56_nbfc-mac

Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our

website www.macquarie.com/disclosures.

INDIA

Inside

CV lending industry bottoming out 2 Two years of consecutive downturn in M&H

CV sales 3 Early signs of bottoming out 4 Asset quality to be under control for larger

players 8 Regulatory changes unlikely to have

material longer term impact 10 Rural/semi-urban growth story intact 11 Valuations and key picks 13 India Retail NBFC - Fitch Ratings 16 Shriram Transport Finance 19 M & M Financial Services 27 Chola Invest & Fin 32 Sundaram Finance 41 Shriram City Union Finance 49

Valuation table

P/E (x) P/BV (x) RoE

Company FY14E FY15E FY14E FY15E FY15E

SHTF IN 9.6 7.6 1.6 1.4 19.7 MMFS IN 15.1 12.6 3.0 2.5 21.5 SUF IN* 14.2 12.4 2.7 2.3 20.1 CIFC IN* 9.6 7.6 1.6 1.3 18.9 SCUF IN* 11.8 9.5 2.2 1.8 20.2

Prices as of 9th January 2014,

Bloomberg consensus estimates Source: Macquarie Research, January 2014

Analyst(s) Parag Jariwala, CFA +91 22 6720 4083 [email protected] Suresh Ganapathy, CFA +91 22 6720 4078 [email protected]

10 January 2014 Macquarie Capital Securities India (Pvt) Ltd

India Retail NBFCs CV lending industry bottoming out We met NBFCs and Fitch Ratings for an update on their growth/asset quality

outlook for CV lending. Though the current situation is grim and there is excess

capacity, the industry looks to have bottomed out and we think any recovery will be slow and gradual. Buy SHTF for a ~20% upside.

M&H CV lending situation is grim currently GDP growth has halved and related activities such as infrastructure, manufacturing

and investment have seen a big pullback. We have seen two consecutive years

of decline in M&H CV sales the first time this has happened in a decade. If the current trend continues, annualised CV sales for FY14 would be ~200K about half as much as in FY12. Utilization levels for M&H CVs are at a multi-year low:

40% of fleet capacity is lying idle. Resale prices have dropped significantly (~20% in the last 1 year).

We are nearing a bottom; any improvement/revival will be slow and gradual Our conversations with Fitch and some operators/lenders suggest that capacity

utilisation is close to a bottom and a further drop in utilisation levels is unlikely.

An improvement in the economy next year, driven by exports and a stronger

rural economy, lifting of the mining ban, and a better rabi harvest should lead to

higher utilisation rates. We are seeing early signs of a bottom for the CV lending

industry (page 4). With an improvement in utilisation levels, asset quality can

bottom out well before we see a revival in loan growth. Correlation of the CV

cycle with IIP and GDP growth is reasonably high and in the event of a widely-anticipated revival, CV sales could improve, albeit marginally.

Expertise/sensible lending norms have kept asset quality robust for larger players Delinquencies have increased for all CV lenders in the industry. However,

experienced players, through sensible lending, have kept their delinquencies

well under control. A closer look at India Ratings-rated CV pools (FY12/13),

reveals that delinquencies for loans originated with +80% LTV is 2x than on

pools originated with less than 70% LTV (4x of loans with 60% LTV). We gather

collections/ recoveries are better for strong players like SHTF IN and SUF IN 180 DPD (days past due) delinquencies are 1/10th to 1/7th of 90 DPD (Figs 3

and 4). SHTF in particular has been lending at lower LTVs and we dont see a material hit to its asset quality.

Regulatory changes unlikely to have material long-term impact on normalised returns Most NBFCs (non-bank finance companies) are well above the proposed tier 1

capital requirement of 10%. In our view, the companies are unlikely to change

their business model even if NPL recognition norms are changed. Accounting

will change, but cash flows will remain intact. They may take a one-time hit on

profitability by providing more (at 2Q14 coverage level, additional provision is equal to ~12% of FY15/16 profits) or may bring down their coverage ratio.

What to do with the stocks? For SHTF, margins and RoE have bottomed out, in our view, and the stock has

very high correlation with CV sales. We expect stock to do well if the CV cycle

recovers. The stock is currently trading at a P/BV of 1.4x on FY15E (near -1SD

of past 10 years average) at a 50% discount to MMFS, and this is a good entry point from 1-2 years perspective. We retain our Underperform rating on MMFS, as we think the stock is expensive at its current P/BV of ~2.8x on FY15E.

Macquarie Research India Retail NBFCs

10 January 2014 2

CV lending industry bottoming out M&H CV lending the situation is grim

M&H CV sales declined 23% in FY13 and were down ~27% in the first 8 months of FY14

(Apr-Nov 2013). Utilization levels for M&H CVs are at a multi-year low: 40% of the fleet

capacity is lying idle. Resale prices have dropped significantly (~20% in the last one year).

Fuel prices are rising every month and passing this cost through is difficult, due to idle

capacity. The M&H CV market is now a buyers market. Although freight rates have gone up,

vehicle utilisation (trips per vehicle/month) has dropped meaningfully versus a year ago.

Early signs of bottoming out

1. Exit of inexperienced/new players. In addition, unorganised (informal) players have

curtailed their operations significantly in the last 1-1.5 years.

2. Strong players like Shriram Transport and Sundaram Finance are gaining market share.

3. Withdrawal of attractive promotional schemes by NBFCs (mainly owned by CV

manufacturers) and return of rational pricing in the market.

4. Pressure on pricing easing and NBFCs LTVs falling (LTV reduction of 3-5% by all most

all players in the last six months)

5. Early signs of improvement in collection efficiencies collections were good in Oct-Dec

2013 for large CV lenders.

6. Utilisation levels are at a record low and a further drop is unlikely. Asset quality is directly

linked with utilisation levels. Asset quality can bottom out well before the recovery in loan

growth (as utilisation levels start improving).

7. Resumption of mining activities (lifting of Karnataka mining ban) / improvement in the

political situation in Andhra Pradesh to benefit.

Valuation and picks

SHTF is attractively valued relative to its peers and we would play the recovery in CV cycle

through SHTF.

Fig 1 Valuations and recommendation table

P/E (x) P/BV (x) RoE Reco CMP TP Upside/ FY14E FY15E FY14E FY15E FY15E (Rs) (Rs) Downside

SHTF IN 9.6 7.6 1.6 1.4 19.7 OP 610 730 19.6% MMFS IN 15.1 12.6 3.0 2.5 21.5 UP 284 215 -24.3% SUF IN 14.2 12.4 2.7 2.3 20.1 Not Rated 589 NA NA CIFC IN 9.6 7.6 1.6 1.3 18.9 Not Rated 249 NA NA SCUF IN 11.8 9.5 2.2 1.8 20.2 Not Rated 1,065 NA NA

Note: * Valuations for SUF, CIFC and SCUF are based on Bloomberg consensus estimates. Prices as of 9

th January 2014

Source: Bloomberg, Macquarie Research, January 2014

SHTFs stock performance is highly correlated to CV cycle. The stock has shown high

correlation with CV sales (0.83x) from Apr04 to Nov13. As such, we expect the stock to

do well if the CV cycle recovers.

Earnings growth to improve from FY15E. Margins are at their lowest since 2QFY10 and

we expect them to improve gradually over FY15/16. Asset quality is likely to bottom out in

FY14, in our view, with gross NPA unlikely to increase by more than 510bps from current

levels.

We are ahead of consensus by ~10% for FY15E. We expect margins and asset quality

(lower credit cost) to improve in FY15. We expect EPS growth of 27% in FY15 and our

EPS estimate for FY15 is ~10% higher than the Bloomberg consensus.

SHTF is trading at discount to its peers/historical average: We expect the company to

report ~18% RoE in FY14 despite the weak CV cycle. It is currently trading at a P/BV of

1.4x (lower end of trading band at -1SD of its historical averages) at a 50% discount to

MMFS, and this is a good entry point from 1-2 years perspective.

The industry looks to have bottomed out and we expect any

recovery to be gradual. We would

prefer to play the sector through

SHTF.


10 January 2014 3

Two years of consecutive downturn in M&H CV sales In FY10 and FY11, M&H CV volumes (domestic) grew at a healthy rate of ~32%. Even in

FY12, M&H CV grew ~10% on the higher base of FY11. This created a lot of latent

capacity in the hope of a better investment climate and higher GDP growth / manufacturing

activity.

For M&H CVs, we have seen two consecutive years of declines, (FY13 and Apr-Nov 2013)

and if the current trend continues, annualised CV sales for FY14 would be ~200K (level

last seen in FY09).

M&H CV sales declined 23% in FY13 and YTD FY14 (till November 2013) it has registered

a decline of ~27%. Nov 2013 M&H CV sales are ~40% of those in Nov 2011 sales. For the

first time since FY01, we have seen two consecutive years of such a sharp decline in M&H

CV volumes.

