Sundaram Finance: Riding the recovery - Buy

With the equity market turning volatile, investors should stick with stocks that have sound fundamentals and are well placed to weather near-term shocks, as well as ride the gradual economic recovery.

The stock of Sundaram Finance, after more than doubling in 2014, has clocked a healthy 13 per cent return so far this year. One of the leading lenders in the commercial vehicle (CV) space, the company’s stable margins and good asset quality have held it in good stead.

Aside from its core CV financing business, its presence in other segments, such as home loans, mutual funds and non-life insurance also adds value to the stock.

The stock has been re-rated, thanks to its strong performance in the last year-and-a-half; its valuation is at a premium to some of its peers.

At 3.6 times its one-year forward book, the stock trades at par with Bajaj Finance, but much higher than Shriram Transport and Mahindra and Mahindra Financial Services that are trading at two times its one-year forward book. But for investors with a long-term horizon of two to three years, the recent blip in the stock price offers a good buying opportunity.

The performance of Sundaram Finance on the asset quality front has been notably good. The company’s gross non-performing assets (GNPA) stood at 2.2 per cent as of June 2015, lower than peers, such as Shriram Transport (4 per cent) and M&M Finance (8 per cent). This is despite following stringent asset classification norms.

Last year, the RBI tightened the NPA recognition norms for non-banking financial companies (NBFCs). They will now have to classify loans as NPAs when borrowers default for 90 days or more, as against 180 days earlier. These norms have to be implemented in a phased manner by end of March 2018.

Sundaram Finance has been adopting a 120-day norm since 2012-13.

In contrast, Shriram Transport Finance follows a 180-day practice and M&M Finance a 150-day norm.

Lower NPAs and strong returns — return on equity of 18 per cent — should continue to kindle investor interest in the Sundaram Finance stock.

More so, given the challenges that some of its peers will face in coping with the regulatory changes.

The other reason to bet on the stock is the gradual pick up in CV volumes seen in recent months. After a 23-25 per cent decline in 2012-13 and 2013-14, medium and heavy commercial vehicle (MHCV) volumes have grown by 16 per cent in 2014-15 and 24.8 per cent so far this fiscal.

The slowdown impacted the growth of Sundaram Finance, but its cautious stance on asset quality and steady margins aided performance.

Now, the recovery in the CV cycle over the next year or so should provide a leg up to the company’s disbursements.

In the latest June quarter, while the company’s assets under management (AUM) grew 4.5 per cent over the same period last year, healthy traction in CV volumes led to higher disbursement in the segment.

Overall, the company’s disbursements grew 16 per cent in the June quarter, compared with the same period last year.

The company’s focus on asset quality will also ensure that risks are kept under check as growth returns.

A chunk (about 55 per cent) of the company’s lending is to the new CV segment, which reduces risk.

Sundaram Finance also has stake in other businesses, such as home loans, mutual funds and non-life insurance, which add about ₹400 a share to the stock value.

The mutual fund business’ net profit of ₹22 crore in 2014-15 was 47 per cent higher than in the previous year. The AUM of the business increased 28 per cent to ₹19,511 crore in 2014-15.

In February 2015, Sundaram Finance acquired an additional 26 per cent stake in Royal Sundaram, its non-life insurance joint venture with the RSA Group, UK.

With this acquisition, the company now holds 75.9 per cent stake in Royal Sundaram, a leading player in the general insurance space in the country.

The increase in FDI limit in the insurance sector from 26 per cent to 49 per cent could act as a trigger for parent companies, such as Sundaram Finance.

This can unlock value in their insurance subsidiaries.