Institutional Equities Sundaram Finance 20 May 2021 Reuters: SUNDARAMFIN.BO; Bloomberg: SUF IN Strong franchise ; initiate with an Accumulate ACCUMULATE Sundaram Finance (SUF) has demonstrated its ability to maintain profitability while Sector: BFSI retaining healthy asset quality over economic cycles, comfortable capitalization and a well diversified resource profile. The focus on growth, quality, profitability, high CMP: Rs2,421.8 repeat customer base, strong market understanding and seasoned management team place the business in strong position. The GNPAs remain better than the peers Target Price: Rs2,374 by wide margins, testimony to its strategy of chasing quality over growth. Downside: 2.0% Remarkably, SUF has not raised capital in over four decades and has built other businesses of insurance (LTM GWP of Rs29.8bn), housing finance (AUM of Sonal Gandhi ~Rs91bn), AMC (AAUM of Rs 355 bn) through internal accruals apart from Research Analyst standalone vehicle finance business (AUM Rs 312bn). SUF’s long term credit rating [email protected] is at AAA, highest amongst peers operating in the same line of business. +91 9552595929 Historically, CV contributed over 50% of SUF’s AUM. Thus we believe it to be the Key Data largest beneficiary Coverage Initiating of growth once CV demand revives. We expect disbursement in standalone business to grow at ~31% CAGR over FY21E-23E translating into AUM Current Shares O/S (mn) 111.1 growth of ~10% over the same period. The RoA and RoE are likely to reach 2.6% and 14.5% by FY23E (last 5-yr avg. of 2.5% and 14%, respectively). The stock is currently Mkt Cap (Rsbn/US$bn) 269.1/3.7 trading at 4x 12-m forward P/ABV vs a 5-yr avg 12m fwd P/ABV of 3.4x. We initiate 52 Wk H / L (Rs) 2884/1181 with an Accumulate rating and Price Target of Rs 2,374 (2% downside). We value Daily Vol. (3M NSE Avg.) 48,470 standalone business at Rs 1,848 per share, valuing at 3.75x P/ABV, (in line with Initiating Coverage Initiating Cholamandalam Investment) and value other businesses at Rs526 (per share) after 20% holding company discount (Refer to our SOTP table). The second wave of covid Share holding (%) 3QFY21 2QFY21 1QFY21 has acted as a dampener to recovery in CV sales witnessed in 4Q. Furthermore, the Promoter 35.9 35.9 35.9 asset quality issue is likely to exacerbate due to decline in fleet utilization and increase in diesel prices, thereby impacting operator profitability. This should cap the Public 63.3 63.2 63.2 sector re-rating over the next two quarters thereby limiting any upside in the stock. Others 0.8 0.8 0.8 Largest beneficiary of CV upcycle: The industry CV volume growth has been in negative territory for 7 quarters before registering a 43% growth in 4QFY21. Only once in last 64 One Year Indexed Stock Performance quarters the CV growth has been in a negative territory for over 7 quarters in a row. We believe that the huge replacement demand has been built up, however for the same to 260 240 materialize – (a) the operator cash flow needs to improve (witnessed improvement from 220 200 Nov’20 to Mar’21, before the onset of second covid wave) (b) pick-up in private and public 180 capex. CVs contribute ~50% of SUF’s AUM and it should be the largest beneficiary once 160 140 the demand revives. 120 100 Superior asset quality: While the average GNPA’s for peer auto NBFC’s have ranged 80 60 between 3.5%-8%, SUF reported average GNPA of 1.7% over the last 5 years due to May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 strong underwriting practices and high proportion of repeat customers. 65% of its SUNDARAM FINANCE Nifty 50 customers opted for moratorium last year, lowest within its peer set. It has restructured accounts worth 4.1% of advances until Feb’2021. Price Performance (%) Strong capital allocation and return ratios: SUF has not raised any capital over the last 1 M 6 M 1 Yr 4 decades and have built all businesses organically. Its avg. ROA’s has been consistent between 2.3-2.5% and ROE’s hovered in the range of 14-16% due to low leverage levels. SUF 6.5 40.6 101.0 Nifty Index 5.1 16.9 65.8 Y/E March (Rs mn) FY19 FY20 FY21E FY22E FY23E Source: Bloomberg NII 11,754 13,344 14,837 16,147 17,677 PPOP 10,026 12,315 14,278 14,902 16,011 PAT 