With delinquencies hitting them hard, many financial companies have resorted to a cautious approach on extending credit. Given that more pain may be lurking in the coming quarters, investors also will be better off with more resilient businesses that are sitting on healthy capital buffers. Cholamandalam Investment Finance Company is one such NBFC with a proven track record of its underwriting skills, and a sturdy capital base (CRAR of 19.08 per cent in June 2021) that can help absorb losses. Its presence in high-yielding vehicle finance segment, diversified product portfolio and strong parental backing (part of the Murugappa group) are other key positives for the stock. The stock is currently trading at about 5 times its June 2021 book value, which is a 43 per cent premium to its three-year average multiple. While its premium valuation appears to have factored in the positives, long-term investors can continue holding the stock given its good fundamentals that position it well to benefit from any pick up in economic activity, while at the same time can help tide through any periods of stress in asset quality in case economic recovery is delayed..

Diversified portfolio

Despite the NBFC space and automobile industry facing a challenging environment, the company’s AUM grew by 14 per cent CAGR over FY19-21 to ₹69,996 crore.

Within the vehicle finance segment that contributes 71 per cent of the AUM (June 2021), the company has much diversified target segments, that have helped it steer through demand slowdowns in certain categories. Cholamandalam’s current exposure in vehicle finance is quite fragmented. For intance, used vehicles and LCVs constitute 27 and 21 per cent respectively of the vehicle finance portfolio, while the rest is from Cars (11 per cent), HCV, (9 per cent), Mini LCV (4 per cent), Tractors (10 per cent), Construction Equipment (6 per cent), MUV (7 per cent), 2-wheelers (4 per cent) and 3-wheelers (1 per cent). In the coming quarters, while LCVs are expected to pick up momentum, tractor sales are expected to be impacted by lower than normal monsoon.

Given the slowdown in vehicle finance industry, the company has been consistently diversifying its portfolio. The share of vehicle finance business in disbursements dropped from 90 per cent in June 2020 to 78 per cent in June 2021 . While the company’s overall AUM grew by 10 per cent (y-o-y) in the recent June quarter to ₹67,821 crore , it was predominantly led by loan against property (LAP) & SME and Home loan segments—up 12 and 33 per cent (y-o-y), respectively.

LAP & SME and Home loan segments, constitute 22 and 7 per cent of the AUM, respectively in June 2021. Within the LAP & SME segment, 84 per cent of the portfolio is lent against residential property, while SME constitutes just 3 per cent of the segment. The most recently forayed home loans segment is largely led by loans for self-construction (comprising 51 per cent of the segment), new purchases (31 per cent) and resale (13 per cent) properties. Besides, the company’s 1,137 branches are spread across the country, with 80 per cent locations in Tier-3, 4, 5 and 6 towns. Barring Maharashtra (constitutes 10 per cent of the vehicle finance portfolio as of June 2021), the company’s exposure does not exceed 10 per cent in any other state. This helped the company to stay largely immune to sporadic lockdowns in the country last year.

Steady financials

The company has been able to maintain its net interest margins in the range of 6.8 to 7.7 per cent in the last decade, owing to its exposure to high-yielding segments. Besides, with a healthy operating leverage (expense to assets ratio less than 3 per cent) and stable loan losses and provisions (less than 2 per cent of AUM), it has posted healthy return ratios in the past. In FY21, it reported a return on equity of 16.9 per cent.

However, the pandemic has brought in fresh challenges for the company. With most of its customers being fleet operators and other self-employed personnel, it saw heightened slippages in the recent June 2021 quarter. Its Gross Stage-3 assets inched up to 6.8 per cent in June 2021, from 4 per cent in March 2021 quarter. Further, its Gross Stage-2 assets, which may likely slip in the coming quarters too spiked to 14 per cent of their AUM in June 2021, from 6.2 per cent in March 2021.

However, much of the spike in Stage-2 assets was on account of the company prudently parking the restructured assets in Stage-2 (about 5.4 per cent of the AUM). That apart, provisions currently cover 35.5 per cent and 12.5 per cent of its Gross Stage 3 and Stage 2 assets, respectively.

With the credit costs inching up to ₹552 crore in June 2021 from ₹56 crore in the year ago period (provisions delayed due to moratorium), the company saw a 24 per cent drop in its net profits for the quarter to ₹327 crore.

While the company’s collections dropped to a low of 84 per cent in May 2021 due to lockdowns, management has however indicated a rebound in its collections to over 100 per cent in June and July 2021. Another comforting factor is the company’s low loan to value ratio (at 52-58 per cent on its LAP and home loans), which can help contain the losses on default.