LCV volumes (domestic) grew at a better rate in FY12/13, primarily led by consumption

demand and a buoyant rural economy. However, given a slowdown in the overall

economy, LCV volumes dropped 12.5% in the first eight months of FY14 (Apr-Nov 2013).

Fig 2 LCV sales have dropped in FY14

Fig 3 M&H CV sales down sharply in FY13/YTD FY14

Source: SIAM, Macquarie Research, January 2014 Source: SIAM, Macquarie Research, January 2014

Volumes are down significantly and utilisation levels are at multi-year lows: GDP

growth has halved compared to five years ago and related activities like infrastructure,

manufacturing and investment have seen a big pullback. Mining is the largest contributor

for M&H CV usage. In certain states, it (including related mining activities) accounts for 20-

25% total capacity utilisation. Ban on mining in various states (Karnataka, Goa, Orissa)

has adversely affected utilisation levels. Utilization levels for M&H CV are at a multi-year

low; 40% of the capacity is lying idle. Fuel prices are rising every month and passing these

costs is difficult due to idle capacity.

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10 January 2014 4

Early signs of bottoming out Further drop in utilisation levels/CV sales unlikely

M&H CV sales were down ~27% YoY for the period Apr-Nov 2013. As per SIAMs sales data

(company sales to dealers), November 2013 volumes were 40% of those in November 2011.

Inventories at dealers levels have also gone up and some of them are holding two months

inventories. These inventories are included in sales data (though final sell-down to truck

owners is pending). If we exclude this, retail sales are further lower than what was reported

by SIAM. Our conversations with Fitch ratings and some operators/lenders suggest that

capacity utilisation is nearing a bottom and a further drop in the utilisation level is unlikely. An

improvement in GDP growth in the next year, lifting of the mining ban, and a better rabi

harvest should lead to a higher utilisation rate. We are seeing early signs of a bottom for the

CV lending industry.

Signs of bottoming out

The typical leading indicators of an improvement in the CV lending industrys fortunes are as

follows:

1. Exit of inexperienced/new players: Many players (late entrants/new players/companies

that have ventured into new product categories) have either completely exited the CV loan

market or they have curtailed their loan portfolios significantly. For example, banks like

Kotak and HDFC are going slow in new CV disbursements (mainly for SRTOs), and have

taken a one-time hit on asset quality/credit cost for their CV portfolios. Incrementally, they

are lending only to fleet operators that have a good repayment history with them. NBFCs

like MMFS (which entered one and half years ago) are no longer doing any CV lending and

have completely exited the market.

Unorganised players have curtailed their disbursements: The last two years were

difficult for unorganised players. Higher delinquencies have impacted their return ratios.

They have curtailed their operations significantly.

2. Strong players gaining market share: Traditional strong players like Shriram Transport

Finance and Sundaram Finance have gained market share in FY13/1HFY14. SHTF said

that in many regions/segments (mainly in more than 5-8 year old CVs) they are the only

lender and other players have either exited or curtailed their operations significantly.

3. Withdrawal of enticing schemes: Many NBFCs (particularly owned by CV manufacturers

like Tata Motors Finance) were offering special schemes to lure customers, like 100% LTV,

EMI starting after 1 year of possession, higher repayment period of 5-7 years, etc. This has

led to higher defaults. For example as per the structured finance report published by Fitch

Ratings, Tata Motors Finance Ltds three pools originated in Jan/Feb 2013 recorded a

sharp increase in 90+ DPD delinquencies to ~5%. Fitch also highlighted that 90 DPD

delinquencies for pools originated with LTV of +80% are ~2x the pools originated with LTV

of less than 70%. 90 DPD delinquencies for less than 60% LTV are 1/4th to 1/6th those of

the +80% LTV.

Even good players bore the brunt due to unrealistic pricing by some players: Resale

values for vehicles have dropped considerably (~20%) in the past year as many

unqualified/inexperience borrowers (largely under 100% LTV schemes, and higher

repayment schedules) are defaulting. In addition, they have also applied aggressive pricing

for transportation in order to save their vehicles. This has resulted in an unrealistic

correction in the freight rate. Even genuine CV operators and/or CV lenders are suffering

as freight rates are lower due to unrealistic pricing and a drop in resale value.

Return of rational pricing: Industry players have stated that such schemes are now being

withdrawn. Removal of such schemes should benefit the industry (mainly beneficial for

traditional and strong players) as rational pricing should return slowly to the market. This

should keep delinquencies under control.


10 January 2014 5

4. Easing pressure on pricing / reduction in LTVs by NBFCs: Players like SHTF, Chola,

and Sundaram Finance have reduced their LTVs by 3-5% in the last six months to one

year. This is likely to support their asset quality. Most of the SHTF securitized pools

originated in the last year have less than 70% LTV and 180 DPD and are well under

control at 0.5%. Competition has eased significantly and there is no pricing pressure in

most of the market segments. NBFCs hiked their lending rates by 25-50bps in 2Q14.

5. Early signs of improvement in collection efficiencies: The first visible sign of easing in

asset quality pains is improvement in collection efficiencies. The largest player, SHTF,

indicated that visibility is improving and collections were good in Oct/December 2013

(Nov13 is seasonally weak due to festivals). January 2014 could be a bottom for asset

quality pains.

6. Asset quality to bottom out well before the recovery in growth: Asset quality is directly

linked with utilisation levels in the industry. Asset quality can bottom out well before the

recovery in loan growth as utilisation levels start improving. However, improvement in CV

sales will take some time due to excess capacity; though the change in sentiment can kick

start investment activities a bit earlier. Normalcy is a few quarters away.

7. Resumption of mining activities / improvement in the political situation in Andhra

Pradesh to benefit: Mining is the largest contributor to M&H CV usage. In certain states

(including mining related activities) it accounts for 20-25% of total capacity utilisation. The

ban on mining in various states (Karnataka, Goa, Orissa) has impacted utilisation levels

and growth/asset quality of CV lenders.

Mining ban in Karnataka has been lifted by the Supreme Court. Players are indicating

that their exposure to the Karnataka belt is not significant but the lifting of the mining ban in

Karnataka is definitely a positive sign. The demand-supply imbalance may improve as

demand for vehicles in the industry should go up. NBFCs have stated that ~10k M&H CVs

will benefit from this decision. Similar action in Orissa and other mining regions would

benefit the industry.

Political situation in Andhra is impacting volumes and recovery. Political disturbance

in Andhra is hurting all businesses in the state. Some businesses/shops are operational

only 2/3 days in a week. Recovery and further lending have become difficult. Any

improvement in this situation would benefit the industry.

We expect CV volumes to recover in FY15

Our India economist, Tanvee Gupta Jain, expects GDP growth to decelerate sharply to a

near-decade-low of 4.8%YoY in FY14. However, Indias GDP growth is likely to pick up to

5.4%YoY in FY15 and further to 6.1%YoY in FY16. (Link - Macro Mantra - India: 2014

outlook changing gears).

CV sales and their utilization levels have a high correlation with the GDP growth and it

follows economic cycles. M&H CV sales have a high correlation with IIP growth also.

Fig 4 Strong correlation between IIP growth and M&HCV growth

Source: RBI, SIAM, Macquarie Research, January 2014

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10 January 2014 6

Fig 5 Long term trend for CV sales and GDP growth

Source: RBI, SIAM, Macquarie Research, January 2014

Our India auto analyst, Amit Mishra, expects domestic CV volumes to recover in FY15. We

are projecting LCV and M&H CV volumes to grow by 10% and 8% respectively in FY15.

Fig 6 LCV volumes to recover in FY15

Fig 7 M&H CV volumes to register 8% growth after two years of consecutive declines

Source: SIAM data, Macquarie Research, January 2014 Source: SIAM data, Macquarie Research, January 2014

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10 January 2014 7

Fig 8 What Fitch Ratings / CV lenders are saying?

Company Key takeaways

Sundaram Finance Poor economic conditions are unlikely to improve before January 2015

The company is not growing aggressively. 1HFY14 disbursement growth was below 10% and this

trend is expected to continue

Utilization levels are at multi-year lows. Around 35-40% of vehicle capacities are laying idle

(Utilisation rate is ~60%).

Asset quality could bottom out well before the pickup in loan growth (due to the improvement in

utilisation levels).

Chola Finance The M&H CV market is behaving like a buyers market. Although freight rates have gone up the

number of trips per vehicle/month has come off meaningfully.

