Saturday, 28 January 2012

Shriram Transport Finance: Wonderful Business at Reasonable Price

As we witness extra ordinary volatility in the market both ways, it is indeed very interesting time for value investors. As described by Seth Klarman, volatility is the friend of value investors that creates fertile ground for avid stock pickers. Warren Buffet is one such master stock picker who has repeatedly invested in some of the greatest businesses on earth in turbulent times to reap gigantic benefits from such investments. Mr.Buffet always focused on investing in companies that are engaged in business that is easy to understand, enjoys sustainable competitive advantage (moat), generates high return on equity and is run by competent management. In my opinion, Shriram Transport Finance (STF) fits very well in all the parameters.

STF is India's largest commercial vehicle finance company established in 1979. STF is also one of the largest asset financing NBFC in India with network of 488 branches and service centers. STF has established a unique business model whereby it finances the purchase of pre-owned (used) trucks by small truck operators. STF has, over a period, developed this as its niche as banks are reluctant to lend to this class of borrowers due to lack of credit records and perception of higher risk. STF has more than 25% market share in pre-owned commercial vehicles which makes it the largest player in this segment. What is really heartening is that STF is leveraging its strong brand recognition, distribution network and knowledge base of small truck operators to create new business models such as auto malls and sale of refurbished vehicles (similar to used certified cars) that will create synergies between various business segments and diversify its revenue stream. 

Now let us look at the some critical factors that investors like Warren Buffet and Charlie Munger look for while making investment decision.

Is Business Easy to Understand?: 

STF is engaged in business of financing purchase of pre-owned and new commercial vehicles and construction equipment. This business is very similar to banking business with only difference that entire lending of STF is backed by assets i.e. commercial vehicle that is financed. STF borrows money from retail investors (through fixed deposits, debentures) or financial institutions and banks at certain rate and lends them to individuals/companies for purchase of commercial vehicles/construction equipment at higher rate. STF makes money from the differential between cost of borrowing and revenue from lending (net interest margin). The most crucial aspect of the business is managing credit quality of the loans that it provides to borrowers. As an investor, one has to keep tab on cost of borrowing, revenue from lending, interest differential between borrowing and lending, non performing assets and operating cost/asset under management to review business periodically.

Strong Franchise or Economic Moat:    

Warren Buffet has made enormous gains from buying companies/stocks that demonstrates strong franchise and have developed sustainable competitive advantage. I believe that STF has a very strong franchise on two accounts. 

Risk Management: STF was pioneer in tapping a customer segment of small truck operators that was ignored by mainstream financial institutions. STF, in the process, has gained a strong understanding of this segment and has developed appropriate system to assess credit quality and manage credit risk. This attribute is discernible if we look at net NPA for STF at 0.4% is in line with some of the best managed private sector banks in the country. Moreover, STF does exert pricing power as small truck operators do not have many alternatives for financing. 

Strong Brand Recognition & Trust: STF has developed a very strong relationship with the community of small truck operators by giving them a platform to prosper and improve their quality of life. STF has a strong brand recognition and garners trust from this community. STF caters to all the financing needs of truck operators such as tyre loan, engine replacement loan, freight bill discounting and plethora of other services through countrywide distribution network of 488 branches and service centers. This wide reach combined with holistic services is very difficult to replicate and hence is a strong competitive advantage. 

Management Quality: Mr.Buffet always prefers to invest in companies that is run by able managers having utmost integrity. In case of STF, management has displayed both these qualities. STF caters to a customer segment that is considered inherently more risky however management has been able to manage this risk extremely well without compromising growth. This is demonstrated with the fact that STF asset under management grew from 12000 crore to 36000 crore in last 5 years, its net NPA in terms of % of networth has declined consistently. Moreover STF management is leveraging its strength of strong brand equity, knowledge of CV sector and distribution network to develop new business models by investing in Shriram Auto Mall (auctioning platform for used CV) and Shriram New Look (refurbished certified vehicles) that reflects management's effort to be agile and pro active. 

I have gone through annual reports of the STF for last 4 years, and all the reports have been really engaging providing a very detailed discussion on analysis of the past year's performance and outlook for the upcoming year. STF management has been forthright in terms of dealing with difficult situations as demonstrated during the regulatory issues that cropped up due to change in RBI's guidelines on priority sector lending. STF  has recently won coveted award from Institute of Chartered Accountants for financial reporting, that measures the transparency in reporting financials by various companies.
STF top brass is run by professional management which has rose through the ranks and have been with company for a long time. This reflects very well on company as it is able to create an environment where high quality talent stays with the company for a long time. This further strengthens my belief that STF management quality is top notch. 

Financial Performance: If one is able to find a simple business having strong franchise run by able and honest management, as suggested by Mr.Buffet, one has to go further to understand company's track record in terms of financial performance. STF has been able to grow its top line by CAGR 30% in last 5 years from 1400 crore to 5200 crore while its bottom line grew from 190 crore to 1230 crore with CAGR 45%. STF has managed to maintain its ROE consistently over its peers in NBFC sector. STF enjoys ROE in the range of 25-30%, reflecting strong franchise and well managed business. STF has also consistently maintained capital adequacy ration (CAR) substantially higher than requirement of RBI regulations. This higher CAR will help STF sail through in adverse conditions in terms of rising NPA and shrinking NIM. 

