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Equity Research

INDIA

March 1, 2016
BSE Sensex: 23779

ADD

Cholamandalam Investment and Finance

Target price Rs700


Shareholding pattern
Promoters
Institutional
investors
MFs and UTI
FIIs
Other Inst
Others

Jun
15
57.7

Sep
15
53.2

Dec
15
53.2

35.4
8.2
17.0
10.2
6.9

40.4
7.5
10.0
22.9
6.4

39.8
8.4
31.3
15.0
7.1

I-Sec vs. Bbg* consensus


(% Var)
NII
PPP
PAT
*Bloomberg

FY16E
9.6
2.2
(1.3)

FY17E
8.9
5.1
5.3

Price chart

Mar-16

Mar-15

Sep-15

Mar-14

Sep-14

Mar-13

800
700
600
500
400
300
200
100
Sep-13

(Rs)

Rs649

On a steady path

NBFC

Reason for report: Initiating coverage


Impeccable in group pedigree, Cholamandalam Finance is primarily an auto
financing NBFC with a significant presence in home equity loans (~30% of AUM).
A brief and unsuccessful sortie into unsecured lending in FY07-09 had damaged
its balance sheet and arguably held it back from claiming its rightful share in its
core domain of CV financing (expertise spans the breadth of both tonnage class
and vehicle vintage). Through careful strategic recalibration that married legacy
strengths with new technology, it has increased its market share in the new
vehicle financing space from 2.8% in FY11 to 6% in FY15 and enjoyed earnings
CAGR of 95% since the bottom reached in FY10. In the same period RoE has
improved from 3.2% in FY10 to 15.9% in FY15. Based on a troika of (i) operating
leverage, (ii) ahead of schedule provisioning & GNPA recognition in FY16 and (iii)
asset growth that is relatively de-risked by diversification; we expect an earnings
CAGR of 15% over FY16-18E and RoE to touch 18% by FY17E. However, current
valuation at 2.4xFY17E P/B is at a significant premium (30-35%) to most of its
asset finance NBFC peers and reflect the relatively better asset quality (despite
significant LCV exposure) and higher earnings predictability. We set our target
multiple at 2.2x FY18E P/B which leads to a 12M target price of Rs700. We initiate
coverage with a recommendation of ADD. Key risks are; (i) asset quality risks in
its LAP portfolio and (ii) risks to the operating leverage thesis from lower asset
growth or increase in collection/ technology costs.
X Diversified vehicle finance play, housing foray improves capital productivity.
In the last four years, its market share in the M&HCV segment has almost tripled to
6-7% and LCV market share has been maintained at about 17-18% (still 24% of
vehicle finance AUM).The benefit of diversification was therefore critical to the 30.7%
vehicle AUM CAGR and we expect 13.2% over FY16E-18E. Despite lower margins
in home equity loans, significantly lower operating and credit costs ensure that it
boosts overall capital productivity (both segments have same risk weight).
X Technology, a key enabler of operating excellence. Technology has been an
area of significant investment & management attention and in terms of its integration
into business operations - Chola qualifies as a top quartile performer amongst peers.
This has complemented return to legacy strengths of a self employed customer
base, secured lending, deep distribution presence and empowered branches.
X Safer, but lower delta to cyclical revival than peers. Ahead of schedule asset
classification/provisioning, better underlying asset quality and growth certainty
benefits of diversification render Cholas earnings much more predictable than most
peers. However, the argument cuts both ways as the companys FY16E-17E credit
cost run rate is not as high compared to FY09-14 history, as it is for peers. These
peers earnings can therefore have much more northward delta in case of a cyclical
turnaround. Leverage headroom for asset growth acceleration (RoE accretive), in
such an eventuality, also seems higher in its peers (~15% less effective leverage).
Market Cap

Rs101bn/US$1.5bn

Year to March

Reuters/Bloomberg

CHLA.BO / CIFC IN

NII (Rs mn)

Shares Outstanding (mn)


52-week Range (Rs)

156.1

FY16E

FY17E

FY18E

20,768

24,096

27,463

4,352

5,211

7,020

8,558

EPS (Rs)

27.9

33.4

44.9

54.8

Free Float (%)

46.8

% Chg YoY

19.2

10.2

34.7

21.9

FII (%)

31.3

P/E (x)

23.3

19.5

14.4

11.8

santanu.chakrabarti@icicisecurities.com

Daily Volume (US$/'000)

906

P/BV (x)

3.2

2.8

2.4

2.1

+91 22 6637 7351

Absolute Return 3m (%)

1.4

Net NPA (%)

2.3

2.9

3.5

3.0

Harshit Toshniwal

Absolute Return 12m (%)

14.5

Dividend Yield (%)

0.5

0.7

0.9

1.1

Sensex Return 3m (%)

(9.1)

RoA (%)

1.9

2.0

2.4

2.6

(17.9)

RoE (%)

15.9

15.4

18.0

18.7

Research Analysts:

Santanu Chakrabarti

harshit.toshniwal@icicisecurities.com

+91 22 6637 7230

Sensex Return 12m (%)

721/547

Net Income (Rs mn)

FY15
17,034

Please refer to important disclosures at the end of this report

Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

TABLE OF CONTENTS
One of the leaders in vehicle finance ............................................................................ 3
Diversification complements core strengths in vehicle finance....................................... 4
Housing foray improves capital productivity................................................................ 8
It is not all a bed of roses though .................................................................................. 11
Technology a key enabler of operating excellence .................................................... 13
Operational strengths are revealed in deep dive .......................................................... 13
Technology has played a crucial role............................................................................ 17
In a nutshell, Chola has married old and new strengths ............................................... 18
Safer, but lower delta to cyclical revival than peers .................................................. 22
Earnings predictability higher than most peers ............................................................. 22
Earnings predictability cuts both ways .......................................................................... 26
12M target price set at Rs700 ....................................................................................... 29
Annexure 1: Vehicle finance sub-segments - analysis .............................................. 30
Light Commercial Vehicles remain a calling card ......................................................... 30
Passenger cars have become an important segment for Chola ................................... 32
HCV tailwind is despite multiple roadblocks ................................................................. 33
Used vehicles presence in both refinance as well as resale ..................................... 34
Tractor business - steady growth given segment realities ............................................ 35
3W and SCV clearly a pain point ............................................................................... 36
Annexure 2: Financials.................................................................................................. 38
Annexure 3: Company Profile....................................................................................... 41
Annexure 4: Index of Tables and Charts ..................................................................... 42

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

One of the leaders in vehicle finance


Cholamandalam Finance has a well-diversified presence in the Vehicle Finance (VF)
space (68% of loan AUM), spanning multiple product categories and tonnage classes.
Chart 1: Overall Cholamandalam loan AUM mix

Other Loans
2%

HCV
14%

LCV
24%

Tractor
10%
Vehicle Loan
68%
Home Equity Loan
30%

Car & MUV


17%

Older
Vehicles
13%
Refinance
15%

3W & SCV
7%

Source: Company data, I-Sec research

Table 1: Vehicle Finance business snapshot


Category

% of VF
Portfolio

AUM
(Rs
bn)

Market
share
estimate
(%)

45.3

2 year AUM
CAGR
(9 qtrs
figure
annualised)
(4.9)

LCVs

24

Passenger
Cars/
MUVs

16

30.2

MHCVs

14

Used
Vehicles
Refinance
Tractor

Distribution
model

LTV

Interest
rates (%)

17

Avg.
ticket
size
estimate
(Rs mn)
0.46

Dealer linked

8090%

~15%

57.5

0.40

Dealer linked

8090%

~14%

26.4

15.7

1.14

Dealer linked

8090%

~12-13%

13

24.5

6.0

NA

0.16

70%

~19-24%

15

28.3

2.1

NA

NA

70%

~15-19%

10

18.9

12.6

NA

0.37

Broker
sourced
Existing
relationship
Dealer linked

~16-19%

13.2

45.9

NA

NA

Dealer linked

Comm.
1
1.9
*Started in
Equipment
FY16
Source: Company data, I-Sec research

NA

NA

8090%
8090%
8085%

3W & SCV

Key Commentary

With the slowdown in the


rural economy, the
company went on to
reduce the dependency on
LCVs for fuelling its AUM
growth and reduced it
share in the VF AUM.
To maintain the AUM
growth in times when rural
economy was slowing
down, the cars & MUV
segment became one of
the growth driver s for the
company and accordingly,
is share in the total AUM
has increased.
Despite industrial demand
not picking up at the
expected pace, the growth
of MHCV industry volumes
have remained robust and
Cholas share in the
overall VF AUM has
increased marginally.