Resale prices have dropped significantly (15-20% in the last year)

Experienced players (mainly NBFCs) have been very sensible in pricing their loans and therefore

asset quality pains are likely to be lower for them

Shriram Transport Finance In the last six months, SHTF reduced its LTV by 2-3%, which is expected to control delinquencies

and lower the losses on repossessed vehicles

Visibility is improving and collections were good in Oct/December 2013 (Nov13 is seasonally weak

due to festivals). January 2014 could be a bottom for asset quality pains and gross NPA is unlikely to

increase by more than 5-10bps from current levels

Investment activities are unlikely to pick up until elections are concluded. CV sales are unlikely to

improve materially before 1Q15

Fitch Ratings For 2013, within the first eight months, average 90+dpd delinquency reached 3.2% as compared to

2.6% and 1.9% in 2012 and 2011, respectively

Tata Motors Finance Ltds three pools originated in Jan/Feb 2013 recorded a sharp increase in 90+

DPD delinquencies

Recovery closely linked to IIP and agricultural performance

Limited impact of securitization/priority sector guidelines on business volumes

Source: Company, Fitch Ratings, Macquarie Research, January 2014


10 January 2014 8

Asset quality to be under control for larger players Delinquencies have increased for all CV lenders in the industry. However, experienced

players have kept their delinquencies well under control as a result of sensible lending norms.

A closer look at India Ratings rated CV pools (FY12/13) reveals that delinquencies for loans

originated with +80% LTV are 2x those of pools originated with less than 70% LTV (4x those

of loans with 60% LTV). For example as per the structured finance report published by Fitch

Ratings, Tata Motors Finance Ltds three pools originated in Jan/Feb 2013 with ~90% LTV

recorded a sharp increase in 90+ DPD delinquencies to ~5%. 180+ DPD has also jumped

significantly to ~1%. Players with 60-65% LTV had 180+ DPD well under control at 0.3-0.5%.

Fig 9 Performance of securitized CV pools rated by India Ratings (Fitch)

90+ DPD 180+ DPD Originator Transaction name Month LTV 3Q13 2Q13 3Q12 3Q13 2Q13 3Q12

SHTF STFCL CV Trust Nov 12 -II Nov 12 62.70 4.20 2.47 NA 0.25 0.04 NA SHTF Small Operators Trust 2013 Dec 12 65.40 5.88 2.69 NA 0.47 0.22 NA SHTF STFCL CV Trust Dec 12 -I Dec 12 68.90 5.09 2.69 NA 0.21 0.17 NA SHTF Small Operators Trust II 2013 Jan 13 64.40 3.28 1.94 NA 0.21 0.11 NA SHTF STFCL CV Trust Feb 2013 Feb 13 65.50 2.49 1.37 NA 0.02 0.09 NA SHTF Sansar Trust March 2013-I March 13 61.40 1.16 0.22 NA 0.04 - NA SHTF Sansar Trust March 2013 III March 13 63.90 1.95 0.37 NA 0.10 0.01 NA SHTF Sansar CV Trust Mar 2013 IV March 13 64.10 2.23 0.44 NA 0.21 - NA SHTF STFCL CV Trust Aug 2013-I Aug 13 70.00 - - NA NA NA NA Chola Platinum Trust 2013 Jan 13 83.30 1.42 0.86 NA 0.24 0.07 NA Chola Platinum Trust - Feb 2013 -

Tranche 2 Feb 13 86.40 2.15 0.73 NA 0.13 - NA

Chola Platinum Trust March 2013 March 13 86.40 0.90 0.16 NA 0.07 - NA Tata Motors Fin Indian Receivable Trust

January 2013 B Jan 13 91.00 4.33 1.25 NA 0.88 0.02 NA

Tata Motors Fin Indian Receivable Trust January 2013 A

Jan 13 89.10 5.08 1.80 NA 1.04 0.09 NA

Tata Motors Fin Indian Receivable Trust February 2013 A

Feb 13 89.60 5.63 1.77 NA 1.09 - NA

Source: India Ratings, Macquarie Research, January 2014

Fig 10 State- and LTV-wise 90+ dpd

Source: Ind-Ra (Fitch Ratings), January 2014

Fitch Ratings: CV

delinquencies vary

widely among

players


10 January 2014 9

Collections/ recoveries are better for strong players like SHTF/SUF - 180 DPD delinquencies

are 1/7th to 1/10th of 90 DPD (Figs 9 and 11). Players like SHTF, Chola, and Sundaram

Finance have reduced their LTVs by 3-5% in the last six months to one year. This is likely to

support their asset quality.

Fig 11 STFCL CV Trust Feb 2013 difference between 90+ DPD and 180+ DPD



10 January 2014 10

Regulatory changes unlikely to have material longer term impact Tier 1 requirement of 10%

As per RBIs draft guidelines, retail NBFCs are required to maintain 10% tier 1 capital (total

CAR at 15%). As per the draft, NBFCs will be given three years to comply with the

requirement.

Most NBFCs are well above the proposed tier 1 capital requirement of 10%. Therefore the

higher capital requirement is unlikely to impact them.

Fig 12 Except Chola, Other NBFCs are well above the proposed 10% tier 1 capital requirement

Source: Company data, Macquarie Research, January 2014

NPL recognition norms

At present, the period for classifying loans into NPAs in the case of retail NBFCs is higher

at 180 days compared to 90 days for banks. Draft guidelines have proposed that the asset

classification and provisioning norms (including standard asset provisioning norms) should,

in a phased manner, be made similar to those of banks for all registered NBFCs.

As per the draft guidelines, NBFCs are required to comply with 120 DPD norms by FY15

and 90 DPD norms by FY16.

The companies are unlikely to change their business models even if the NPA recognition

norms are changed. Accounting would change but cash flows would remain intact. They

may take a one-time hit on profitability by providing more (at the 2Q14 coverage level,

additional provisions would be equal to ~12% of FY15/16E profits) and/or may lower their

coverage ratios.

Fig 13 Impact of 90 DPD recognition norms on NBFCs

Gross NPAs

Gross NPA - %

Gross NPA with

90 DPD % NPA

coverage Impact FY15 -

PBT

% of FY15 PBT

MMFS 12,223 4.1% 18,185 6.1% 54.7% 3,261 19,200 17.0% SHTF 12,543 3.3% 25,085 6.5% 79.0% 9,909 27,539 36.0% SHTF - Cov ratio at 55% 12,543 3.3% 25,085 6.5% 55.0% 6,898 27,539 25.0% SCUF 3,198 2.5% 4,811 3.7% 73.0% 1,177 8,600 13.7% Chola 2,900 1.5% 4,833 2.5% 72.4% 1,400 6,500 21.5% Note: FY15E bloom estimates for SCUF and Chola


16.10% 15.70%

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MMFS SHTF SCUF Chola

Tier 1 Capital as of 2Q14 As per draft guidelines

Changes in the NPL

recognition norms

to have ~15%

impact on PBT


10 January 2014 11

Rural/semi-urban growth story intact Long term growth story is intact

NBFCs operating in rural/semi-urban regions (MMFS, SCUF and Chola) believe that

lending opportunities are strong due to structural changes (increase in the income of

households, increase in affordability and higher passenger vehicle penetration) happening

in the rural economy.

Penetration levels for loan products are expected to increase in rural areas due to a

moderation in interest rates and alleviation of credit risk.

Rural/semi-urban regions are not overcrowded markets and demand remains robust.

Banks need to change their lending models (in terms of appraisal process, collection and

decentralization of decision making etc) if they want to serve these categories of

customers - which is not a near term possibility in our view.

Fig 14 Higher minimum support prices helping rural India

Fig 15 Much of the financial needs to MSME sector still untapped (mainly in rural and semi-urban regions) annual report of MSME industry FY12

Source: SCUF presentation, Macquarie Research, January 2014 Source: SCUF presentation, Macquarie Research, January 2014

Fig 16 Vehicle penetration expected to increase: Lenders to benefit

Source: MMFS presentation, Macquarie Research, January 2014

5.7

3.1 4.0

14.6

12.0 11.2

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

Arhar Wheat Common paddy

CAGR - FY99-06 CAGR - FY06-12

(%) Institutional sources

5% Non-institutional

sources

2%

Self finance/no finance

93%

11 2670

125

184

251280

380

461499

602

0

100

200

300

400

500

600

700

Ind

ia

Ch

ina

Th

ailand

Bra

zil

Mexic

o

Russia

S K

ore

a

US

A

Jap

an

UK

Italy

(PV per thousand people)

We expect these

NBFCs to register

healthy loan/AUM

growth of 20%+ and

RoE of 19-20% over

the next 5 years


10 January 2014 12

Cyclical pressures to impact near term growth/asset quality

NBFCs have cut their loan growth guidance as GDP growth has halved. Rural/semi-urban

centric NBFCs are likely to grow their disbursements by 15-20% in FY14E/1HFY15 as

compared to ~30%+ growth registered in FY13.

Credit costs and gross NPA levels are likely to go up. However, loss rates (loss given

defaults) are unlikely to disturb their long term projected return ratios.

We expect these NBFCs to register healthy loan/AUM growth of 20%+ and RoE of 19-20%

over the next 3-5 years.


