Retail Vehicle Finance Shift And Micro LAP Expansion Are Expected To Drive Long Term Upside

Catalysts

About IndoStar Capital Finance

IndoStar Capital Finance is a retail focused non banking finance company specializing in vehicle finance and Micro LAP for self employed and small business customers.

What are the underlying business or industry changes driving this perspective?

• Shift to a predominantly retail franchise in vehicle finance and Micro LAP, supported by a strong capital adequacy of 37.3% and low leverage, provides room to accelerate asset growth and expand revenue without near term equity dilution.
• Deepening presence across 23 states with 450 branches and conversion of 48 micro branches into full fledged outlets creates operating leverage as disbursements scale, supporting higher AUM growth and improving cost to income and net margins.
• Falling system interest rates and a declining cost of funds, with incremental borrowing around 9 to 9.25 percent versus an on book cost of 10.2 percent, open up spread expansion as old high cost NCDs run off, directly boosting net interest margin and earnings.
• Industry wide growth in used commercial vehicles, passenger vehicles, and equipment finance, coupled with IndoStar’s widening of the customer funnel toward more prime borrowers, is expected to support higher quality disbursements and lower credit costs, improving net profit stability.
• Rapidly growing demand for small ticket secured credit in Tier 3 to 5 towns through Micro LAP, with expansion from Tamil Nadu to Andhra Pradesh and Telangana using the existing vehicle finance network, is expected to accelerate fee and interest income while keeping operating expenses contained and enhancing return on equity.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming IndoStar Capital Finance's revenue will grow by 178.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 848.4% today to 13.5% in 3 years time.
• Analysts expect earnings to reach ₹2.0 billion (and earnings per share of ₹20.88) by about December 2028, down from ₹5.7 billion today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 34.2x on those 2028 earnings, up from 6.1x today. This future PE is greater than the current PE for the IN Consumer Finance industry at 24.6x.
• Analysts expect the number of shares outstanding to grow by 0.26% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 19.9%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The commercial vehicle cycle and used vehicle demand may weaken as infrastructure spending or logistics growth slows. This would reduce disbursements growth in the core vehicle finance franchise and pressure revenue and earnings.
• Persistent or renewed collection softness, evidenced by collection efficiency still around the mid 90s and the need for ARC sales and 210 day write offs, could resurface in a downturn and drive higher credit costs. This would elevate GNPA and compress net margins and earnings.
• The aggressive push into Micro LAP and prime customer segments across new states and many branches may outpace underwriting and local market learning. This could lead to asset quality issues in newer vintages that would erode net interest margin, raise provisions and weaken net profit stability.
• Intensifying competition in used and new vehicle finance, especially as funding costs fall across the NBFC sector and banks, could force IndoStar to cut pricing to retain volumes. This would narrow spreads and slow growth in net interest income and return on equity.
• Regulatory or macro changes such as GST related price resets on vehicles or a turn in the current low inflation, low rate environment could alter collateral values and borrowing costs. This would compress loan to value cushions and NIM, with adverse effects on revenue growth and earnings visibility.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of ₹285.0 for IndoStar Capital Finance based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be ₹14.6 billion, earnings will come to ₹2.0 billion, and it would be trading on a PE ratio of 34.2x, assuming you use a discount rate of 19.9%.
  
• Given the current share price of ₹254.74, the analyst price target of ₹285.0 is 10.6% higher. Despite analysts expecting the underlying business to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.