~16-17%
~14%

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Diversification complements core strengths in vehicle finance


The company has gained significant market share in the new vehicle finance segment
over FY11-14, by maintaining it in the LCV segment and gaining significantly in
M&HCVs and passenger vehicles.
Table 2: Vehicle finance market share estimation
FY11

FY12

FY13

FY14

Industry Disbursements (Rs billion)


LCV & Mini LCVs
MHCV & Tractors
Car & MUVs

134
409
621

183
465
683

227
340
719

189
253
676

Individual Market Shares of Cholamandalam (%)


LCV & Mini LCVs
MHCV & Tractors
Car & MUVs

16.8
1.8
0.5

17.6
3.0
0.9

17.8
5.2
1.2

17.1
7.6
2.2

1,164
33
2.82

1,331
52
3.90

1,286
67
5.23

1,118
67
5.98

Total Industry Disbursements - New vehicles (Rsbn)


Chola Disbursements - New vehicles (Rsbn)
Market Share in new vehicles (%)
Source: Company data, I-Sec Research, CRISIL Research

Chart 2: New vehicle finance market share has increased steadily


New vehicle finance market share
7
6.0
6

5.2

(%)

5
3.9

4
3

2.8

2
1
0

FY11

FY12

Source: Company data, I-Sec Research, CRISIL Research

FY13

FY14

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 3: Market Share Trend in LCV and MHCV segmentsreflects the overall
strategic reaction to cyclical realities

MarketShare(%)

FY11
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
-

17.6

16.8

17.8

FY12

FY13

FY14

17.1

7.6
5.2
1.8

3.0

LCV

MHCV

Source: Company data, I-Sec Research, CRISIL Research

The obvious advantage to Cholas well diversified presence in the vehicle finance
segment is that cyclical vulnerability is comparatively lower than peers focusing on
specific niches. As both the rural economy and industrial activity has nosedived in
India in the last two years, this diversification has ensured that the company could be
nimble about the avenues to pursue asset growth in this segment.
Chart 4: Flexibility to switch segment focus, hedges the overall portfolio growth
against economy driven risks to individual segments
LCV

Car & MUV

MHCV & Tractors

Others

100
90

(% of VF AUM)

80

39

38

37

36

36

35

35

20

21

22

23

22

23

24

12

13

14

15

15

16

16

29

29

28

27

26

26

25

24

42

70
60
50

21

40
30
20
10
0

Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16


Source: Company data, I-Sec research

Although, credit costs in the business have gone up substantially in the last two years
(thanks to both cyclical headwinds as well NPA recognition norm migrations), margins
have improved, thanks to multiple relatively high yield segments and liability tailwinds.

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 5: Credit costs increasing sequentially in last two years


Credit Costs of VF business segment
2.5

2.2
1.9

2.0

(%)

1.5
1.5
1.0

1.9

1.8

2.0

2.1

2.1

1.6
1.4

0.6

0.6

Q1FY13

Q2FY13

Q3FY13

0.8
0.6

0.5

0.5

Q2FY16

Q3FY16

Q4FY15

Q1FY16

Q3FY15

Q3FY15

Q2FY15
6.9

Q2FY15

Q1FY15

7.5

6.7

7.2

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Q4FY13

0.0

8.1

8.1

8.2

Source: Company data, I-Sec research

Chart 6: NIM has improved


NIMs of VF business segment

7.3

Q3FY13

Q4FY13

7.3

7.1

7.0

7.1

Q4FY14

7.2

Q3FY14

7.1

Q2FY14

7.2

Q2FY13

Q1FY13

9
7

(%)

6
5
4
3
2
1

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q1FY14

Source: Company data, I-Sec research

Consequently, segmental pre-tax RoA has come down but not by much.
Chart 7: Segmental pre-tax RoA has reduced but not collapsed
Pre Tax RoA of VF Business segment
2.8

3.0

3.1

(%)

2.5

2.2

2.2

2.1

2.0

1.6

1.6

1.8

2.0

2.2

2.2

Q2FY16

2.7

Q1FY16

2.8

Q2FY15

3.0

Q1FY15

3.5

2.4

1.5
1.0
0.5

Source: Company data, I-Sec research

Q3FY16

Q4FY15

Q3FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Q4FY13

Q3FY13

Q2FY13

Q1FY13

0.0

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

We build in ~13.2% AUM growth for the vehicle finance business over FY16E-18E.
We feel that risks to these growth assumptions are significantly lower than most peers
due to diversification benefits.
Chart 8: Vehicle finance AUM growth over FY16E-FY18E to remain healthy but
not spectacular
VF AUM

YoY Growth rates (RHS)


16

300

12

(Rs bn)

200

10
8

150

100

YoY Growth (%)

14

250

4
50

2
0

0
FY15

FY16E

FY17E

FY18E

Source: Company data, I-Sec Research

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Housing foray improves capital productivity


Cholamandalam Finance seeded its home equity loans business back in FY08, much
before it was the popular NBFC/HFC loan product that it is today. The business really
picked up steam in FY10, when Cholamandalam started to realign its business
strategy towards its traditional strength in secured products after the disastrous foray
into unsecured lending in FY07-09.
Chart 9: Housing business AUM grew at a very fast pace
Home Equity AUM
80
70

(Rs bn)

60
50
40
30
20
10
0
FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

Chart 10: as evidenced by a high disbursements growth in segment


Home Equity Disbursements

35
30

(Rs bn)

25
20
15
10
5
0
FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

While the asset growth in the business has been impressive, it has also been led by
an expansion in average loan ticket size which currently stands at ~Rs5mn.
The company focuses on the self-employed non-professional segment of the
population in the B & C mid-level socio-economic categories (a traditional
strength). The loan tenor can be up to 10 years and the collateral is generally
limited to self-occupied residential property (a strong disincentive against the
moral hazard of opportunistic/speculative borrowing).

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

With yields in the home equity loans business significantly lower than vehicle finance,
margins are obviously lower. This is however a significantly lower operating cost
segment, thanks to larger ticket size and lower collection intensity requirement. The
biggest benefit of the foray into this business however has been in credit costs, which
despite hardening, is significantly lower than the vehicle finance business.
Chart 11: Higher NIMs supported by higher yields in vehicle finance business
NIMs
9
Vehicle finance

(% of total assets)

Home Equity

7
6
5
4
3
2
1

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Source: Company data, I-Sec research

Chart 12: but higher operating costs associated with vehicle finance
Operational Costs
Vehicle finance

(% of total assets)

Home Equity

4
3
3
2
2
1
1
Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

Source: Company data, I-Sec research

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016


Chart 13: and credit costs are significantly higher
Credit Costs

(% of total assets)

2.5

Vehicle finance

Home Equity

2.0
1.5
1.0
0.5

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

0.0

Source: Company data, I-Sec research

This leads to significantly higher pre-tax RoA for the home equity loans business. With
risk weights for both segments at 100% and no difference in tax rates, home equity
loans have clearly been a RoE accretive diversification.
Chart 14: Home Equity Loans, a higher RoA business for the company
Pre Tax Return on Total Assets
Vehicle finance

4.0

Home Equity

(% of total assets)

3.5
3.0
2.5
2.0
1.5
1.0
0.5

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Q3FY14

Q2FY14

Q1FY14

0.0

Source: Company data, I-Sec research

We build in a CAGR of 16.8% for the segment AUM over FY16E-18E. In the absence
of a major correction in real estate prices, the risks to these growth assumptions
appear low.

10

Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

It is not all a bed of roses though


The home equity loans or LAP (Loan against Property) business as it is called in India
has boomed in recent times and been a key growth driver for many NBFCs and
housing finance companies. While Cholas deep distribution reach, significant on
ground underwriting capabilities and reasonable loan ticket size/ pricing seem to
indicate that it is at the low to mid end of the risk spectrum in this product, we do have
some concerns about the segment as a whole. Our interactions with credit appraisers
and decision-makers at various HFCs/NBFCs suggest that they remain wary of the
inherent credit risk in the segment due to the following reasons:

Most lenders remain wary of customers financial position when they avail this
loan. With loan rates at 13-15%, apart from the cases where such borrowings are
deployed by customers into their own business, the general suspicion remains that
the borrower is in some sort of financial emergency.

Lenders do not like the fact that the ultimate end use of the money is not under
their direct control.

While the collateral may be enforceable in the case of individual LAP loans
through SARFAESI (not yet notified by RBI, although granted in the last Union
Budget), our contacts in credit underwriting businesses feel that the pool defaults
are likely to be higher than plain vanilla mortgages.

In order to mitigate the risks, the most prominent players are taking the following
precautions:

LTVs are much lower than the 80% maximum allowed for mortgage loans. For
most players, it tops out at 70% with 50-60% being the usual range.

Lenders try to gauge the cashflow pattern based repayment capacity of the
borrower and not just rely on the adequacy of collateral.

The exposure to this business line is capped to a limited portion of the overall
asset portfolio.