10 January 2014 13

Valuations and key picks Valuations

We expect CV lenders EPS growth to come off significantly in FY14E. For SHTF, we are

projecting EPS growth of ~6% in FY14 (on the lower base of 8% EPS growth in FY13).

Bloomberg consensus estimates suggest that Sundaram Finance (SUF IN) and Chola

Finance (CIFC IN; ~50% of loan book is CV lending) will report lower EPS growth in

FY14E as compared to FY13 (see Fig 17 below).

We expect modest recovery in earnings in FY15E for CV lenders due to recovery in loan

growth and margins.

Fig 17 Earnings growth to slow in FY14E

Companies EPS (Rs) EPS growth (%) RoE (%) FY13 FY14E FY15E FY13 FY14E FY15E FY13 FY14E FY15E

SHTF IN 60.0 63.4 80.5 8.0 5.5 27.1 20.6 18.4 19.7 MMFS IN 16.5 18.9 22.5 31.4 14.5 19.4 24.4 21.3 21.5 SUF IN* 36.9 41.6 47.5 15.4 12.7 14.2 19.5 19.2 20.1 CIFC IN* 22.9 25.9 32.9 59.0 13.1 27.0 19.4 17.5 18.9 SCUF IN* 81.1 90.2 112.0 12.4 11.2 24.2 19.9 20.5 20.2

Note: * Bloomberg consensus estimates.

Source: Bloomberg, Company data, Macquarie Research, January 2014

Fig 18 Valuation and recommendation table

P/E (x) P/BV (x) CMP TP Upside/ FY14E FY15E FY14E FY15E Reco (Rs) (Rs) Downside

SHTF IN 9.6 7.6 1.6 1.4 OP 610 730 19.6% MMFS IN 15.1 12.6 3.0 2.5 UP 284 215 -24.3% SUF IN 14.2 12.4 2.7 2.3 Not Rated 589 NA NA CIFC IN 9.6 7.6 1.6 1.3 Not Rated 249 NA NA SCUF IN 11.8 9.5 2.2 1.8 Not Rated 1,065 NA NA

Note: * Bloomberg consensus estimates. Prices as of 9

th January 2014


Key pick: Play the recovery in CV cycle through SHTF

SHTFs stock performance is highly correlated to CV cycle. The stock has a high

correlation with CV sales (0.83x). We expect the stock to do well if the CV cycle recovers.

Fig 19 SHTFs stock performance is highly correlated to the CV cycle


-

100

200

300

400

500

600

700

800

900

1,000

-

10

20

30

40

50

60

70

80

90

100

Ap

r-04

Sep

-04

Feb-0

5

Jul-

05

Dec-0

5

May-0

6

Oct-

06

Mar-

07

Aug

-07

Jan

-08

Jun

-08

No

v-0

8

Ap

r-09

Sep

-09

Feb-1

0

Jul-

10

Dec-1

0

May-1

1

Oct-

11

Mar-

12

Aug

-12

Jan

-13

Jun

-13

No

v-1

3

Total domestic CV sales SHTF's stock price - RHS

('000) (Rs)

Correlation = 83%

SHTF trades at 1.4x

PBV (lower end of

trading band at -1SD

of its historical

averages) 50%

discount to MMFS,

which is a good

entry point from 1-

2yr perspective


10 January 2014 14

Margins/Return ratios are at bottom: We expect margins to slowly improve to the 7%+

level in the next year. SHTF hiked their lending rates by 50bps on 15th August 2013 and

the full impact will be felt in 3Q14. Management stated that margins are lower by 20-25bps

due to high cash levels (Rs95bn 36% of total borrowings). Cash on the balance sheet will

start reducing from 1Q15 which would aid margins further. AUM mix will change with

improvement in the economy/CV volumes which will benefit margins further in FY15/16E.

Asset quality likely to peak out in FY14: As per the company, visibility is improving and

collections were good in Oct/December 2013 (Nov13 is seasonally weak due to festivals).

January 2014 could be a bottom for asset quality pains and gross NPA is unlikely to

increase by more than 5-10bps from current levels.

We are ahead of consensus by ~10% for FY15E. We expect margins and asset quality

(lower credit cost) to improve in FY15. We expect EPS growth of 27% in FY15 and our

EPS estimate for FY15 is ~10% higher than the consensus

SHTF is trading at a discount to its peers/historical average: We expect the company

to report ~18% RoE in FY14 despite a weak CV cycle. Currently, it trades at 1.4x PBV

(lower end of trading band at -1SD of its historical averages) at a 50% discount to

MMFS, which we think is a good entry point from a 1-2 year perspective.

Fig 20 SHTF one year forward PBV trading at -1SD

Source: Company data, Bloomberg, Macquarie Research, January 2014

Fig 21 One year forward PBV SHTF is trading at significant discount to MMFS


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Jun

-04

Sep

-04

Dec-0

4

Mar-

05

Jun

-05

Sep

-05

Dec-0

5

Mar-

06

Jun

-06

Sep

-06

Dec-0

6

Mar-

07

Jun

-07

Sep

-07

Dec-0

7

Mar-

08

Jun

-08

Sep

-08

Dec-0

8

Mar-

09

Jun

-09

Sep

-09

Dec-0

9

Mar-

10

Jun

-10

Sep

-10

Dec-1

0

Mar-

11

Jun

-11

Sep

-11

Dec-1

1

Mar-

12

Jun

-12

Sep

-12

Dec-1

2

Mar-

13

Jun

-13

Sep

-13

Dec-1

3

(x)

PBV Avg +1std -1std

-51.6%

Average 14.4%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

Mar-

06

Jun

-06

Sep

-06

Dec-0

6

Mar-

07

Jun

-07

Sep

-07

Dec-0

7

Mar-

08

Jun

-08

Sep

-08

Dec-0

8

Mar-

09

Jun

-09

Sep

-09

Dec-0

9

Mar-

10

Jun

-10

Sep

-10

Dec-1

0

Mar-

11

Jun

-11

Sep

-11

Dec-1

1

Mar-

12

Jun

-12

Sep

-12

Dec-1

2

Mar-

13

Jun

-13

Sep

-13

Dec-1

3

SHTF - premium/ discount over MMFS Average


10 January 2014 15

Mahindra Finance Retain Underperform

Volume growth to slow down going ahead: In line with the industry trend, overall

disbursement growth is expected to slow down in FY14/ 1HFY15. The company is

targeting 10-15% disbursement growth in FY14 and overall AUM is likely to grow at 22%+

as compared to 30% YoY growth as of Sept13.

Credit cost is expected to increase: Delinquencies have gone up across various

segments. If slowdown continues then overall credit cost could increase to 2%+ levels.

Losses on repossessed vehicles have also gone up by 15% in the last year.

Maintain Underperform: MMFS is trading at 2.5x FY15E (+1SD of its historical average).

Incremental trends are not encouraging in terms of loan growth and asset quality outlook.

Though the long term story is intact, we expect the stock to remain under pressure for the

next year.


10 January 2014 16

INDIA

CV delinquencies are increasing for FY13 vintage pool


Tata motors Fin CV pools sharp increase in delinquencies

90+ DPD

LTVs 3Q13 2Q13

Jan 13 91.00 4.33 1.25 Jan 13 89.10 5.08 1.80 Feb 13 89.60 5.63 1.77




India Retail NBFC Fitch Ratings: CV delinquencies vary widely among players Event

We met up with Mr. Jatin Nanaware Director, Structured Finance at India

Ratings & Research (Fitch Group). As per their structured finance

performance report 3Q13, weighted average 90+ days past due (DPD)

delinquencies increased to 3% - up 23% from 2Q13.

Impact

CV loan delinquencies are increasing: Stress in the economy is reflected in

the transactions originated in 2013, for which loans were defaulting faster than

the earlier vintages. For 2013, within the first eight months, average 90+dpd

delinquency reached 3.2% as compared to 2.6% and 1.9% in 2012 and 2011.

The Early Delinquency Index (EDI) has also showed a QOQ rise of 165bps to

8.2% in 3Q13 (~200bps YoY increase), indicating that the asset quality

deterioration into the 90+dpd delinquency bucket has not yet bottomed out.

However there is a significant variation among players / LTVs: A closer

look at the vintage pools of FY13 reveals that there is a significant variation in

EDI and 90+ DPD delinquencies among various players. For examples, Tata

Motors Finance Ltds three pools originated in Jan/Feb 2013 recorded a sharp

increase in 90+ DPD delinquencies (Fig 1). Data also suggest that significant

recovery is happening between the 90 days and 180 days bracket. For the

2012 and 2013 vintage pools, 180 DPD delinquencies are 1/7th to 1/10

th of the

90 DPD. Fitch also highlighted that 90 DPD for pools originated with LTV of

+80% is ~2x that of pools originated with LTV of less than 70%. Most of the

SHTF securitized pools originated in the last year have LTVs of less than 70%

and 180 DPD well under control at 0.5%. Fitch highlighted that originator

expertise in the regions/particular asset class plays a big role in performance

of the underlying pool.

