book value. We believe that FY08 estimates
would get factored in a 12 to 18 months timeframe, which equals to Rs.201. We further
get Rs.31 as the value of its asset management and insurance business. We recommend
a BUY on the stock with a price target of Rs.232 over 18-month horizon, an upside of
32%.
One-year performance (Rel to Sensex)
Sum of the part valuation

(FY 08E valuation)
Cholamandalam
Core business 201
AMC 20
Sensex
Insurance 11
Total value 232
Source: Capitaline
Financials: Cholamandalam Investment & Finance Co

Other income 1 50 100 100
Total income 2,147 2,332 2,979 4,008
Interest expenditure 845 930 1,212 1,723
Miscellaneous expenses 177 204 234 269
Provisions 230 207 186 168
Gross profit 609 677 1,000 1,467
Profit before tax 516 593 925 1,399
Net profit 341 394 614 929
Adjusted BVPS (Rs) 72.6 77.1 84.8 99.6

Total networth 3,128 3,312 3,717 4,437
Unsecured loans 6,033 6,938 9,713 13,599
Secured loans 7,276 8,368 11,715 16,401
Total loans 13,309 15,306 21,428 29,999
Total liability 16,437 18,618 25,145 34,437
Net block 160 161 178 213

Investments 1,288 1,288 1,288 1,288
Stock on hire 12,007 14,048 19,667 27,534
Cash 417 151 104 323
Loans & advances 3,306 3,829 4,857 6,180
Current liabilities 504 570 650 740
Provision 293 315 338 363
Deferred tax assets 56 26 39 2
Total assets 16,437 18,618 25,146 34,437

CAR (%) 19.5 17.8 14.8 12.9
Net NPA (%) 1.8 1.6 1.6 1.7
RONW (%) 12.2 12.2 17.5 22.8
RoAA (%) 2.1 2.2 2.8 3.1
Spread (%) 8.2 7.7 7.6 7.3
Jay Prakash Sinha

jay.sinha@kotak.com
Sundaram Finance (SFL)
+9122 56341207 (Rs.395, P/ABV: 1.6x, BUY)
SFL is a major NBFC in financing automobiles with an asset base of over
Rs.44bn. The company has formidable presence in other financial sectors
Stock details like asset management, insurance, home finance and distribution of
BSE code : 521305 financial products. Recently the company has also entered into software
NSE code : SUNDARMFIN services and BPO, though they are still in the nascent stage. The robust
Market cap (Rs bn) : 11.16 growth in the medium & heavy commercial vehicles, cars, multi-axles, two-
Free float (%) : 63.05 wheelers, housing loans, personal loans and more importantly prospects
52-wk Hi/Lo (Rs) : 409/240 of insurance provide an investible opportunity in SFL.
Wk Avg Qty : 6,966
Shares o/s (mn) : 27.78 We have valued the company using sum-of-the-parts valuation for its
various subsidiaries & divisions. Our estimate suggests a fair value of
Rs.518 based on FY08 estimates, which we expect to be factored in another
Valuation table 12-18months. We recommend a BUY with a price target of Rs.518, an upside
Rs mn FY05 FY06E FY07E FY08E of 29% over an 18-month horizon.
Total income 4591 5240 5905 6777
Gross profit 1446 1497 1672 1974 Investment rationale
Net profit 760 843 985 1208 q Robust growth of automobile segment, which provides over 20% growth opportunity
Earning/share (Rs) 27.4 30.4 35.4 43.5 for the company. Given the low leverage, SFL has potential to step up its asset growth
BV/share (Rs) 245.9 268.8 296.7 332.7 without having much capital concern.
Adj. BVPS (Rs) 235.1 258.0 285.9 321.9
q The Sundaram group is associated with automobiles & related products and the global
Dividend/share (Rs) 7.5 7.5 7.5 7.5
phenomenon suggests that such a combination provides higher growth opportunity
Debt-equity ratio 5.3 5.7 5.9 6.1
for both the manufacturer and the finance company
APATM (%) 16.6 16.1 16.7 17.8
CAR (%) 14.7 14.6 14.4 14.2
q Penetration level of General Insurance is still quite low at 0.56% of GDP against the
global average of 2.19%. We believe that huge growth potential is still untapped
Gross NPA (%) 1.5 1.8 2.0 2.0
Net NPA (%) 0.5 0.5 0.5 0.5 q SFL has amalgamated Lakshmi General Finance (LGF) with itself, which has further
RONW (%) 12.6 11.8 12.5 13.8 boosted the business potential for the company
RoAA (%) 2.0 1.8 1.8 1.9 q Software and services business, which are into nascent stage, are likely to grow at
Spread (%) 6.0 4.9 4.8 4.8 a rapid pace
Dividend yield (%) 1.9 1.9 1.9 1.9
q The company has a healthy capital adequacy of 14.6% besides net NPA of merely
P/E (x) 14.7 13.2 11.3 9.2 0.45%
P/ABV(x) 1.7 1.6 1.4 1.2
q Sum of the parts valuation suggests that the stock is undervalued and would be re-
Source: Company & Kotak Securities - Private rated based on synergy of the group companies
Client Research
Risks and concerns