One rule of thumb we rely on, to gauge the risk inherent in a LAP portfolio, is to
focus on ticket size and loan pricing. Obviously, all other things remaining
equal, the smaller the better on both counts from a risk perspective. We also
believe that LTV in the case of LAP loans is a subjective opinion and should not
be accorded the same importance to analysis of portfolio risks, as one would
give it for judging an auto or mortgage portfolio. The simple reason is that for
the latter cases, valuation of asset is based on a transacted price of the asset
and therefore more objective in nature.
On both these counts, Cholamandalam Finance checks out reasonably well. As we
saw earlier, despite significant ticket size inflation current average ticket size of Rs5mn
is not excessive by sector standards. When we try to plot average interest income
yield from the home equity loans business, loan pricing also seems to suggest a focus
on the low to moderate risk end of the customer risk profile spectrum.

11

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 15: Home equity interest yields remain moderate a good sign
Home Equity - Interest Yield
14.5
13.3

14

12.9

12.0
12

11.9

10.6

(%)

10
8
6
4
2
0
FY10

FY11

FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

Having said this, a LAP exposure remains somewhat vulnerable to risks from a sharp
real estate price correction, by its very nature. We indicate in our opening investment
thesis that asset quality of the LAP portfolio will remain a key risk to monitor for
existing and potential investors. Management also indicated in the Q3FY16 earnings
conference call that certain geographical pockets are seeing some stress.

12

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Technology a key enabler of operating excellence


Cholamandalam Finance is one of the pioneers in the CV financing business, starting
1978. Its departure from its traditional business strengths and customer base in FY0609 led to a disastrous asset quality outcome and perhaps missed opportunities to
claim its rightful stake in the CV financing pie. The strategic re-organisation of the
company after this period has rightly focussed on shifting focus back to areas of core
competence but with one added dimension. The company has been one of the
pioneers in technology adoption in day to day operations in the NBFC space. Before
we delve into the nuts and bolts of these efforts that we feel are key to
competitiveness in coming years, a look at what we mean by operational excellence
will be illustrative.

Operational strengths are revealed in deep dive


First and foremost, we note that the level of slipped assets for Chola is much lower
than most of its peer group (Sundaram Finance excepted) on apples to apples basis
(120 dpd GNPA recognition, estimates for peers derived from public management
commentary). In evaluating the comparison below, please keep in mind the fact that
even though home equity loans form ~30% of AUM, their GNPA levels are only
~88bps lower than the blended level of 4.8%.
Chart 16: NPA levels (120 days) vis--vis peers
Gross NPA (Based on 120 dpd recognition)
14
11.6

12

(%)

10
7.0

6.0
6

4.8

4
2.1
2
0
Cholamandalam M&M Financials Shriram City
Investments
Union Finance

Shriram
transport

Sundaram
Finance

Source: Company data, I-Sec research, Industry data

13

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

To understand why Chola has been able to pull off this level of relative
outperformance on asset quality, one has to look at their collection specific costs
which are separately provided within other operating expenses in their annual reports.
Chart 17: A higher expenditure on strengthening recovery efforts has helped the
asset quality to remain healthy A STITCH IN TIME, SAVES NINE
1,600

Collection costs

1,400

(Rs mn)

1,200
1,000
800
600
400
200
0
FY12

FY13

FY14

FY15

Source: Company data, I-Sec research

The increase in collection effort costs is illustrative of Cholas early response to


cyclical stress. The companys AUM growth had surpassed employee growth by a
margin in FY12-14, post which employee additions were sharp to boost on ground
presence for stepping up collection effort in a period of cyclical stress. After this step
jump in number of employees, there has once again been a steady increase in
AUM/employee.
Chart 18: AUM per employee has stabilised
AUM per employee
25
21
20

(Rs mn)

17

21
19

18

15
10
5
0
FY12

FY13

FY14

FY15

Q3FY16

Source: Company data, I-Sec research

However, the step up in collection costs emphasises the extent to which employees
have been reallocated towards collection management efforts, as the cycle turned
adverse. The company has managed the collection effort by creating separate teams
for overdue loan assets, depending on bucket of default. Employees managing higher
buckets handle lesser number of accounts on a per capita basis given higher intensity
of effort required per account.
14

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Table 3: Employee classification bucketing system by Cholamandalam for


efficient collection mechanism
No. of month default bucket
1-2 bucket category
3-4 bucket old category
>4th bucket old customers
Source: Company Data

No. of Customers per officer


~130-160 accounts
~50-80 customer accounts
~30-45 customer accounts

Time/Visits devoted per customer


Low
Medium
Highest

Secondly, notice the trend in operating costs as a percentage of AUM in Chola. While
LAP is certainly a lower cost to assets business than vehicle finance, it cannot explain
all the improvement since FY12, nor can operating leverage.
Chart 19: Operating costs as a % of AUM
Total Opex as a % of Average AUM

4.5
4.0

4.0
3.6

3.5

3.1

3.1

3.2

FY14

FY15

9MFY16

(%)

3.0
2.5
2.0
1.5
1.0
0.5
FY12

FY13

Source: Company data, I-Sec research

Even if we strip out new disbursement related direct costs and the collection cost
(stepped up for cyclical stress) from operating costs it has remained stable over last 5
years. This bears testimony to productivity gains achieved with the intelligent use of
technology.
Chart 20: Business origination expense as a % of disbursements remain
constant over the period

1.5

1.5

FY15

1.4

FY14

1.4

FY13

1.5

FY12

1.5

FY11

1.6

FY10

Business origination expense as a % of disbursements

1.4
1.2

(%)

1.0
0.8
0.6
0.4
0.2
-

Source: Company data, I-Sec research

15

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 21: Operating expense excluding business origination & collection costs
has fallen as a % of AUM

2.0

1.79

1.72

FY15

Operating Expense (excl Business Origination & collection expense) as a % of AUM


2.28
2.07

FY14

2.5

(%)

1.5
1.0
0.5

Source: Company data, I-Sec research

16

FY13

FY12

0.0

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Technology has played a crucial role


Technology investments have been a part of Cholas strategy even in the challenging
days of FY10-11 when it was finding its feet after the large losses in the unsecured
lending business. Today, it is a key competitive advantage and deeply embedded in
most aspects of its business.
Chart 22: Technology impact map

Front End

OPERATIONS

RISK MANAGEMENT / CONTROL

Mobility Solutions: Tablet based application that the company is


in the process of implementing. It is a comprehensive solution
suite spanning credit, sales and collection. It will empower the field
staff with the ability to make instant decisions with access to CIBIL
scores, internal credit score, two way documentation transfer etc.
This should have significant impact on TAT and therefore
operating economics and customer satisfaction.
Credit Scoring Model. The company is developing a credit scoring model based on parametric business rules. Despite, the possibility for
a manual override this can work both as a first screen as well as a credit guidepost. It will also create a pool of data where the scoring
model can be back tested for efficiency once a viable data pool has been established in the future.
Risk Based Pricing. With the scoring model indicating credit
worthiness field staff can have risk based pricing freedom in
individual cases, subject to centrally set prudential limits.

Partner
sites

Back End

Core lending platform. The companys core lending platform,


Fin-One Suite is now being adopted to dovetail with its tablet
based mobility solution.
MIS. The company is developing a Hyperion based near real
time MIS, where managers can track their business dynamics
and parameters near-live. This would include P&L of each
branch which will be part of the branch managers KPI.
Planning & Budgeting. The same platform will also provide a
budgeting and business planning tool, capable of both bottom
up and top down analysis.

Dealer Portal. Online portal for vehicle dealers to manage their


business partnership with Chola.
Chola Money. A product for SME loan customers to manage
their loan account, including details of interest and repayment
calculation.

Source: I-Sec Research

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Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

In a nutshell, Chola has married old and new strengths


Cholamandalam Finances history since its foray into unsecured lending is the story of
embracing progress without forgetting its roots. We have explored in the last subsection the role that new technology has played but in many aspects of its business it
has built on historical strengths. Some of these are as follows:
Return to its core customer base. The companys positioning in the vehicle finance
business targets micro and small enterprises often with agriculture linked
transportation. While these customers are not FTUs (First Time Users) graduating
from being drivers to vehicle owners that a Shriram Transport Finance would typically
target they are not large freight operators either (served by banks and Sundaram
Finance). These customers are not necessarily un-banked but remain definitely underbanked, especially when it comes to credit products.
Chart 23: Cholas positioning in the vehicle finance space

Source: Company Investor presentation

Collateral based secured lending in focus. Cholamanadalam Finances deep


branch penetration and credit underwriting knowhow is best manifest in livelihood
linked lending. This is where collateral linked products (vehicles and LAP) become so
important to the company. The advantage for Chola in such categories is that once it
can avoid moral hazard issues in customer selection, deep knowledge of cyclical risks
and dynamics in these segments make them a play on its strengths.