Recovery closely linked to IIP and agricultural performance: The rating

agency highlighted that performance of the CV industry is directly linked to

manufacturing and the agricultural industry. Better IIP numbers or a good

agricultural harvest can improve the performance of CV loans.

Limited impact of securitization/priority sector guidelines on business

volumes: The total amount of underlying loans which can qualify for sell

down have reduced due to seasoning requirements and 8% cap on spread

(from the banks base rate). However, NBFCs sell down only 20-30% of their

disbursements and therefore volumes are not affected. Gross spreads have

remained unchanged and there is a slight compression in tier 1. Tax treatment

for investors is broadly clear and gets reflected in the interest shown by banks

in buying PTC paper for their priority sector requirements.

Outlook

SHTF to benefit from the recovery in CV cycle: For SHTF, we believe that

margins and RoE are at bottom and the stock has a high correlation with CV

sales (0.83x). We expect the stock to do well if the CV cycle recovers.

Currently, it trades at1.5x PBV at a 50% discount to MMFS, which is a good

entry point from a 1-2 year perspective in our view.


10 January 2014 17

Fig 1 CV Vintage Weighted average 90+dpd as % of Original POS


Fig 2 CV loans Early Delinquency Indicator (EDI)


Fig 3 Performance of securitized CV pools

90+ DPD 180+ DPD Originator Transaction name Month LTV 3Q13 2Q13 3Q12 3Q13 2Q13 3Q12


Tranche 2 Feb 13 86.40 2.15 0.73 NA 0.13 - NA




Jan 13 89.10 5.08 1.80 NA 1.04 0.09 NA


Feb 13 89.60 5.63 1.77 NA 1.09 - NA

Source: Ind-Ra (Fitch Ratings), Macquarie Research, January 2014


10 January 2014 18

Fig 4 State and LTV wise 90+ dpd


Fig 5 STFCL CV Trust Feb 2013 difference between 90+ DPD and 180+ DPD



10 January 2014 19

INDIA

SHTF IN Outperform

Price (at 10:30, 09 Jan 2014 GMT) Rs610.30

Valuation Rs 730.00 - Gordon Growth 12-month target Rs 730.00

Upside/Downside % +19.6

12-month TSR % +21.2

Volatility Index Medium

GICS sector Diversified Financials

Market cap Rsm 142,869

Market cap US$m 2,298

Free float % 58

30-day avg turnover US$m 3.2

Number shares on issue m 234.1

Investment fundamentals Year end 31 Mar 2013A 2014E 2015E 2016E

Net interest Inc m 35,264 39,377 46,168 53,871 Non interest Inc m 1,669 1,168 1,635 1,831

PBT m 20,162 20,545 27,273 32,050 PBT growth % 7.2 1.9 32.7 17.5 Reported profit m 13,606 14,382 18,273 21,473 EPS rep Rs 59.97 63.39 80.54 94.64 EPS rep growth % 7.9 5.7 27.1 17.5 PER rep x 10.2 9.6 7.6 6.4 Total DPS Rs 7.01 7.92 10.07 11.83 Total div yield % 1.1 1.3 1.6 1.9 ROA % 3.4 3.0 3.3 3.4 ROE % 20.6 18.4 19.7 19.5 Equity to assets % 16.0 16.8 17.6 17.9

P/BV x 1.9 1.6 1.4 1.2

SHTF IN rel BSE Sensex performance, & rec history

Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period.

Source: FactSet, Macquarie Research, January 2014

(all figures in INR unless noted)

Analyst(s) Suresh Ganapathy, CFA +91 22 6720 4078 [email protected] Parag Jariwala, CFA +91 22 6720 4083 [email protected]


Shriram Transport Finance Incremental trends getting better Event We met up with the management of SHTF and key takeaways are presented

below. Incremental trends are getting better for asset quality. Margins/RoEs

are at bottom. Reiterate Outperform with a TP of Rs730.

Impact Margins/Return ratios are at bottom: NIM has consistently declined by 100

bps from 7.7% reported in 2Q13 to 6.7% in 2Q14 (lowest in the last three

years). We expect margins to slowly improve to the 7%+ level in the next

year. SHTF hiked their lending rate by 50bps on 15th August 2013 and the full

impact will be felt in 3Q14. Management stated that margins are lower by 20-

25bps due to high cash levels (Rs95bn 36% of total borrowings). Cash on the balance sheet would start reducing from 1Q15 which would aid margins

further. AUM mix will change with improvement in the economy/CV volumes

which would benefit margins further in FY15/16.

Asset quality likely to peak out in FY14: Credit cost (on AUM) has gone up

by ~30bps since FY12. This is despite the fact the business mix has changed

in favour of LCVs and less than 5 year old CVs, which have lower margins

and consequently lower credit costs. Therefore, there is no under-reporting of

NPLs/credit costs and this has increased in line with industry trends. In the

last six months, SHTF reduced its LTV by 2-3%, which is likely to control

delinquencies and lower the losses on repossessed vehicles. Management

stated that visibility is improving and collections were good in Oct/December

2013 (Nov13 is seasonally weak due to festivals). January 2014 could be a bottom for asset quality pains and gross NPA is unlikely to increase by more

than 5-10bps from current levels.

Not losing market share; business model remains intact: The CV industry

has undergone a change in the last 2-3 years. LCV volumes have increased

despite a weak economy. For the first time in the last 10 years, M&H CV

volumes have declined consistently for two years (FY13 -23% YoY growth,

YTD FY14 -27% YoY growth). This created the less than 5 year old CV

segment as new CV owners were selling down due to the weak economy.

Structural changes in the rural economy increased the opportunity for

financiers to lend towards LCVs/mini LCVs. We believe that SHTFs core strength in financing towards used vehicles is intact. In fact, in the last six

months to one year, many players have reduced their exposure to CV lending

or exited completely from the riskier segments.

Growth will take some time to pick up: Investment activities are unlikely to

pick up until elections are concluded. CV sales are unlikely to improve

materially before 1Q15. SHTF may see overall AUM growth of ~18% in FY14.

Earnings and target price revision We cut our estimates by ~10% for FY14 due to lower margins and slower

AUM growth. FY15/16 estimates are fine tuned. No change in TP.

Price catalyst 12-month price target: Rs730.00 based on a Gordon growth methodology.

Catalyst: Improvement in loan growth/margins and lower asset quality pains

Action and recommendation Good play on CV cycle/economic recovery: We maintain Outperform with

a TP of Rs730.


10 January 2014 20

Margins/Return ratios are at bottom

NIM has consistently declined by 100 bps from 7.7% reported in 2Q13 to 6.7% in 2Q14 (lowest in

the last three years). Accordingly, return ratios have also come off sharply in the last year. RoE

has declined from 20%+ to 17% in 2Q14.

Fig 1 NIMs have declined consistently in the last year


Fig 2 Return ratios have come off meaningfully in the last year


7.6%

8.2%

7.4%

7.2%

7.4%

7.7%

7.5%

7.2%

7.0%

6.7%

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

1Q FY12 2Q FY12 3Q FY12 4Q FY12 1Q FY13 2Q FY13 3Q FY13 4Q FY13 1QFY14 2QFY14

NIM on AUM

4.3%

3.6% 3.6% 3.5%

3.7%3.9%

3.6%

3.3%

3.0%

2.8%

27.4%

22.2%21.4%

20.9% 20.9% 20.8%20.4% 20.1%

18.5%

17.0%

15.0%

17.0%

19.0%

21.0%

23.0%

25.0%

27.0%

29.0%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%


ROA ROE (RHS)


10 January 2014 21

Changes in the AUM mix have impacted margins: Management stated that the LCV proportion

has gone up in the last 1-2 years as LCV volume growth was robust. The less than 5 year old CV

proportion has also gone up over the years. This segment now constitutes 12-13% of overall

AUMs. Therefore changes in AUM mix have impacted margins, albeit the impact is not very

significant as less than 5 year old CV disbursements were done at a cost of new vehicles. Yield in

less than 5 year old CVs is 50-100bps higher than for new CVs. There could be slight

compression due to a higher LCV proportion and lower +5 year old M&H CVs.

Fig 3 Changes in AUM mix since FY11


AUM mix will change with improvement in economy/CV volumes: We believe that current

AUM mix is mainly due to industry trends. LCV volumes have been higher due to the strong rural

economy and better than expected consumption demand in tier 2 and tier 3 cities. The less than 5

year old CV segment was created due to slowdown in investment related/manufacturing activities

in the last two years. M&H CV volumes are likely to improve with improvement in the economy/

investment and manufacturing activities.