q Slowdown in the economy may impact the demand of automobiles and hence the
financing business
Foreign
11% Institutions q Poor agricultural output/ poor monsoon can impact the business of the company
9% q Stiff competition from the commercial banks could negatively impact NBFCs business
Public & & margins in particular
others Corp. holding q Low liquidity on bourses
42% 1%
Valuation & recommendation
Promoters We have valued the company using sum-of-the-parts valuation for its various subsidiaries
37% & divisions. Our estimate suggests a fair value of Rs.518 based on FY08 estimates,
which we expect to be factored in another 12-18months. We recommend a BUY with a
price target of Rs.518, an upside of 29% over an 18-month horizon.
One-year performance (Rel to Sensex) Valuation

Sundaram Finance
(Rs) Weight (%) Value for SFL
SFL, standalone 415 100 415
RSAICL, insurance 68 60 40
Sensex
SHFL, housing finance 24 60 14
SAMCL, asset management 35 60 21
Cash in SFL 28 100 28
Total 518
Source: Capitaline Source: Kotak Securities - Private Client Research
Financials: Sundaram Finance

Other income 178 233 269 310
Total income 4,591 5,240 5,905 6,777
Interest expenditure 2,148 2,649 3,031 3,482
Gross profit 1,446 1,497 1,671 1,974
Profit before tax 1,224 1,259 1,469 1,803
Profit after tax 760 843 984 1,208
Net profit 760 843 984 1,208
Earning per share, Rs 27.4 30.4 35.4 43.5
Book value per share, Rs 245.9 268.8 296.7 332.7
Adjusted BVPS, Rs 235.1 258.0 285.9 321.9

Total networth 6,830 7,465 8,241 9,241
Unsecured loans 23,260 27,912 33,494 40,193
Secured loans 14,804 15,544 16,322 17,138
Total loans 38,064 43,456 49,815 57,330
Total liability 44,894 50,921 58,057 66,571
Net block 1,666 1,547 1,596 1,788

Lease 223 190 161 137
Investments 3,111 3,267 3,430 3,602
Stock on hire 4,189 3,561 3,027 2,573
Cash 1,004 774 582 159
Loans & advances 37,612 46,034 54,194 63,845
Provision 556 2,104 2,589 3,183
Deferred tax assets (20) 106 231 356
Total assets 44,894 50,921 58,056 66,571

CAR (%) 14.7 14.6 14.4 14.2
Net NPA (%) 0.5 0.5 0.5 0.5
RONW (%) 12.6 11.8 12.5 13.8
RoAA (%) 2.0 1.8 1.8 1.9
Spread (%) 6.0 4.9 4.8 4.8
Comparative analysis: charts
RoE (%) - FY06E D/E (x) - FY06E P/ABV (x) - FY 06E
40.0 8.0 6.0
5.0
30.0 6.0
4.0
20.0 4.0 3.0
2.0
10.0 2.0
1.0
0.0 0.0 0.0