18

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Deepening of distribution reach. In the last six years, the company has grown its
branch network at 25% CAGR v/s 3.8% CAGR between FY06-09. The focus on
deepening its reach is a natural outcome of a return to its old asset classes, where
lending success depends on on-the-ground presence. The new businesses like rural
finance are also a benefit of this increased depth in presence.
Chart 24: Branch expansion post strategic realignment from FY10 has been
brisk till FY14 followed by current pause and consolidation
YoY Growth (RHS)

-20

100

-40

-60

Q3FY16

200

FY15

FY14

300

FY13

20

FY12

400

FY11

40

FY10

500

FY09

60

FY08

600

FY07

80

FY06

700

(%)

Number of Branches

Source: Company data, I-Sec research

Chart 25: A truly diversified geographical presence


Cholamandalam Regional Branch Distribution

East, 20%

South , 27%

West, 26%
North , 26%

Source: Company data, I-Sec research

19

Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

Chart 26: Branch distribution map

Source: Company Investor presentation

Positioning the branch as the rightful heart of the business. The company
understands that in the product-segments it focuses on businesses are made or
broken at the branch level. To this end, the company has clearly de-lineated sales,
credit and collection responsibilities to separate heads at the branch level. They have
also introduced a branch P&L as the branch managers responsibility. This is to
manage motivation and reduce moral hazard at its most granular and critical level of
presence the branch.
Table 4: Organizational hierarchy of the network
Type of office
Category A
Category B
Category C

Nomenclature
Zonal Office
Regional Office
Area Office

Primary Responsibility
Controlling
Controlling
Controlling / Operational

Category D
Category E

Branch Office
Sub Branch Office

Operational
Operational

Source: Company data

20

Additional Remark
Around 6 such offices
Around 20 such offices
Area Regional Manager/ Area Credit
Manager/ Area Collection Manager
Category E (+) Credit officer
~4-5 people (Sales, Collection, Cashier,
Branch Manager)

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016


Table 5: Business strategy environment outcome
Strategic action
Legacy strengths refocused
Connect with self-employed owners of
micro and small enterprises
Expansion of distribution reach to
maintain intensive customer connect and
leverage local know-how
Collection activity attuned to level of
cyclical stress early strategic resource
allocation response
Sticking to secure collateral based
lending
Maintaining a diversified presence both
geographical and product category to
avoid concentration risks to asset growth
and quality

New initiatives technology/ process


Empowerment of the branch while
delineating sales, credit, collection
responsibilities Branch manager given
individual P&L responsibility with state of
the art MIS to have key information
available at fingertips for course
correction
Moving to tablet based mobility platform
for field staff to cut down TAT
Credit scoring/ risk based pricing,
enabled live on the field through the
mobility platform
Significant analytical work on data from
loan pools for early warnings signs of
cyclical stress
Diversification into new areas like rural
finance building on customer-geography
strengths built up through deep regional
presence

Business environment
Stress in the rural economy from consecutive weak monsoons
Some weakness in LCV segment
Serious weakness in the SCV segment (thanks to overcapacity)
Despite industrial slowdown, tailwind in HCV sales
Regulatory requirements of moving to tighter asset classification and
provisioning norms

Business outcomes
Asset quality at 120dpd significantly better than most peers
Loan AUM CAGR of 29.2% in last 5 years (FY11-15)
In recent times LCV business slack and SCV decline, compensated by sharp up
tick in Cars & MUVs and HCV business robustness
LAP business has scaled up fast to 30% of AUM and remains RoE accretive
(some segment risks remain though)
Asset classification and provisioning changes implemented on an accelerated
timeline way ahead of RBI stipulation
ROE has improved from 3.2% in the bottom of FY10 to 15.9% in FY15 and PAT
has registered a CAGR of 95% over the same period
Source: Company data, I-Sec research

21

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Safer, but lower delta to cyclical revival than peers


Earnings predictability higher than most peers
Cholamandalam Finance has a number of advantages over most vehicle financing
peers when it comes to earnings predictability over the next two years

The company has pre-emptively moved towards 90day GNPA recognition and
40bps standard asset provisioning at an accelerated pace far ahead of RBI
requirements as well as most peers

Asset growth is likely to be much more predictable given diversified base

Multiple liability side earnings levers still remain

Ahead of schedule on asset recognition & provisioning will have


advantage over peers in terms of incremental credit costs
Even though the RBI has mandated movement to 90 day GNPA recognition (180 day
norm earlier) and 40bps standard asset provisioning (25bps norm earlier) by Mar-18 in
3 equal steps over FY16, FY17 and FY18, Cholamandalam Finance has followed an
accelerated timeline.
The company has already moved to 120 day GNPA recognition and 35bps of standard
asset provisioning by Q2FY16, a Mar-17 requirement. We feel the remaining transition
will also be finished off latest by H1FY17E.
Chart 27: We expect transition to 90dpd GNPA recognition in H1FY17

5.1

5.0

4.9

4.8

Q2FY18E

Q3FY18E

Q4FY18E

Q1FY17E

5.1

Q1FY18E

4.2

5.2

Q4FY17E

4.2

5.2

Q3FY17E

4.3

Q4FY16E

3.3

4.4

Q3FY16

3.1

Q1FY16

(%)

Q4FY15

Q2FY16

Q2FY17E

GNPA

3
2
1
0

Source: Company data, I-Sec research

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ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Therefore we expect lower credit costs for Chola in FY17-18E, assuming that
provisioning norms do not change significantly, as the transition pain is largely already
absorbed.
Chart 28: Credit cost to reduce going forward
Credit Costs as a % of AUM
4

3.6
3.0

(%)

3
2.2
1.9

1.7
1.3

1.3

1.5

1.3

0.8

1
0.4
0
FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15 FY16E FY17E FY18E

Source: Company data, I-Sec research

Chart 29: despite assuming reasonable coverage ratio


Coverage Ratio
100

87

90
80

73

80

77
69

67

(%)

70

63

60
50
35

40

40

40

45

30
20
10
0
FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15 FY16E FY17E FY18E

Source: Company data, I-Sec research

Following is a comparison of the prudential norms as required by RBI and those as


followed by the company. A far more conservative approach of provisioning adopted
by the company adds to the earning predictability.
Table 6: RBI Prudential Norms
Due Period
Upto 6 months
From 6 months to 2 years
From 2 years to 3 years
From 3 years to 5 years
Beyond 5 years
Source: RBI guidelines

Provisioning %
0
10
20
30
50

23

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Table 7: Cholamandalam Provisioning Policy (much more conservative)


Due period
New Vehicle Finance Business
Upto 4 months
From 4 months to 6 months
From 6 months to 2 years
Beyond 2 years
Used Vehicle Finance / Refinance Business
Upto 4 months
From 4 months to 6 months
From 6 months to 1 year
Beyond 1 year
Tractor Finance Business
Upto 4 months
From 4 months to 6 months
From 6 months to 1 year
From 1 year to 2 year
Beyond 2 years
Housing Business
Upto 4 months
From 4 months to 6 months
From 6 months to 2 year
From 2 year to 5 years
Beyond 5 years
Source: Company data

Provisioning %
0
10
25
100
0
10
40
100
0
10
25
40
100
0
10
25
50
100

Higher predictability of asset growth


Barring one off credit events in the LAP space, it is a booster for overall asset growth.
While vehicle finance has been plagued by a slow rural economy and muted industrial
activity, a more urban LAP business geared more to real estate prices and overall
economy should grow faster. Therefore chances of single digit overall loan growth
remain low, given multiple engines for the same.

Segment CAGR (FY16E-18E)


36
17

14

Total Loan AUM

Total Vehicle AUM

CE

HCV

Tractor

Older Vehicles

Refinance

3W & SCV

17
13
10

Source: Company data, I-Sec research

24

15

Other Loans AUM

15

13

Home Equity Loan


AUM

20

Car & MUV

40
35
30
25
20
15
10
5
0

LCV

(%)

Chart 30: FY16E-18E CAGR of various loan AUM segments

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Liability side levers remain


We see two major levers from the liability side that could ease borrowing costs and
help margins for Cholamandalam Finance.

Firstly, we see possibility to improve its long term rating of AA. Peers with much
worse asset quality have one notch higher ratings despite similar levels of Tier-1
capitalization.

Secondly, bank financing remains a high proportion of borrowings and there is


much scope for substitution through bulk borrowings like non-convertible
debentures. The relative interest rate advantage would widen even more if the
rating upgrade does come through. However, in our opinion, in absence of a rating
upgrade the company is unlikely to start the substitution process in right earnest.