SHTF is focusing on small-vehicle finance (LCVs and mini LCVs) in rural markets (yield of +18%).

Currently, this segment is less than 5% of the total loan book. SHTF expects that the share of rural

loans will go up and this is likely to benefit margins.

SHTF hiked their lending rate by 50bps on 15th August 2013 and the full impact will be felt from

3Q14. The lending rate hike is applicable only to new loans and therefore the full impact will take

some time to reflect in the financials. As per the company, this is likely to help margins by ~15bps

in the coming quarters.

Management stated that margins are lower by 20-25bps due to high cash levels (Rs95bn 36% of

total borrowings). This is mainly due to quarter end securitization done in 2Q14.

The company highlighted that cash levels are expected to remain high in the next 1-2 quarters as

selldown activities are higher in the second half of any financial year. The company is targeting

securitized assets of Rs20bn in the next two quarters.

Cash on the balance sheet (cash and bank balance + current investments) should start reducing

from 1Q15 which would aid margins further.

Management stated that there is no pricing pressure in any of its segments and in fact competition

has eased in the last six months. We expect margins to slowly improve to the 7%+ level in the

next year.

We expect return ratios to improve with the improvement in margins. We are forecasting ~18%

RoE in FY14/15E.

76% 76%77% 77%

78%79% 79%

81%

83%

84%

24%24%

23% 23%22% 21% 20%

19%

17%

16%15%

16%

17%

18%

19%

20%

21%

22%

23%

24%

25%

70%

72%

74%

76%

78%

80%

82%

84%

86%


Used CVs New CVs


10 January 2014 22

Asset quality likely to peak out in FY14

Credit cost (on AUM) has gone up by ~30bps since FY12. This is despite the fact that the

business mix has changed in favour of less than 5 year old CVs and LCVs. These two segments

have lower margins and consequently lower credit cost. Therefore, there is no under-reporting of

NPLs/credit cost and this has increased in line with industry trends.

However, the company has maintained its NPA coverage and net NPA levels, which is

encouraging in our view. NPA coverage is at ~80% with net NPA of 0.7% as of 2QFY14.

Fig 4 Credit costs have gone up; coverage remains adequate at ~80%


Fig 5 NPAs are well under control and within guided range


2.3%

3.0%

2.3%

2.1%2.2% 2.2% 2.2% 2.2%

2.4% 2.4%81.9%

85.0%

86.1%85.9%

79.7% 79.5%78.9% 78.9% 78.7% 79.0%

74.0%

76.0%

78.0%

80.0%

82.0%

84.0%

86.0%

88.0%

1.5%

1.7%

1.9%

2.1%

2.3%

2.5%

2.7%

2.9%

3.1%


Credit cost on AUM (%) NPA coverage (%) - RHS

2.7% 2.7%2.8%

3.1% 3.0%2.9% 2.9%

3.2%3.1%

3.3%

0.5%0.4%

0.4%0.4%

0.6% 0.6%0.6%

0.8%

0.7%0.7%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%


Gross NPA (%) Net NPA (%) - RHS


10 January 2014 23

SHTF took a hit on its profits in 1Q/2Q12 due to their mining related exposure. Currently, only 1-

1.5% of its loan book is exposed to mining related activities (all operational currently).

In the last six months, SHTF reduced its LTV by 2-3%, which is expected to control delinquencies

and lower the losses on repossessed vehicles.

Management stated that visibility is improving and collections were good in Oct/December 2013

(Nov13 is seasonally weak due to festivals). January 2014 could be a bottom for asset quality

pains and gross NPA is unlikely to increase by more than 5-10bps from current levels.

We have analysed the rated securitized pool (by India Ratings) of SHTF. For 2012 and 2013

vintage pools of all NBFCs, 180 DPD delinquencies are 1/7th to 1/10

th those of 90 DPD (better

recovery). Most of the SHTF securitized pools originated in the last year have LTV of less than

70% and 180 DPD well under control at 0.2-0.5%. Fitch highlighted that originator expertise in the

regions/particular asset class plays a big role in performance of the underlying pool.

Fig 6 Performance of securitized CV pools

90+ DPD 180+ DPD

Originator Transaction name Month LTV 3Q13 2Q13 3Q12 3Q13 2Q13 3Q12


Tranche 2 Feb 13 86.40 2.15 0.73 NA 0.13 - NA




Jan 13 89.10 5.08 1.80 NA 1.04 0.09 NA


Feb 13 89.60 5.63 1.77 NA 1.09 - NA


Not losing market share; core strength/business model remains intact

We believe the CV industry has undergone a change in the last 2-3 years. LCV volumes have

increased despite the weak economy. For the first time in the last 10 years, M&H CV volumes

have declined consistently for two years (FY13 -23% YoY growth, YTD FY14 -27% YoY growth).

This created the less than 5 year old CV segment as new CV owners were selling down due to the

weak economy. Structural changes in the rural economy increased the opportunity for the

financiers to lend towards LCVs/mini LCVs.

We believe that SHTFs core strength in financing of used vehicles is intact. In fact, in the last six

months to one year, many players have reduced their exposure to CV lending (HDFC Bank, Kotak

Bank) or exited completely from the segment (MMFS).


10 January 2014 24

We are ahead of consensus by ~10% for FY15E

We expect margins and asset quality (lower credit cost) to improve in FY15. We expect EPS

growth of 27% in FY15 and our EPS estimate for FY15 is ~10% higher than the consensus.

Valuations

We value SHTF using a two stage Gordon growth model. P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n))

+ (pn(1+g)n(1+gn))/((r-gn)(1+r)n)} where g=growth rate for the first n (high-growth period) years,

p=payout ratio in the first n years, gn=perpetual growth rate, pn=perpetual payout ratio.

Fig 7 SHTF: Two-stage Gordon growth model

RoE 20.2% g (initial growth) 15% r (CoE) 16% gn (perpetual growth rate) 4% n (initial growth period, yrs) 10 K1 2.36 K2 6.08 P/BV 1.71x FY15E ABV 427 TP (Rounded off) 730

Source: Macquarie Research, January 2014

Fig 8 1 year forward PBV


0.0

0.5

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10 January 2014 25

Fig 9 SHTF Balance sheet and Profit and loss account (Rs mn)

BALANCE SHEET FY11 FY12 FY13 FY14E FY15E FY16E

Share Capital 2,262 2,262 2,269 2,269 2,269 2,269 Reserves and surplus 46,782 57,660 69,679 82,262 98,251 117,041 Loan Funds 198,817 231,219 231,999 269,616 307,140 349,942 Non-convertible Debentures 47,529 52,282 104,589 123,095 141,559 162,793 Term Loans 102,188 126,609 85,501 98,326 110,159 123,418 Subordinated Debts 32,982 23,303 31,284 35,977 41,373 47,579 Public Deposits 11,295 11,860 6,822 7,846 9,022 10,376 Short-term debt and others 4,823 5,306 3,803 4,373 5,026 5,776 Current Liabilities and Provisions 68,223 66,051 144,386 158,033 174,133 208,653 Total liabilities & stockholders' equity 316,084 357,192 448,332 512,180 581,793 677,905 Investments 36,507 39,646 35,689 37,327 39,046 40,852 Current Assets, Loans and Advances 78,631 95,104 94,766 107,652 123,090 141,589 Cash and Bank balances 36,251 53,809 63,193 75,832 90,998 109,198 Loans and advances 41,800 39,673 29,099 29,099 29,099 29,099 Other Current assets 579 1,622 2,473 2,720 2,993 3,292 Fixed Assets, net 384 397 601 661 727 799 Commercial Vehicle Loans 198,656 219,878 314,438 363,419 415,496 490,887 Other Assets 1,906 2,167 2,838 3,122 3,434 3,778 Total assets 316,084 357,192 448,332 512,180 581,793 677,905

PROFIT & LOSS ACCOUNT FY11 FY12 FY13 FY14E FY15E FY16E

Interest earned 37,122 36,990 45,244 53,042 61,729 71,831 Interest expended 23,020 24,895 28,703 31,981 36,289 41,396 Net interest income 14,103 12,095 16,541 21,062 25,440 30,435 Income on securitization 15,348 20,935 18,723 18,315 20,728 23,436 Other income 948 1,014 1,669 1,168 1,635 1,831 Fees 270 289 476 333 466 522 Profit on sale of Investment 642 686 1,129 791 1,107 1,240 Others 36 38 63 44 62 69 Operating expenses 6,362 7,552 8,262 9,861 11,075 13,030 Payments to / Provisions for employees 3,582 3,701 3,848 4,540 4,863 5,777 Depreciation 108 135 183 202 222 244 Others 2,671 3,717 4,231 5,120 5,990 7,009 Pre-provisioning profit 24,037 26,492 28,670 30,684 36,728 42,673 Loan and investment loss provisions 5,548 7,683 8,508 10,139 9,455 10,623 Profit before tax 18,489 18,809 20,162 20,545 27,273 32,050 Extraordinary items - - - - - - Income taxes 6,190 6,235 6,556 6,164 9,000 10,576 Net profit 12,299 12,574 13,606 14,382 18,273 21,473



