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Indostar Capital Finance, a non-banking finance company that began operations in 2011, focussing on corporate lending, has grown at a healthy pace over the past few years. A low base, and gradual diversification into SME lending and overall sanguine prospects for the NBFC sector have aided performance.
Between FY13 and FY17, Indostar witnessed a loan growth of 30 per cent CAGR (compounded annual growth rate) and profit growth of 23.7 per cent. The company has a healthy net interest margin of 6.8-6.9 per cent and return on asset ratio of around 4 per cent. The company has recently (in 2017) expanded its portfolio to provide vehicle and housing finance. The management plans to build its retail business focussing on vehicle, SME and housing finance over the next three to five years.
While healthy financials, experienced management team and attractive valuations are positives for Indostar Capital, concentrated portfolio, higher exposure to real estate, limited track record of operations and possible pressure on profitability going ahead, are key risks.
Needs watching
Also, while the company has been able to maintain a fairly stable asset quality, gross non-performing assets (as a per cent of loans) have been inching up over the past two years (from 0.2 per cent in FY16 to 1.4 per cent in FY17 and 1.7 per cent as of December 2017), owing to its SME portfolio. Given that the company plans to focus on the riskier used-vehicle segment, asset quality may need watching.
Also, while Indostar has a healthy return on asset, its return on equity has been modest at around 11-12 per cent due to low leverage (ratio of assets to capital) of about three times. Hence, diversifying into retail segments that can increase leverage and add scale, is imperative.
Given the company’s limited expertise in the newer segments such as vehicle and housing finance, investors need to wait and assess the business over the next few quarters, before placing their bets. Also, shift towards retail segment will require investments into branch network, leading to increase in the company’s cost-to-income ratio, impacting margins. However, investors with a high-risk appetite can subscribe to the issue with a long-term perspective, given the attractive valuations.
Business metrics
At the upper band of the issue price of ₹572, the valuation works out to about 1.9 times FY18 book value (expected) pre-issue and about 2.1 times post-issue. Given that NBFC players such as Shriram Transport and Mahindra and Mahindra Financial Services trade at 2.5-2.8 times book and others such as Sundaram Finance and Cholamandalam Investment & Finance trade at a steeper 4-odd times, the asking price for Indostar is reasonable.
Indostar Capital that began its operations in corporate lending, commenced lending to the SME segment in 2015. Over the last two to three years, its exposure to corporate lending has come down significantly to 76.8 per cent as December 2017 from nearly 100 per cent in FY15. SME constitutes 22.7 per cent of its loan portfolio, while vehicle and housing are still fledgling businesses.
The corporate lending business primarily consists of lending to mid-to-large sized corporates and to real estate developers. As of December 2017, a little over half of the corporate lending portfolio pertains to the riskier real estate segment.
With a view to diversify its portfolio, the management is looking to build its vehicle finance business aggressively. R Sridhar, Executive Vice-Chairman and CEO of the company, who joined Indostar a year back, has been associated with Shriram Group and also served as managing director of Shriram Transport Finance Company.
While there are ample opportunities in the vehicle finance business, it could take a while for Indostar to stabilise its business. Also, the company proposes to focus on financing of used commercial vehicles (small and medium freight operators) which pegs up the risk. Shriram Transport Finance that has a higher exposure to the used-vehicle segment has seen delinquencies rise owing to the gradual tightening of NPA recognition norms over the past three years.
The CV business is also highly cyclical, leaving it susceptible to growth risks, when the tide turns.
Offer
The current IPO is a combination of a fresh issue of shares worth ₹700 crore and an offer-for-sale of up to two crore equity shares.
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