5,936 7,239 8,309 9,941 10,759 Loans 2,72,715 2,80,447 3,04,512 3,21,700 3,69,560 RoA (%) 2.1 2.3 2.4 2.7 2.6 RoE (%) 12.9 13.7 14.1 15.0 14.5 P/ABV 5.6 5.4 4.7 4.1 3.6 Source: Company, Nirmal Bang Institutional Equities Research Institutional Equities Investment Arguments Largest beneficiary of pick-up in CV demand SUF has 6 decades of experience in vehicle financing with strong penetration in the South. With a presence across diverse products, its primary focus is on financing of CV’s and cars. CV financing contributed 51% (avg.) of AUM over the last 8 years. Naturally, there is a strong correlation between the growth in CV segment and growth in SUF’s disbursements. The industry CV volume growth has been in negative territory for 7 quarters before registering a growth in 4QFY21. Only once in last 64 quarters the CV growth has been in a negative territory for over 7 quarters in a row. We believe the replacement cycle to pick-up once the economic activity revives to normalcy. The increase in prices on BS VI transition should further aid in disbursements growth. Exhibit 1: AUM Mix – segment wise Exhibit 2: AUM mix – region wise 4 3 3 4 4 5 4% 4% 3% 3% 4% 4% 4% 4% 100 5 9 100% 5 4 3 4 5 5 12% 7 7 7 13% 13% 14% 13% 13% 13% 12% 7 8 10 11 7 80 11 11 80% 17% 19% 19% 20% 19% 19% 21% 21% 31 31 25 60 37 29 25 25 40 60% 40 40% 20 44 49 56 53 52 54 52 48 20% 0 63% 64% 63% 67% 65% 66% 62% 62% 0% FY19 FY15 FY16 FY17 FY18 FY20 FY14 FY14 FY15 FY16 FY17 FY18 FY19 FY20 9MFY21 CVs Cars CE Tractors Others 3QFY21 South North West East Source: Nirmal Bang Institutional Equities Research Source: Nirmal Bang Institutional Equities Research The share of CV disbursements has largely remained around 50% historically; however, we have seen a change in trend in 9MFY21 with share of CV disbursements declining to 30%. Strong end market led to increase in share of cars, CE and tractor disbursements. Interestingly, we also see an increase in the share of Northern geography, indicating an effort to diversify its geographical presence. Exhibit 3: Disbursement mix – segment wise Exhibit 4: Disbursement mix – region wise 4% 3% 3% 4% 4% 5% 5% 4% 4% 3% 3% 4% 4% 100% 100% 4% 5% 5% 4% 3% 4% 5% 7% 5% 7% 16% 14% 13% 13% 12% 10% 7% 7% 8% 10% 13% 13% 13% 11% 11% 80% 13% 80% 17% 19% 19% 19% 20% 19% 21% 31% 14% 27% 60% 31% 25% 60% 37% 29% 25% 40% 40% 28% 40% 20% 20% 44% 49% 56% 53% 52% 54% 52% 30% 63% 64% 63% 67% 65% 66% 62% 58% 0% 0% FY14 FY15 FY16 FY17 FY18 FY19 FY20 9MFY21 FY14 FY15 FY16 FY17 FY18 FY19 FY20 9MFY21 CVs Cars CE Tractors Others South North West East Source: Nirmal Bang Institutional Equities Research Source: Nirmal Bang Institutional Equities Research 2 Sundaram Finance Institutional Equities Exhibit 5: Disbursements growth strongly related to CV growth YoY growth 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 MHCV industry (Vol.) LCV industry (Vol.) SUF disbursement (Rs) Source: Nirmal Bang Institutional Equities Research Exhibit 6: Conservative lending in CV’s observed in 9MFY21 YoY growth 40% 30% 31% 25% 19% 16% 16% 13% 17% 15% 14% 20% 7% 9% 0% 0% 0% -20% -12% -15% -20% -40% -30% -42% -60% -55% -61% -80% FY15 FY16 FY17 FY18 FY19 FY20 9MFY21 MHCV industry (Vol.) LCV industry (Vol.) SUF CV disbursement (Rs) Source: Nirmal Bang Institutional Equities Research Exhibit 7: CV demand to revive with pick-up in mfg. growth and.. Exhibit 8: ..increase in mining and quarrying activities 20 60.0 20 60.0 15 15 45.0 45.0 10 30.0 10 30.0 5 5 15.0 0 15.0 -5 0 - - -10 (15.0) -5 (15.0) -15 -20 (30.0) -10 (30.0) FY12 FY06 FY07 FY08 FY09 FY10 FY11 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 Manufacturing growth (%) CV Vol. growth (%, RHS) Mining & Quarrying CV Vol. growth (%, RHS) Source: Nirmal Bang Institutional Equities Research Source: Nirmal Bang Institutional Equities Research 3 Sundaram Finance Institutional Equities Equities Nirmal Bang Institutional Research, Source: Exhibit 100 110 120 130 140 70 80 90 Apr/14 1 Jul/14 0: Oct/14 4 Diesel prices have inchedupwards…. have prices Diesel Jan/15 Indexed average freight rates freight average Indexed Apr/15 Jul/15 Oct/15 Jan/16 Apr/16 Jul/16 Oct/16 Equities Nirmal Bang Institutional Source: Exhibit 9 demand replacement growing 43% in 4QFY21.