Table 8: Comparison of credit ratings with peers in the industry (Long term)
Credit Rating Analysis

Long Term

CRISIL
Cholamandalam Investments
AA
Shriram Transport
AA+
M&M Financials
AA+
Shriram City Union Finance
AASundaram Finance
AA+
Source: I-Sec Research, Industry sources

ICRA
AA
AA
AA
AA+

CARE
AAAA+
AAA
AA+
-

Commentary
While Shriram Transport, Sundaram Finance and
M&M Financials are rated slightly above
Cholamandalam and SCUF by the credit rating
agencies, even then Chola's current ratings are a
mark of strong long term stability.

Table 9: Comparison of credit ratings with peers in the industry (Short term)
Credit Rating Analysis

Short Term

CRISIL ICRA
Cholamandalam Investments
A1+
A1+
Shriram Transport
A1+
A1+
M&M Financials
A1+
Shriram City Union Finance
A1+
A1+
Sundaram Finance
A1+
A1+
Source: I-Sec Research, Industry sources

CARE
A1+
-

Commentary
Most of these NBFCs have a similar rating profile
for the short term horizon and enjoy a rating
indicative of a stable outlook.

Chart 31: Borrowings mix


Borrowing Mix
Tier II Capital
12%

Debentures
24%
Bank Term Loans
55%

Commercial
Paper
9%
Source: Company data, I-Sec research

25

Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

Earnings predictability cuts both ways


It would be remiss of us to not mention the flip side of our earlier arguments. In case of
a cyclical recovery, the delta to earnings for Cholamandalam Finance is not as high as
some of its peers. The reasons behind this are;

Credit costs are likely to shift downwards from current estimates much more
drastically for most peers of Chola, in case of a cyclical recovery

Although, Tier 1 capitalization level of Chola is comparable to its peer-set, actual


leverage defined as AUM (including off balance sheet loans)/ Equity is significantly
higher. For peers, the extra ability to leverage as asset growth picks up will
incrementally boost RoE more than Chola.

Valuation for Chola is at a significant premium to most peers for similar RoEs. Rerating potential in case of a cyclical recovery is also therefore limited.

Credit cost relatively inelastic to cyclicality


Given the superior asset quality demonstrated by Cholamandalam Finance,
improvements from a cyclical upturn will also be more limited than peers. Consider the
following two examples from its peer set to understand this well.

Shriram Transport Finance has an obvious delta from an improvement in industrial


and construction activity in the asset quality of it CE subsidiary that has faced a
massive meltdown. Even in the core business, in the last 8 quarters, the company
has reported a cumulative credit cost of ~Rs27bn. Of this only ~Rs9.3bn has gone
towards increases in GNPA provisioning stock. A large part of the balance
therefore has come from write-offs. When the cycle turns and write-offs stop
(perhaps even be replaced by some write-backs), credit costs will reduce
significantly. The fact that its FY16E-17E credit cost run rate is 3.3%, as against
the average of annualised quarterly credit costs of last 6 years of 1.9%
demonstrate the efficacy of this argument.

M&M Financial Services current GNPA is 2.1x its FY11-15 average, which is
therefore clearly close to a cyclical peak, even after adjusting for dpd reporting
norms. In the same period coverage has moved from 82.5% to 57.3%.

Chola unfortunately will not have the same delta in credit costs for FY17E, if the
business cycle turns for the better. The fact that credit costs for peers like Shriram
transport Finance is currently expected to be elevated in FY17E due to reporting
transition, while Chola would have likely completed the journey, reduces the delta to
an already fairly moderate credit cost expectation.

26

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 32: Cholas FY16E-17E credit cost comparatively inelastic to cyclicality


Average FY16E-17E Credit Cost as a % of AUM
7 Year (FY09-15) Average Annual Credit Cost as a % of AUM

4.0

3.3

(%)

3.0

2.0

2.5
1.9

1.9

1.8

1.6

1.0

0.0
Cholamandalam

Shriram Transport

M&M Financials

Source: Company data, I-Sec research, Industry data

Despite high Tier-1, leverage possibilities are limited


The tier-1 capitalization of Chola is reasonable, but lower than peers.
Chart 33: Adequate Tier-1 capital
Tier 1 Capital
20
18
16
14

(%)

12
10
8
6

13.5

15.4

15.0

Shriram Transport

M&M Financials

4
2
0
Cholamandalam
Source: Company data, I-Sec research

27

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

However, when we look at total implied leverage defined as total assets (including off
balance sheet) divided by shareholders funds, Cholas effective gearing is much
higher than peers.
Chart 34: Crucially, significantly higher total implied leverage (even after
including off-book assets)
Total Assets (excl off-book assets) / Shareholders Funds
Total Assets (incl off-book assets) / Shareholders Funds
8.5

9.0
8.0

7.6

7.2
6.4

7.0

6.5

6.7

6.0
5.0
4.0
3.0
2.0
1.0
0.0
Cholamandalam

Shriram Transport

M&M Financials

Source: Company data, I-Sec research

The reason behind Cholas higher effective leverage is its higher use of bilateral
assignments which now no longer have a tier-1 capital implication, given absence of
credit enhancements. Since, the credit performance of the pools sold down under this
route have no direct bearing on Cholas financials, one may tend to argue that
significant leverage headroom remains. However, we feel that credit rating agencies
are unlikely to take this view and would indeed look at effective leverage
benchmarks. The fact remains that Chola would have to continue servicing all
originated loans, irrespective of whether they are sold down. An effective leverage
ceiling therefore keeps in check the extent to which its operating network is being
sweated.

28

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Valuation at a premium to most peers


Cholamandalam Finances valuation multiples reflect the relative earnings
predictability that we discussed above and is trading not only at a premium to most
peers but also at the top quality of its own trading range, when most peers are
languishing at the bottom quartile of its trading range. The possibility of significant
upward re-rating therefore remains remote.
Table 10: Peer comparison valuation matrix
P/E
P/B
Company
FY16E
FY17E
FY16E
FY17E
Cholamandalam Investment
19.0
15.2
2.8
2.4
Shriram Transport
15.1
11.8
1.9
1.7
Shriram City Union Finance
17.4
13.8
2.1
1.9
Mahindra & Mahindra Financial
15.5
9.5
1.9
1.6
Sundaram Finance
21.7
18.2
3.3
2.8
Source: I-Sec Research, Bloomberg (Based on prices as on March 1, 2016)

Chart 35: P/E band chart

EPS CAGR (%)


(FY15-17E)
17.9
26.2
10.3
17.2
14.5

Chart 36: P/B band chart


800

800

2.7x

17x

600

700
600

13x

2.0x

500

300

Source: I-Sec Research

May-15

Aug-14

Dec-13

Mar-13

Jul-12

Oct-11

Feb-11

0.8x

Apr-08

Jan-16

May-15

Aug-14

Dec-13

Mar-13

Jul-12

Oct-11

Feb-11

May-10

100

Sep-09

100

Dec-08

200

Apr-08

200

May-10

300

1.6x

400

Sep-09

7x

Dec-08

10x

400

(Rs)

500

Jan-16

700

(Rs)

RoE (%)
FY16E
FY17E
16.2
16.9
13.1
14.9
12.5
14.2
12.7
18.3
15.9
16.6

Source: I-Sec Research

12M target price set at Rs700


With RoE for Cholamandalam inching up to 18%+ by FY18E without any benefit of a
cyclical turnaround, we feel that its target multiple should be at a 20-25% premium to
its direct peers whose current RoE are ~300bps lower. The target multiple we use for
Shriram Transport Finance is 1.7x 1yr fwd P/B and accordingly the target multiple that
we choose for Cholamandalam is 2.2x (applied on Q4FY18E BVPS, of course). As an
aside, the target multiple we use for M&M Financials now is 1.5x 1 yr fwd P/B, but that
is necessitated by the extraordinarily high quantum of GNPA.
We concede that RoE for these two peer may actually converge with Chola and even
exceed it once the cycle turns and the valuation gap can even reverse on earnings
momentum. However, we feel that the premium we are according to Cholamandalam
above this peers is justified given; (i) significant differences in asset quality as well as
progress on 90dpd reporting (transition hits to earnings), (ii) much more predictable
earnings, (iii) no visibility on resurgence in the business cycle and (iv) the housing
piece in the pie which generally receives a higher market multiple (more comparable
with SME finance).
29

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Annexure 1: Vehicle finance sub-segments - analysis


Light Commercial Vehicles remain a calling card
Light Commercial Vehicle (LCV) finance remains a traditional strength of
Cholamandalam Finance. Although the segment has dropped from being 21% of
overall loan AUM in FY14 to 16% now, one has to keep in mind that the portfolio has
grown at 0.9% annualised which comfortably outpaces the volume decline for auto
manufacturers in the segment at 4.2% annualised.
Chart 37: LCV disbursement showing muted growth
8,000

CAGR = 0.9%

7,000

(Rs mn)

6,000
5,000
4,000
3,000
2,000
1,000

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Source: Company data, I-Sec research

Chart 38: as against a 4.17% decline in the LCV sales volumes


120

Units ('000)

100
80
60
40

Source: Company data, I-Sec research

30

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

20

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 39: Company is maintaining a steady LCV finance market share


Market Share (LCV)
20
16.8

17.6

17.8

FY12

FY13

17.1

16

(%)

12
8
4
0

FY11

FY14

Source: Company data, I-Sec research

One of the key theses about the commercial vehicle industry in India is that mid-level
tonnage classes will eventually get phased / squeezed out and the overall logistics will
work in a hub and spoke model with LCVs dominating the spokes and HCVs handling
transport between hubs. The driving factors of this transition will be.