Valuation:  Now that we have been able to find a well managed business which is simple to understand and demonstrates strong franchise that has consistently shown good financial performance, let us analyze whether the company is available cheap or not. Currently STF is trading at P/E multiple of 10.5 which is much lower than industry average of 16.5. STF has in the past grown its top line and bottom line at CAGR 30% and 45% respectively. Even if we consider modest 15% growth for next few years, stock looks reasonable priced. Moreover, I see Shriram auto malls and New look business to contribute substantially in next 5 years as the business model picks up. 

Another indication that STF is currently undervalued is that promoters are buying heavily from the market. In last one month, promoters have bought shares worth 400 Crores representing 4.5% equity capital.

Concerns: STF has corrected significantly in last one year and has under performed the market due to number of concerns such as regulatory over hang, rising interest rates, slow down in economic activity and write off from assets in mining areas due to ban on mining in Karnataka. However, most of these concerns are short to medium term and seems to be factored in the price. 

However from longer term perspective, I feel this is a good opportunity to own a great business at very reasonable price. 

12 comments:

  1. P/B is more than 2.5.

    Isn't that costly?

    ReplyDelete
  2. I do agree than P/B is more than 2.5. However, When I look at business,instead of looking one parameter, I would like to look at number of them together such as P/E, P/B , RoE, RoA etc. As per Ben Graham's investing principles, a conservative investor shall look at investment opportunities is P/E * P/B is less than 22.5.

    In case of STF , P/E * P/B is around 27 on TTM basis which is slightly higher than the criteria defined by Mr. Graham. However, If I look at the qualitative aspects of the business such as above average ROE/ROA, top quality management and strong franchise, I may consider paying slight premium to the criteria suggested by Mr. Graham.

    In all, I think STF is a not a deep value investing opportunity, however it is a high quality business with top quality management available at reasonable price.

    ReplyDelete
  3. There are many companies that invest money manger companies that exist today to help with their financial needs. Unfortunately, today many people are in a difficult financial situation, and not all their fault. The fact is that most schools teach very little in the way of financial knowledge.
    small business loan

    ReplyDelete
  4. what is your take on the Q4 results of STFC? the ban on illegal mining has surely hit them while the soaring interest rates and the securitization issue together are a triple whammy.

    disclosure: i hold and will add on dips, funds permitting

    ReplyDelete
    Replies
    1. Hi Shiv Kumar,

      Q4 numbers seems to be generally in line except for the provisions which are on higher side due to ban on illegal mining. However, there is nothing wrong fundamentally on the business side. As in any business, there are good years and there are not so good years. This is one such "not so good" years. Typically, I look at any business with 5 year time horizon, and I am fairly confident about the prospects of STFL. What I particularly like is that STFL is adopting di-risking cum growth strategies through automall concept. I see it bringing lots of synergy for STFL and opening up new vistas which no other CV finance company can match. I feel STFL has a competitive advantage which is going to be reflected in numbers in next few years.

      Best Regards
      Dhwanil Desai

      Delete
  5. Dhwanil,

    Drawing parallels from the analysis above, I feel the gold loan companies (Muthoot and Manappuram) also enjoy similar moats such as
    1. Strong risk management : Loan against household jewelery. Sentimental value to these ornaments for an indian family and short term (2-3 months) nature of the loans
    2. Strong brand : Muthoot is a strong brand in south and slowly being recognized in other parts of the country
    3. Huge Network : Both these companies have around 3000 branches across India. Also most of these branches are in underbanked and underserved areas. Though banks (HDFC offlate) have been trying to increase thier gold loan portfolio, they will not be able to match these companies as gold loan is not the core activity of banks. Also, it takes few lakhs to set up a brach as aganist a crore or two to set up a branch of a bank.

    Both these comapnies as available at close to/below BV. Market has overreacted to the recent RBI regulations. In fact if you analyze these norms (60% LTV etc.), RBI has done a great job in making this industry stronger and it will become an entry barrier for the new/small entrants in this sector.

    Strongs hands Baring PE, Sequoia (same guys who made 7x returns on thier earlier investment in Manappuram) are increasing stake. In my opinion, these gold loan companies will give very good returns in another 2-3 years time frame.

    Would love to hear your thoughts.

    Regards,
    Vijay

    ReplyDelete
    Replies
    1. Hi Vijay,

      I have not looked at these companies so will be difficult to comment. Let me go through the industry/companies. I will get back yo you with my views on the same.

      Best Regards
      Dhwanil Desai

      Delete
  6. It has corrected about 15-20% from its high in recent time.
    Its a very goof buy at this levels.

    What do you make of this quarter numbers

    ReplyDelete
    Replies
    1. Hi Anon,

      I think, at current price, 480-500, it is a very good buy. STFL's Q4 results are all right. Management has admitted and indicated that currently business is facing headwinds and hence given a realistic and conservative guidance. However, both shriram equipment finance and shriram auto mall are gaining traction in terms of growth and profitability. I think from a linger terms its a very decent bet. Moreover, promoters are accumulating stock at this price from market, a definite sign of confidence in the business and undervaluation w.r.t. fair value.

      Best Regards
      Dhwanil Desai

      Delete
  7. Hi Dhwanil,

    "Another indication that STF is currently undervalued is that promoters are buying heavily from the market. In last one month, promoters have bought shares worth 400 Crores representing 4.5% equity capital."

    How did you find out that the promoters have bought shares worth 400 crores representing 4.5% as I don't find such disclosure under SAST on bseindia.com.

    Regards,
    Aksh

    ReplyDelete

  8. Trucking is a large and important industry. No matter where you live, a day is unlikely to go by when you will not see a truck. We use these vehicles to

    deliver almost every material item we buy. Without trucks, our economy would not work efficiently.

    Thanks
    Trucking Business India

    ReplyDelete