10 January 2014 26

Fig 10 SHTF Ratios and other data (%)

RATIOS FY11 FY12 FY13 FY14E FY15E FY16E

Per share data (Rs) Period end shares outstanding (mn) 226.2 226.2 226.9 226.9 226.9 226.9 Basic EPS 54.4 55.6 60.0 63.4 80.5 94.6 Diluted EPS 54.4 55.6 60.0 63.3 80.5 94.6 Book value per share 216.8 264.9 317.1 372.6 443.0 525.9 Adjusted book value per share 213.5 260.6 306.5 356.7 426.6 505.4 Operating ratios (%) Operating cost to income 20.93 22.18 22.37 24.32 23.17 23.39 Operating expenses/ Avg. assets 2.70 2.80 2.78 3.00 2.91 2.97 Employee cost/ Total income 11.78 10.87 10.42 11.20 10.17 10.37 Core Cost Income Ratio 21.38 22.79 23.24 24.32 23.17 23.39 Revenue measures (%) Interest income/ total avg. assets 17.91 17.21 15.88 14.86 15.07 15.13 Net interest income/ total income 96.88 97.02 95.48 97.12 96.58 96.71 Non-interest income/ total income 3.12 2.98 4.52 2.88 3.42 3.29 Profitability ratios (%) Yield on average assets 17.22 15.09 14.97 14.24 14.53 14.65 Average cost of funds 12.01 11.58 12.39 12.60 12.55 12.50 Spread 5.22 3.52 2.58 1.64 1.98 2.15 Net interest margin 6.54 4.94 5.47 5.65 5.99 6.21 Effective tax rate 33.48 33.15 32.52 30.00 33.00 33.00 Return on avg. assets 4.20 3.74 3.38 2.99 3.34 3.41 Return on avg net worth 28.12 23.08 20.64 18.38 19.75 19.54 Asset quality and capital (%) Credit Loan funds ratio 99.92 95.10 135.53 134.79 135.28 140.28 Gross NPA 2.60 3.07 3.18 3.57 3.59 3.65 Net NPA 0.37 0.44 0.77 0.99 0.90 0.95 Loan loss coverage ratio 85.91 85.92 76.43 73.03 75.60 74.73 Tier I CAR 16.62 15.16 13.60 13.83 14.38 14.45 Tier II CAR 8.18 7.10 7.00 6.97 7.01 6.82 Total CAR 24.80 22.26 20.60 20.79 21.39 21.27



10 January 2014 27

INDIA

MMFS IN Underperform

Price (at 10:30, 09 Jan 2014 GMT) Rs283.90

Valuation Rs 215.00 - Gordon Growth 12-month target Rs 215.00

Upside/Downside % -24.3

12-month TSR % -22.5

Volatility Index Medium

GICS sector Diversified Financials

Market cap Rsm 161,472

Market cap US$m 2,597

Free float % 48

30-day avg turnover US$m 4.1

Number shares on issue m 568.8

Investment fundamentals Year end 31 Mar 2013A 2014E 2015E 2016E

Net interest Inc m 22,238 27,580 33,126 39,442 Non interest Inc m 2,209 2,651 3,181 3,817

PBT m 13,244 16,123 19,233 23,121 PBT growth % 51.3 21.7 19.3 20.2 Reported profit m 9,007 10,651 12,705 15,273 Adjusted profit m 9,007 10,651 12,705 15,273 EPS rep Rs 16.00 18.92 22.57 27.13 EPS rep growth % 40.0 18.2 19.3 20.2 PER rep x 17.7 15.0 12.6 10.5 Total DPS Rs 1.46 4.33 5.17 6.21 Total div yield % 0.5 1.5 1.8 2.2 ROA % 3.9 3.6 3.7 3.7 ROE % 23.7 21.4 21.6 22.0

Equity to assets % 16.9 17.1 16.9 17.1 P/BV x 3.5 3.0 2.5 2.1

MMFS IN rel BSE Sensex performance, & rec history

Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period.

Source: FactSet, Macquarie Research, January 2014

(all figures in INR unless noted)

Analyst(s) Suresh Ganapathy, CFA +91 22 6720 4078 [email protected] Parag Jariwala, CFA +91 22 6720 4083 [email protected]


M & M Financial Services Growth/asset quality under pressure; retain UP Event

We met the management of MMFS and present our takeaways below.

Impact

Volume growth to slow down: In line with the industry trend, overall

disbursement growth is likely to slow down in FY14/ 1HFY15. The company is

targeting 10-15% disbursement growth in FY14 and overall AUM is likely to

grow at 22%+ as compared to 30% YoY growth as of Sept13 (for segment

breakdown of management target please see fig 1 below). A strong rural

economy, a presence across multiple products, market share gain from

unorganised players and PSU banks and a lower base in certain segments

would support above-industry growth. Management is confident of ~25%

CAGR in loan book over the next 3-5 years.

Exited M&H CV vehicle financing: The company is not doing any

incremental disbursement to this segment as slowdown has badly affected the

M&H CV market. Gross NPAs are running at 5%+. LCV volumes have also

started declining and the company is very selective in their disbursements.

Asset quality to remain in the guided range; however, credit cost is

likely to increase: Delinquencies have gone up across various segments.

Credit cost as a percentage of AUM stood at 1.8% for 1HFY14 (annualised)

as against 1.6% in 1HFY13 and 1.4% in 1HFY12. The company stated that if

slowdown continues then overall credit cost could increase to the 2%+ level.

Losses on repossessed vehicles have also gone up by 15% in the past year.

However, loss rates and delinquencies are well within their internal estimates

and are unlikely to disturb long term average return ratios (RoA of ~3% and

RoE ~20%). Gross NPA may go up by 60% (200bps) if NPA recognition norms

are changed to 90 DPD (days past due) as compared to 180 DPD currently.

NIM to remain protected at 9.5-10% levels: Correction in wholesale cost of

funds (CP rates) is unlikely to benefit much as short term borrowings

constitute 7-8% of overall borrowings. Cost of funds is unlikely to come off

meaningfully as banks have not cut their base rates. Overall margins would

remain protected at between 9.5-10%.

Other key takeaways: 1) New priority sector/securitization guidelines have

reduced qualifying assets for selldown. Overall gross spread has not declined

as banks can invest in PTC instruments at below base rate.

Earnings and target price revision

No change.

Price catalyst

12-month price target: Rs215.00 based on a Gordon Growth model

methodology.

Catalyst: Slower than expected loan growth and asset quality pressure

Action and recommendation

Maintain Underperform: We find the valuation expensive at 2.5x FY15E

P/BV. Maintain Underperform and our target price of Rs215.


10 January 2014 28

Fig 1 Management guidance on loan growth

Segments Proportion in overall AUM

Projected disbursement

growth Comments

Tractors 19% 15-20% 1. M&M tractor portfolio growth is better than expected initially at the beginning of the year. Industry is likely to grow at 15%+ as compared to their earlier estimate of 6-10% growth.

2. MMFS is likely to gain market share in M&M tractor portfolio by 2-3% in FY14E

3. 2-3% growth will be supported by increase in prices

4. Started financing non-M&M portfolio. Market share gain/growth is good so far.

Auto / Utility vehicle (M&M) 28% 8-10% 1. Parent company M&M commands 50%+ market share

2. UV sales are expected to grow at ~10% in FY14

3. MMFS is likely to maintain market share and growth rate

Cars and others (non M&M) 33% 15-17% 1. Rural car sales are likely to remain better than overall industry growth rates.

2. Focusing on players which are increasing rural market penetration like Hyundai, Tata motors and Toyota

3. Financing ~1200 cars per month for Hyundai motors.

Commercial Vehicles and construction equipment

12% Flat to decline 1. The company has completely exited heavy commercial vehicles due to slowdown.

2. LCV/ CE volumes are also slowing down considerably.

3. Doing very selective business in this segment

Used Vehicles 7% 35%+ 1. Base is very small.

2. Used vehicle market is growing rapidly in rural areas.

3. Portfolio break-up Cars 35%; UVs (majority M&M) 30-32%; Tractors 20% and LCVs 13%


Valuations

We value the stock using a two stage Gordon growth model. Here the P/BV = RoE * {(p(1+g) * (1-

(1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)} where g=growth rate for the first n (high-growth

period) years, p=payout ratio in the first n years, gn=perpetual growth rate, pn=perpetual payout

ratio.

Our TP values the core business at 2.02x FY15E adjusted BVPS for a 19.2% sustainable ROE.