Better highway coverage allowing really heavy tonnage class vehicles

Stricter vigilance on overloading

Stricter emission norms and compliance limiting the length of life of a CV on


National Highways

Implementation of the GST removing interstate taxes for the large trucks leading to
the share of higher tonnage trucks going up within the HCV space, due to be
better cost benefit.

The recent slowdown in LCV sales is hardly a surprise given

A rural economy hit by two consecutive sub-par monsoons

Given the paucity of freight related to application of higher tonnage CVs


(construction, roads etc.) some of the larger tonnage vehicles are migrating to the
local agricultural produce, consumer goods transportation markets

Massive overcapacity in the SCV (Small Commercial Vehicle) segment triggered


by easy finance schemes driven blockbuster sales in earlier years

We feel that the near term fortunes of the LCV cycle will be closely linked to the
fortunes of the rural economy. This in turn would depend on

Winter crop outcome

Early sentiments about monsoon driven by rainfall estimates

Actual quantum of rains and distribution

MSP hikes in the coming fiscal

Use of funds from endowment schemes like MNREGA (budget allocation


significantly higher this year compared to last)

We build in low growth maintaining adequate margin of safety.


31

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016


Chart 40: LCV AUM expected to grow at a moderate pace
YoY Growth (RHS)

10
5
0

Q4FY18E

Q3FY18E

Q2FY18E

Q1FY18E

Q4FY17E

Q3FY17E

Q2FY17E

Q1FY17E

-10

Q4FY16E

Q3FY16

Q2FY16

Q1FY16

-5

YoY Growth (%)

15

Q4FY15

(Rs bn)

LCV AUM

54
52
50
48
46
44
42
40

Source: Company data, I-Sec research

Passenger cars have become an important segment for Chola


Cholas presence in the passenger cars and MUV (Medium Utility Vehicle) segment
has increased significantly despite the recent downturn in UV sales. From being 6% of
AUM in FY14 it now stands at 11% of AUM. Its AUM in this segment has registered a
CAGR of 57.5% vis--vis overall vehicle finance AUM CAGR of 6% over the same
period.
Chart 41: Passenger car related disbursements have remained strong
Passenger Car & MUVs Disbursements

6,000

(Rs mn)

5,000
4,000
3,000
2,000

Source: Company data, I-Sec research

32

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

1,000

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 42: Passenger car & MUV segment AUM has grown fast
Passenger Car & MUVs AUM
35
30

(Rs bn)

25
20
15
10

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Source: Company data, I-Sec research

We are assuming a AUM CAGR of 12.5% over FY16E-18E given the relatively lesser
degree of cyclicality in this business versus commercial vehicles. Dependence, if any,
is to the rural income cycle and direct industrial activity related vulnerability is lower.

HCV tailwind is despite multiple roadblocks


As the I-Sec Auto Research team members Nishant Vass & Jeetendra Khatri write in
their report entitled Rising consumer demands on products & technology on
November 21, 2015
M&HCV segment witnessed voluminous buying on the back of fleet replacement
cycle, better freight economics due to lower fuel prices and ABS legislation driven prebuying in recent months
However, there are a lot of issues with freight volumes in the HCV business that could
get redressed over a period of time, leading to further buoyancy.

Mining activity is yet to pick up in a major way (some improvement has happened)

Road construction is nowhere near budgetary targets

Large scale industrial project related demand remains almost missing

Infrastructure projects are practically at a standstill

If the cash for clunkers program takes off, it could support new vehicle prices by
creating more buoyancy in the operator eco-system

Its share in AUM has been relatively stable at ~9% in FY14 and now as well. Its AUM
in this segment has registered a CAGR of 15.7% vis--vis overall vehicle finance AUM
CAGR of 6% over the same period.

33

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 43: Cholas market share in MHCV and Tractor financing segment (not
separately available for M&HCV)
Market Share (MHCV & tractors)
7.6

8
7
6

5.2

(%)

5
4

3.0

3
1.8

2
1
0

FY11

FY12

FY13

FY14

Source: Company data, I-Sec research, CRISIL Research

We build in a healthy 20.5% AUM CAGR over FY16E-18E.


Chart 44: HCV AUM expected to grow at a healthy 20.5% over FY16-18E

45
40
35
30
25
20
15
10
5
0

YoY Growth (RHS)


35

25
20
15
10

YoY Growth (%)

30

Q4FY18E

Q3FY18E

Q2FY18E

Q1FY18E

Q4FY17E

Q3FY17E

Q2FY17E

Q1FY17E

Q4FY16E

Q3FY16

Q2FY16

Q1FY16

Q4FY15

(Rs bn)

HCV AUM

Source: Company data, I-Sec research

Used vehicles presence in both refinance as well as resale


Cholamandalam Finance has about 10.1% of its AUM in the vehicle refinance
segment. These are mostly old Chola customers who are given a loan after the earlier
ones run down. While the yield on this segment is more lucrative at 15-19% (~300
bps) higher than new vehicle loan pricing, they are even higher (~19-24%) on
financing resale of old vehicles which now forms 8.8% of loan AUM. Shriram Transport
Finance is a virtual monopoly in the old CV resale financing business with segment
AUM at Rs609.4bn. Cholamandalam is one of the other larger players in this highly
specialised segment. Given the lower cyclical vulnerability of these segments, we build
in FY16E-18E AUM CAGRs of 15.4% and 15.2% on used vehicle finance and
refinance business respectively.

34

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 45: Used vehicle finance expected to grow at ~15.4% over FY16-18E
Used Vehicles

YoY Growth (RHS)


20

30

15

(Rs bn)

25
20

10

15

10
0

5
0

YoY Growth (%)

35

Q4FY18E

Q3FY18E

Q2FY18E

Q1FY18E

Q4FY17E

Q3FY17E

Q2FY17E

Q1FY17E

Q4FY16E

Q3FY16

Q2FY16

Q1FY16

Q4FY15

-5

Source: Company data, I-Sec research

Chart 46: Refinance business AUM expected to grow at ~15.2% over FY16-18E
YoY Growth (RHS)

15
10
5
0

YoY Growth (%)

20

45
40
35
30
25
20
15
10
5
0

Q4FY18E

Q3FY18E

Q2FY18E

Q1FY18E

Q4FY17E

Q3FY17E

Q2FY17E

Q1FY17E

Q4FY16E

Q3FY16

Q2FY16

Q1FY16

-5

Q4FY15

(Rs bn)

Refinance

Source: Company data, I-Sec research

Tractor business - steady growth given segment realities


Amongst all the vehicle finance categories that Cholamandalam Finance has a
presence in, tractors are obviously most closely geared to the currently weak rural
income cycle. Organised tractor finance in India has proved a challenge for most
incumbents with success stories few and far between. Tractor finance has a few
challenges that are unique in nature:

When in agricultural usage, a tractor is not a commercial asset. By this, we mean


that the cashflows / revenues from agricultural produce are not directly mapped to
the vehicle. Moreover, it is a productivity enhancer in most cases given the
average agricultural landholding size in India, rather than an absolute necessity.
Thus, credit default behaviour mimics a discretionary rather than a livelihoodlinked commercial asset.

35

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Agricultural cashflows in themselves are also lumpy with payoffs generally


happening twice a year. This means that repayment instalments have to be
generally quarterly and half-yearly and even one single payment default puts the
asset in the NPA category (as per the 180-day NPA norm).

Over-invoicing at the dealers end has been a consistent problem that financing
companies have faced as asset values have often been overstated.

This is a highly people-centric business with the collection effort needing


continuous monitoring and cash-handling at the customers doorstep. This has
proven a challenge to non-specialised players or players with fast asset growth
aspirations.

Repossession of defaulted assets has been complicated in some cases with


agricultural implements being a touchy and politically sensitive subject.

The countrys large size ensures that every year some part of India or the other
has a relatively low agricultural produce due to poor rainfall, drought etc.