STF SCUF CIFL SFL STF SCUF CIFL SFL STF SCUF CIFL SFL
Source: Source: Source:
P/E (x) - FY 06E ROAA (%) - FY 06E CAR (%) - FY 06E
14.0 6.0 25
4.5 20
13.0
15
12.0 3.0
10
11.0 1.5
5
10.0 0.0 0
NPA (%) - FY 06E Spread (%) - FY 06E Asset size (Rs bn) - FY 06E
1.5 12.0 60
1.2
9.0 45
0.9
6.0 30
0.6
0.3 3.0 15
0.0 0.0 0

RoE: Return on equity D/E: Debt equity P/ABV: Price to adjusted book value
P/E: Price earnings ROAA: Return on average assets CAR: Capital adequacy ratio
NPA: Non-performing assets NIM: Net interest margin
STF: Shriram Transport Finance SCUF: Shriram City Union Finance
CIFL: Cholamandalam Investment & Finance SFL: Sundaram Finance
Research Team
Name Sector Tel No E-mail id
Jay Prakash Sinha Economy, Banking, FMCG, Agro-Industry +91 22 5634 1207 jay.sinha@kotak.com
Avinash Gorakshakar Auto, Auto Ancillary +91 22 5634 1522 avinash.gorakshakar@kotak.com
Dipen Shah IT, Media, Telecom +91 22 5634 1376 dipen.shah@kotak.com
Sanjeev Zarbade Capital Goods, Engineering +91 22 5634 1258 sanjeev.zarbade@kotak.com
Teena Virmani Construction, Mid Cap, Power +91 22 5634 1237 teena.virmani@kotak.com
Shrikant Chouhan Technical analyst +91 22 5634 1439 shrikant.chouhan@kotak.com
Sunil Singh Editor +91 22 5634 1223 singh.sunil@kotak.com
K. Kathirvelu Production +91 22 5634 1567 k.kathirvelu@kotak.com
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Sector Report

December 19, 2005 FOR PRIVATE CIRCULATION

Jay Prakash Sinha

Comparision of key parameters

SWOT analysis of NBFC

Source: Kotak Securities - Private Client Research

Growth path for NBFCs in future

Get the global expertise

Source: Kotak Securities - Private Client Research

# of NBFCs accepting public deposits NBFC assets as % of banks assets (%)

Geographical distribution of NBFCs Public deposit - Regionwise

Asset & liability mix

Liability mix (FY05) Asset mix (FY05)

Paid up capital Bill business

Spread (%) Net owned funds (Rs bn)

Yield on assets (LHS) 56

Return on assets (%) Asset quality

Capital adequacy ratio

Retail portfolio mix Retail finance portfolio, Rs bn

Market share in 2W segment Average yield (%)

Banks NBFCs Others

Finance penetration (%)

CAGR (%) (FY04-09)

Source: Cris Infac, Retail Finance Annual Review, March 2005

Consumer durable finance

Jay Prakash Sinha

Price target: Rs.127 (18-month horizon)

Risks and concerns

Financials: Shriram Transport Finance - Merged entity

Balance sheet (Rs mn)

Net block 1,300 1,284 1,275 1,264

Source: Kotak Securities - Private client Research

Key financial ratios

Jay Prakash Sinha

Price target: Rs.176 (18-month horizon)

Financials: Shriram City Union Finance

Balance sheet (Rs mn)

Net block 605 625 646 670

Source: Kotak Securities - Private client Research

Key financial ratios

Jay Prakash Sinha

Price target: Rs.232 (18-month horizon)

Rs mn FY05 FY06E FY07E FY08E

Risks and concerns

Sum of the part valuation

Financials: Cholamandalam Investment & Finance Co

Balance sheet (Rs mn)

Net block 160 161 178 213

Source: Kotak Securities - Private client Research

Key financial ratios

Jay Prakash Sinha

Risks and concerns

One-year performance (Rel to Sensex) Valuation

Financials: Sundaram Finance

Balance sheet (Rs mn)

Net block 1,666 1,547 1,596 1,788

Source: Kotak Securities - Private client Research

Key financial ratios

Comparative analysis: charts

RoE (%) - FY06E D/E (x) - FY06E P/ABV (x) - FY 06E

40.0 8.0 6.0

20.0 4.0 3.0

0.0 0.0 0.0