Fig 2 2 stage GGM

RoE 19.2% g (initial growth) 14% r (CoE) 14.5% gn (perpetual growth rate) 4% n (initial growth period, yrs) 10 payout1 25% payoutn 75% K1 2.49 K2 8.03 P/BV 2.02x FY15E adjusted BVPS (Rs) 107 TP (Rs) ) (rounded-off) 215



10 January 2014 29

Fig 3 1 year fwd P/BV

Source: Bloomberg, Company data, Macquarie Research, January 2014

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10 January 2014 30

Fig 4 MMFSL profit and loss account and Balance sheet (Rs mn)

BALANCE SHEET FY11 FY12 FY13 FY14E FY15E FY16E

Share Capital 1,045 1,027 1,126 1,126 1,126 1,126 Reserves and surplus 24,404 29,284 44,670 52,832 62,568 74,273 Loan Funds 97,846 146,464 201,525 243,093 291,073 348,639 Other liabilities and provisions 47 77 237 260 286 315 Current Liabilities and Provisions 16,053 17,350 23,151 18,125 21,802 17,033 Total liabilities & stockholders' equity 139,396 194,202 270,708 315,437 376,856 441,386 Investments 6,252 4,366 4,575 4,330 4,327 4,369 Current Assets, Loans and Advances 130,128 186,775 262,575 307,437 368,735 433,088 Fixed Assets, net 840 1,028 1,137 1,249 1,373 1,509 Other Assets 2,176 2,033 2,421 2,421 2,421 2,421 Total assets 139,396 194,202 270,708 315,437 376,856 441,386

PROFIT & LOSS ACCOUNT FY11 FY12 FY13 FY14E FY15E FY16E

Interest earned 20,661 27,112 38,944 48,699 58,231 69,029 Interest/Discount on Advance/Bills 19,529 25,969 36,491 46,701 56,092 66,353 Income on securitization 906 925 2,145 1,689 1,789 2,283 Interest expended 6,662 11,399 16,706 21,119 25,105 29,587 Net interest income 13,999 15,713 22,238 27,580 33,126 39,442 Other income 83 1,991 2,209 2,651 3,181 3,817 Profit / (Loss) on sale of investment 5 73 23 28 33 40 Profit on sale of assets 1 3 - - - - Others - - - - - - Operating expenses 5,024 6,492 8,321 10,205 12,110 14,250 Payments to / Provisions for employees 2,240 3,128 3,793 4,795 5,644 6,643 Depreciation 161 203 237 260 286 315 Operating & other expenses 2,622 3,161 4,291 5,150 6,180 7,292 Pre-provisioning profit 9,058 11,212 16,126 20,026 24,197 29,010 Loan and investment loss provisions 1,581 1,600 2,882 3,903 4,964 5,889 Profit before tax 7,477 9,613 13,244 16,123 19,233 23,121 Income taxes 2,540 3,168 4,238 5,472 6,528 7,848 Net profit 4,938 6,445 9,007 10,651 12,705 15,273



10 January 2014 31

Fig 5 MMFSL Ratios and other data (%)

RATIOS FY11 FY12 FY13 FY14E FY15E FY16E

Per share data (Rs) Period end shares outstanding (mn) 512.3 513.4 563.0 563.0 563.0 563.0 Basic EPS (on weighted avg. shares) 9.6 12.5 16.5 18.8 22.5 27.0 Diluted EPS (on weighted avg. shares) 9.8 12.4 17.1 18.7 22.3 26.7 Book value per share 49.7 59.0 81.3 95.8 113.1 133.9 Adjusted book value per share 48.2 56.7 76.7 90.6 107.3 127.3 Growth (%) Loan Funds 50.0 49.7 37.6 20.6 19.7 19.8 Loans and advances 49.3 45.1 39.7 17.1 20.0 17.5 Net interest income 36.4 12.9 35.9 28.9 21.0 18.6 Operating expenses 51.8 29.2 28.2 22.6 18.7 17.7 Fee income 14.4 2296.6 9.8 20.0 20.0 20.0 Net profit 38.5 30.6 44.1 14.3 19.3 20.2 EPS 29.7 30.3 31.4 14.3 19.3 20.2 Valuation ratios (x) P/E 28.3 21.7 16.5 14.4 12.1 10.1 P/ABV 5.6 4.8 3.5 3.0 2.5 2.1 Dividend yield (%) 0.7 1.0 1.3 1.6 1.9 2.3 Key ratios (%) Operating cost to income 35.67 36.67 34.07 33.79 33.38 32.97 Net interest margin 11.89 9.28 8.91 9.08 9.28 9.29 Gross NPA ratio 4.18 2.95 2.91 2.98 2.98 3.04 Loan loss coverage ratio 86.44 78.01 65.92 67.73 69.99 71.73 Tier I CAR 17.00 15.10 17.00 17.10 16.82 16.94 Total CAR 20.30 18.00 19.70 19.63 19.14 19.12



10 January 2014 32

INDIA

CIFC IN Not rated

Stock price as of 09/01/2014 INR m 249

GICS sector Financials

Market cap US$m 565

Avg Value Traded (3m) US$m 0.1

12m high/low INR m 202/310

PE FY13 x 10.7

P/BV FY 13 x 1.8

Historical financials

YE Mar (INR m) FY11A FY12A FY13A

Revenue 6336 8000 11447 % growth 45.8% 26.3% 43.1% EBITDA 2996 3632 5751 % growth 86.0% 21.2% 58.3% EPS 5.7 14.4 22.9 % growth 217% 153% 59% EBIT Margin 8.8 7.4 7.6

Source: Company data,January 2014

Historical business risk/reward* HIGH

Reward

x

LOW Risk

*Relative to the market. Source: Macquarie Research, December 2013

Share Price Driver

Thematic

Growth

Value

Event


Price chart

Source: Bloomberg



MacVisit: Chola Invest & Fin Vehicle portfolio to remain under pressure AUM growth robust; likely to grow at moderate rate going forward: AUM

has grown 34% YoY in 2Q FY14. The growth was higher mainly because in

many segments such as tractors, MUV and cars, Chola has small market

share according to management. In addition, home equity business and

business lending (MSME) are also growing at a faster rate. The company

believes these segments will support better than industry growth going

forward. However, lower GDP and slowdown in economic activities may

impact the growth going forward. Overall disbursements were up only 6% YoY

in 2Q FY14 (vehicle disbursements were flat). Overall AUM growth will be

lower than what was seen in the past.

Asset quality pains likely to be lower than that of industry: CV is not a

homogenous market and it has various segments which cater to different

classes of customers. CIFC is primarily into LCV and mini-LCVs. This

segment is more dependent on consumption rather than M&H CV segment

which has linkage to mfg/investment related activities. Therefore asset quality

pains are likely to be lower than the industry. However, the company expects

delinquencies to increase (Gross NPAs have gone up from 1% in FY13 to

1.4% 1H FY14) but it should remain well within their comfort zone.

View on CV cycle

M&H CV - situation is very grim: M&H CV market is behaving like a buyers

market. Operators/business units are dictating terms and pricing. Around 40%

of capacity is lying idle. Fuel price hikes are happening every month and pass

through is difficult due to idle capacity. Although freight rates have gone up,

number of trips per vehicle/month has come off meaningfully. November 2013

volumes were ~40% of November 2011 volumes (retail sales are much lower

if we include ~2 months of dealers inventories). Resale prices have dropped

significantly (15-20% in the last one year).

Even good players are bearing the brunt: Resale value for vehicles has

dropped considerably in the last six months as many

unqualified/inexperienced borrowers (largely under 100% LTV schemes) are

defaulting. In addition, they are also going for aggressive pricing for

transportation in order to save their vehicles. This has resulted in lower than

market rate for freight. Experienced players (mainly NBFCs) have been very

sensible in pricing their loans and therefore asset quality pains are likely to be

lower for them. Many experienced players have reduced LTVs for incremental

loans. CIFC has reduced their LTVs by 4-5% across the segments. Provisions

might go up but the company expects losses will be manageable.

Difficult to say that asset quality is at bottom for M&H CV; however

recovery is a few quarters away: Utilization levels and growth rates are at a

record low. A few NBFCs who were offering attractive schemes have

withdrawn their offering and sensible pricing has returned to the market. A few

well established traditional players have gained market share and the

company thinks it is very encouraging. Lifting of mining ban in Karnataka can

improve demand-supply imbalance.

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Jan-11 Jan-12 Jan-13 Jan-14

CIFC IN Nifty - RHS

(INR) (INR)


10 January 2014 33

Ownership History and corporate governance

Promoters own 57.8% in the company through Tube

Investments 50.5%, Ambadi Enterprises 5.0% and

Others -2.3%.

FII holding 31.6%

Domestic Institu

56_nbfc-mac

Documents

mh cv sales

cv cycle

cv lenders

mh cv lending situation

cv lending industry

annualised cv sales

capacity utilisation

utilisation levels