With two consecutive weak monsoons and the overall weakness in the rural economy,
the company has shown some growth in its tractor AUM, albeit at a slower pace than
its overall growth rate. We build in a small recovery in FY17E and 9.5% AUM CAGR
over FY16E-18E.
Chart 47: Tractor AUM expected to grow at 9.5% over FY16-18E
Tractor AUM

YoY Growth (RHS)

(Rs bn)

20

15

15
10
10
5

Q4FY18E

Q3FY18E

Q2FY18E

Q1FY18E

Q4FY17E

Q3FY17E

Q2FY17E

Q1FY17E

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q4FY16E

YoY Growth (%)

20

25

Source: Company data, I-Sec research

3W and SCV clearly a pain point


Small commercial vehicles segment in India has been struggling from overcapacity
driven by a sales boom that rode on easy and plentiful finance and lasted up until two
years ago. With freight demand relevant to the segment in the doldrums, the
companys AUM in the segment has decreased substantially. From being 10% of AUM
in FY14 it now stands at 5% of AUM. Its AUM in this segment has registered a decline
of 25.6% vis--vis overall vehicle finance AUM CAGR of 6% over the same period.
We do not build in any major recovery even in FY18E as the overcapacity in the
segment is significant. However, given the current contracted base, we build in an
AUM CAGR of 9.5% over FY16E-18E.
36

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Chart 48: Disbursements have remained low in this segment


3W&SCV Disbursements

4,500
4,000

(Rs mn)

3,500
3,000
2,500
2,000
1,500
1,000
500
Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Source: Company data, I-Sec research

Chart 49: 3W and SCV AUM showed a 25.6% annualised decline


3W&SCV AUM

25

Linear (3W&SCV AUM )

20

(Rs bn)

15
10
5

Q3FY16

Q2FY16

Q1FY16

Q4FY15

Q3FY15

Q2FY15

Q1FY15

Q4FY14

Source: Company data, I-Sec research

37

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Annexure 2: Financials
Table 11: Profit and Loss Statement
(Rs mn, year ending March 31)
Particulars
Interest earned
Interest expended
Net interest income

FY14
32,226
17,711
14,515

FY15
36,638
19,604
17,034

FY16E
41,158
20,390
20,768

FY17E
45,787
21,691
24,096

FY18E
51,112
23,648
27,463

402

274

148

170

196

Staff cost
Depreciation
Other operating expenses
Total operating cost

1,875
236
4,471
6,582

2,217
292
4,979
7,489

2,505
202
5,785
8,491

2,988
219
5,839
9,046

3,631
247
6,312
10,190

Pre-provisioning op profit

8,335

9,819

12,424

15,220

17,469

Provisions & contingencies

2,833

3,247

4,485

4,584

4,502

Profit before tax & exceptional items


Exceptional items
Profit before tax & exceptional items

5,502
5,502

6,572
6,572

7,939
7,939

10,636
10,636

12,966
12,966

Income taxes

1,862

2,221

2,727

3,616

4,409

3,640

4,352

5,211

7,020

8,558

FY14
1,433
21,514
22,947

FY15
1,437
30,289
31,727

FY16E
1,562
34,535
36,097

FY17E
1,562
40,477
42,038

FY18E
1,562
47,722
49,284

1,80,932

1,94,752

2,22,866

2,53,581

2,89,629

3,515
8,074

3,858
8,388

6,132
8,602

8,256
8,328

9,941
8,724

Total liabilities & stockholders' equity

2,15,468

2,38,732

2,73,697

3,12,203

3,57,578

Loans & advances

1,94,281

2,21,835

2,50,883

2,86,525

3,28,677

Investments
Cash and Balance

824
8,008

675
3,407

615
4,317

692
4,859

779
5,468

729
11,625

683
12,132

1,006
16,877

1,133
18,995

1,275
21,379

2,15,468

2,38,732

2,73,697

3,12,203

3,57,578

Other income

PAT
Source: Company data, I-Sec research

Table 12: Balance Sheet


(Rs mn, year ending March 31)
Particulars
Capital
Reserves & surplus
Net worth
Pref. shares/ Share application money
Total borrowings
Provisions
Other Liabilities

Fixed Assets
Current & other assets
Total Assets
Source: Company data, I-Sec research

38

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016


Table 13: Key Ratios
(Year ending March 31)
Particulars
Growth (%):
AUM
Disbursements
Loan book (on balance sheet)
Net Interest Income (NII)
Non-interest income
Pre provisioning operating profits (PPoP)
PAT
EPS

FY14

FY15

FY16E

FY17E

FY18E

22.4
8.2
16.4
31.1
6.7
44.9
18.7
18.7

9.5
(2.3)
14.3
17.4
(32.0)
17.8
19.5
19.2

12.9
19.7
14.5
21.9
(46.0)
26.5
19.8
10.2

14.2
15.3
14.2
16.0
15.0
22.5
34.7
34.7

14.7
14.9
14.7
14.0
15.0
14.8
21.9
21.9

6.9
17.2
10.6
6.6
5.0

7.0
16.8
10.4
6.4
5.3

7.7
16.5
9.8
6.7
5.0

7.8
16.0
9.1
6.9
5.0

7.8
15.6
8.7
6.9
5.0

Operating efficiencies
Non-interest income as % of net income
Cost to income ratio (%)
Op.costs / avg AUM (%)
No of employees (including off rolls)
Average annual salary (Rs)
Annual inflation in average salary(%)
Salaries as % of non-int. costs (%)
NII /employee (Rs mn)
AUM/employee(Rs mn)

2.7
44.1
3.1
11,187
1,67,604
15.7
28.5
1.30
20.8

1.6
43.3
3.1
13,090
1,69,395
1.1
29.6
1.30
19.4

0.7
40.6
3.1
13,489
1,85,703
9.6
29.5
1.54
21.3

0.7
37.3
2.9
15,180
1,96,820
6.0
33.0
1.59
21.6

0.7
36.8
2.9
17,084
2,12,566
8.0
35.6
1.61
22.0

Capital Structure
Debt-Equity ratio
Leverage (x)
CAR (%)
Tier 1 CAR (%)
Tier 2 CAR (%)
Tier 1 Capital (Rs mn)
Tier 2 Capital (Rs mn)
RWA

7.9
9.4
17.2
10.5
6.8
20,793
13,475
1,98,852

6.1
7.5
21.2
13.0
8.2
29,712
18,773
2,28,222

6.2
7.6
19.8
12.8
7.0
33,557
18,392
2,62,749

6.0
7.4
20.1
13.1
7.0
39,180
20,980
2,99,715

5.9
7.3
20.4
13.4
7.0
46,066
24,029
3,43,275

1.9
0.7
4,418
1,628
2.3
0.8
63.2
1.34

3.1
2.0
7,890
5,091
3.6
2.3
35.5
1.33

4.2
2.5
12,042
7,225
4.8
2.9
40.0
1.66

5.1
3.0
16,618
9,971
5.8
3.5
40.0
1.49

4.8
2.6
18,077
9,942
5.5
3.0
45.0
1.28

1.8
17.1
13.8

1.9
15.9
11.6

2.0
15.4
13.5

2.4
18.0
12.8

2.6
18.7
12.8

25.4
25.6
160.1
4.1
0.5

27.9
23.3
203.1
3.2
0.5

33.4
19.5
231.1
2.8
0.7

44.9
14.4
269.1
2.4
0.9

54.8
11.8
315.5
2.1
1.1

Yields, interest costs and spreads (%)


NIM
Yield on loan assets (on -book)
Average cost of funds
Interest Spread on loan assets (on -book)
Spread on securitisation

Asset quality and provisioning


GNPA (% of AUM)
NNPA (% of AUM)
GNPA (estimate)
NNPA (estimate)
GNPA estimate (% of on-book AUM)
NNPA estimate (% of on-book AUM)
Coverage ratio (%)
Credit costs as % of average AUM
Return ratios & capital management
RoAA (%)
RoAE (%)
Payout ratio (%)
Valuation Ratios
EPS (Rs)
Price to Earnings
BVPS (Rs)
Price to Book
Dividend yield (%)
Source: Company data, I-Sec research

39

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016


Table 14: Du Pont Analysis
Particulars
Interest earned
Interest expended
Gross Interest Spread
Credit cost
Net Interest Spread
Operating cost
Lending spread
Non-interest income
Operating spread
Exceptional items
Final Spread
Tax rate (%)
ROAAUM
Effective leverage (AAUM/ AE)
RoAE
Source: Company data, I-Sec research

40

FY14
15.3
8.4
6.9
1.3
5.5
3.1
2.4
0.2
2.6
0.0
2.6
33.8
1.7
9.9
17.1

FY15
15.0
8.0
7.0
1.3
5.7
3.1
2.6
0.1
2.7
0.0
2.7
33.8
1.8
8.9
15.9

FY16E
15.2
7.5
7.7
1.7
6.0
3.1
2.9
0.1
2.9
0.0
2.9
34.4
1.9
8.0
15.4

FY17E
14.9
7.0
7.8
1.5
6.3
2.9
3.4
0.1
3.5
0.0
3.5
34.0
2.3
7.9
18.0

FY18E
14.5
6.7
7.8
1.3
6.5
2.9
3.6
0.1
3.7
0.0
3.7
34.0
2.4
7.7
18.7

ICICI Securities

Cholamandalam Investment and Finance, March 1, 2016

Annexure 3: Company Profile


Background
Cholamandalam Investments and Finance Co Ltd was established in 1978, and is now
among the leading NBFCs with its focus on rural and semi-urban self-employed
population. The company was promoted by Murugappa group and has its presence in
multiple business segments of vehicle finance, home equity and financial product
distribution. Vehicle finance which constitutes ~67% of AUM was commenced in 199394. The company has a diversified geographical presence with 534 branches across
25 states. Operationally, the company has a healthy RoA of 2.1% on its AUM book of
Rs302bn supported by a stable asset quality. Cholamandalam Investments is listed on
both BSE and NSE and has a market capitalization of ~Rs100bn.

