511218: Revenue Outlook Will Improve Amid Potential Stake Sale Uncertainty

Key Takeaways

• Anticipated reduction in borrowing costs and improved asset quality could enhance revenue and net margins.
  
• Strategic focus on used vehicle financing and economic growth is expected to drive revenue and earnings.
  
• Stagnant commercial vehicle sales and rising Stage 2 loans threaten Shriram Finance's asset quality, profitability, and future earnings amid liquidity and supply challenges.

Catalysts

A non-banking finance company, primarily engages in the provision of financing services in India.

• The anticipated decline in borrowing costs due to the Reserve Bank of India cutting the repo rate could lead to reduced interest expenses, positively impacting net margins.
  
• Improved predictions for the monsoon and a stronger rural economy are expected to boost credit demand and improve asset quality, potentially leading to higher revenues and better net margins.
  
• Growth in India's GST collection and expected government infrastructure spending could increase credit demand and improve asset quality, impacting revenues positively.
  
• A strategic focus on used vehicle financing, especially given the low supply of new vehicles between 2019 and 2021, can bolster the portfolio and drive revenue growth as economic activity picks up.
  
• Plans to normalize liquidity and the gradual cost reduction in borrowing could improve net interest margins, positively impacting earnings.

Shriram Finance Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Shriram Finance's revenue will grow by 31.1% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 48.4% today to 42.1% in 3 years time.
• Analysts expect earnings to reach ₹196.3 billion (and earnings per share of ₹82.62) by about June 2029, up from ₹100.2 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹222.8 billion.
• 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 17.2x on those 2029 earnings, down from 23.5x today. This future PE is lower than the current PE for the IN Consumer Finance industry at 20.4x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.99%, as per the Simply Wall St company report.

Risks

• The commercial vehicle (CV) sales have remained flat, and supply issues are noted within the used vehicle market, impacting the potential growth in Shriram Finance's core area, affecting revenue streams.
  
• There's been a notable stress in certain geographies, particularly in Central India, which has affected Stage 2 loans, potentially influencing future asset quality and thereby impacting net margins.
  
• The net interest margin (NIM) has declined due to excess liquidity on the balance sheet, a factor that may pressure earnings if not effectively managed.
  
• The technical write-off of ₹2,345 crore in fully provided assets reduced the gross Stage 3 percentage, but it could indicate underlying asset quality issues that might impact future earnings if recovery efforts falter.
  
• Rising Stage 2 categories in segments like passenger vehicles and MSMEs could indicate potential stress, threatening asset quality and profitability if these loans transition to Stage 3.

Valuation

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

• The analysts have a consensus price target of ₹1181.75 for Shriram Finance based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹1300.0, and the most bearish reporting a price target of just ₹1050.0.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be ₹466.2 billion, earnings will come to ₹196.3 billion, and it would be trading on a PE ratio of 17.2x, assuming you use a discount rate of 15.0%.
• Given the current share price of ₹1002.9, the analyst price target of ₹1181.75 is 15.1% higher.
• 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.