Management
Name

Designation

Mr. MBN Rao

Chairman & Independent


Director

Mr. Vellayan Subbiah

Managing Director

Mr. D. Arul Selvan

Chief Financial Officer

Description
Has over 42 years of varied experience in fields of banking, finance, economics,
technology, human resource, marketing, treasury and administration. He has served
as the former Chairman and Managing Director of Canara Bank and Indian Bank.
He joined Chola Board in July, 2010.
Has over 21 years of experience in the varied fields of technology, projects and
financial services. He has worked with Mckinsey and Company and Sundram
Fasteners. He joined the Board of Chola in August, 2010.
Is a graduate in Commerce, an Associate member of the Institute of Chartered
Accountants of India. He has more than 20 years of experience in fields of finance
and strategy and has a long association with Murugappa group. He has been
serving as the CFO since October 2008.

Source: Company data

Capital History (last 15 years)


No. of shares
offered (mn)
84.33
126.5
142.3
142.3
435.02
93.75
105.26
122.85

Date
Type
Year 2003
Rights Issue (1:2)
Year 2004
Rights Issue (1:2)
Year 2007
Rights Issue (3:8)
Year 2008
Conversion of Share Warrants
Year 2010
Preferential Allotment (IFC, TII)
Year 2010
Preferential Issue to PE Investors & AMCs
Year 2013
Issue to QIB
Year 2015
Preference Share Conversion
Source: Company data, I-Sec research

Offer Price per


share
35
55
140
95
92
160
285
407

Proceeds
(Rsbn)
2.95
6.96
19.92
13.52
40.02
15.00
30.00
50.00

Chronology of Key Events


1979
Commenced
Equipment Financing

1990

1992
Commenced Vehicle
Finance Business

1995
Commenced Chola
Securities

1995

1997
Commenced Chola
AMC

2006
JV with DBS Bank
Singapore.
Commenced
Consumer Finance

2005

2010
Sold AMC.
Focus on Secured
lending Lines (Vehicle
Finance, Home Equity)

2007

2007
Commenced Home
Equity Business

2010

2009
Exited Consumer
Finance business

2011
AFC status received
JV with DBS exited

2014
Total AUM
crossed Rs250bn

2012

2016

2012
Launch of Tractor
and Gold Loan

Source: Company data

41

Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

Annexure 4: Index of Tables and Charts


Tables
Table 1: Vehicle Finance business snapshot ....................................................................... 3
Table 2: Vehicle finance market share estimation ................................................................ 4
Table 3: Employee classification bucketing system by Cholamandalam for efficient
collection mechanism .................................................................................................... 15
Table 4: Organizational hierarchy of the network ............................................................... 20
Table 5: Business strategy environment outcome ........................................................ 21
Table 6: RBI Prudential Norms ........................................................................................... 23
Table 7: Cholamandalam Provisioning Policy (much more conservative) ......................... 24
Table 8: Comparison of credit ratings with peers in the industry (Long term) .................... 25
Table 9: Comparison of credit ratings with peers in the industry (Short term) ................... 25
Table 10: Peer comparison valuation matrix ...................................................................... 29
Table 11: Profit and Loss Statement .................................................................................. 38
Table 12: Balance Sheet..................................................................................................... 38
Table 13: Key Ratios........................................................................................................... 39
Table 14: Du Pont Analysis................................................................................................. 40

Charts
Chart 1: Overall Cholamandalam loan AUM mix .................................................................. 3
Chart 2: New vehicle finance market share has increased steadily ..................................... 4
Chart 3: Market Share Trend in LCV and MHCV segmentsreflects the overall strategic
reaction to cyclical realities ............................................................................................. 5
Chart 4: Flexibility to switch segment focus, hedges the overall portfolio growth against
economy driven risks to individual segments .............................................................. 5
Chart 5: Credit costs increasing sequentially in last two years ............................................. 6
Chart 6: NIM has improved ................................................................................................... 6
Chart 7: Segmental pre-tax RoA has reduced but not collapsed ......................................... 6
Chart 8: Vehicle finance AUM growth over FY16E-FY18E to remain healthy but not
spectacular ...................................................................................................................... 7
Chart 9: Housing business AUM grew at a very fast pace................................................ 8
Chart 10: as evidenced by a high disbursements growth in segment .............................. 8
Chart 11: Higher NIMs supported by higher yields in vehicle finance business ............... 9
Chart 12: but higher operating costs associated with vehicle finance ........................... 9
Chart 13: and credit costs are significantly higher .......................................................... 10
Chart 14: Home Equity Loans, a higher RoA business for the company ........................... 10
Chart 15: Home equity interest yields remain moderate a good sign .............................. 12
Chart 16: NPA levels (120 days) vis--vis peers ................................................................ 13
Chart 17: A higher expenditure on strengthening recovery efforts has helped the asset
quality to remain healthy A STITCH IN TIME, SAVES NINE ................................... 14
Chart 18: AUM per employee has stabilised ...................................................................... 14
Chart 19: Operating costs as a % of AUM .......................................................................... 15
Chart 20: Business origination expense as a % of disbursements remain constant over the
period ............................................................................................................................ 15
Chart 21: Operating expense excluding business origination & collection costs has fallen
as a % of AUM .............................................................................................................. 16
Chart 22: Technology impact map ...................................................................................... 17
Chart 23: Cholas positioning in the vehicle finance space ................................................ 18
Chart 24: Branch expansion post strategic realignment from FY10 has been brisk till FY14
followed by current pause and consolidation ............................................................. 19
Chart 25: A truly diversified geographical presence ........................................................... 19
Chart 26: Branch distribution map ...................................................................................... 20
Chart 27: We expect transition to 90dpd GNPA recognition in H1FY17 ............................ 22
42

Cholamandalam Investment and Finance, March 1, 2016

ICICI Securities

Chart 28: Credit cost to reduce going forward ................................................................ 23


Chart 29: despite assuming reasonable coverage ratio.................................................. 23
Chart 30: FY16E-18E CAGR of various loan AUM segments ............................................ 24
Chart 31: Borrowings mix.................................................................................................... 25
Chart 32: Cholas FY16E-17E credit cost comparatively inelastic to cyclicality ................. 27
Chart 33: Adequate Tier-1 capital ....................................................................................... 27
Chart 34: Crucially, significantly higher total implied leverage (even after including off-book
assets) ........................................................................................................................... 28
Chart 35: P/E band chart .................................................................................................... 29
Chart 36: P/B band chart .................................................................................................... 29
Chart 37: LCV disbursement showing muted growth ...................................................... 30
Chart 38: as against a 4.17% decline in the LCV sales volumes................................... 30
Chart 39: Company is maintaining a steady LCV finance market share ............................ 31
Chart 40: LCV AUM expected to grow at a moderate pace ............................................... 32
Chart 41: Passenger car related disbursements have remained strong ............................ 32
Chart 42: Passenger car & MUV segment AUM has grown fast ....................................... 33
Chart 43: Cholas market share in MHCV and Tractor financing segment (not separately
available for M&HCV).................................................................................................... 34
Chart 44: HCV AUM expected to grow at a healthy 20.5% over FY16-18E....................... 34
Chart 45: Used vehicle finance expected to grow at ~15.4% over FY16-18E.................... 35
Chart 46: Refinance business AUM expected to grow at ~15.2% over FY16-18E ............ 35
Chart 47: Tractor AUM expected to grow at 9.5% over FY16-18E..................................... 36
Chart 48: Disbursements have remained low in this segment ........................................... 37
Chart 49: 3W and SCV AUM showed a 25.6% annualised decline.................................... 37

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Cholamandalam Investment and Finance, March 1, 2016

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