Rating Rationale

Strengths
* Market leadership in the pre-owned commercial vehicle (CV) financing segment
STFCL is the largest CV financier in the country with assets under management (AUM) of Rs 104,380 crore (+20.8% Y-o-Y) as on September 30, 2018. With presence of almost four decades in the pre-owned CV financing business, STFCL has created a strong and sustainable competitive advantage through deep understanding of the borrower profile and their credit behaviour. They have done so by building a scalable operating model, extensive reach and strong valuation capabilities of pre-owned vehicles. The company faces limited competition from other organized financiers, including banks, in this segment, due to inherent riskiness of the target product and the customer profile.

Of all the business segments, CV financing (HCV and M&LCV) together constituted 67.3% as on September 30, 2018 of the total AUM and grew by a strong 20.3% Y-o-Y. Passenger vehicles forming another 23.2% of the portfolio grew by 16.7% Y-o-Y. The share of the portfolio under Shriram Equipment has further come down to form just 0.2% of the AUM as on September 30, 2018. The off-book portion of the AUM stood at Rs 16,565 crore or 15.8% and was up 8.7% Y-o-Y. Overall, in the last few years, the share of off-balance sheet AUM has remained around 16% to 18%.

The pre-owned vehicle loan book stood at Rs 86,057.4 crore (+15.1% Y-o-Y) and comprised 82% of AUM as on September 30, 2018 down from 87% in September 2017. With increasing focus on new vehicle financing, this segment stood at Rs 12,719 crore (+46.2% Y-o-Y) and constituted 12% of AUM end September 2018. Working capital, business loans and other such facilities doubled during the year and constituted the remaining 5% of AUM as against 3% during the corresponding period last year. While STFCL's growth will continue to be driven by pre-owned vehicle financing business, the growth in new vehicle financing segment has also picked up, despite competition from banks and other financiers.

CRISIL believes that the business prospects for the pre-owned CV financing segment remain strong given the large unorganized market and significant entry barriers. STFCL has gradually expanded into rural markets and had 864 rural centers as on September 30, 2018. Owing to increased demand for pre-owned vehicles in deep rural areas, the company has been increasing its rural presence with the proportion of rural branches (as a percentage of total branches) rising to 50% as on September 30, 2018 from approximately 45% previous year. The share of rural AUM has also risen to 35% of total AUM as on September 30, 2018 as against 29% as on September 30, 2017. STFCL had also innovated in establishing Shriram Automall India Ltd (SAMIL), a reliable platform for sale, refurbishment, and auction of pre-owned vehicles, besides enabling better price discovery of such vehicles. While STFCL sold majority stake in SAMIL in April 2018, it will continue to hold a large minority stake. CRISIL believes that despite the minority stake, SAMIL's business operations will continue to be closely integrated with STFCL.

Overall, CRISIL believes that STFCL has strong structural advantages over its peers, which will support its growth plans and help it maintain leadership position in the pre-owned CV financing segment over the medium term.

* Comfortable capitalisation and earnings profile
STFCL's capitalisation remains comfortable with networth of Rs 14,596 crore and adjusted gearing (including securitisation) of 6.0 times as on September 30, 2018 (Rs 12,572 crore and 6.3 times respectively as on March 31, 2018). The net non-performing assets (NPA) stood at Rs 2278 crore translating into net-worth coverage for net NPA at 6.4 times, up from 5.9 times end fiscal 2018. CRISIL believes that STFCL's capitalisation will remain comfortable over the medium term, given its demonstrated ability to access equity markets and having a comfortable annualised return on average networth of 17.4% as on September 30, 2018 (13.1% end fiscal 2018 and 11.7% for fiscal 2017. The company's Tier 1 and total capital adequacy ratio stood at 14.27% and 16.69% respectively as on September 30, 2018 (14.24% and 16.87% respectively as on March 31, 2018), well above the regulatory minimum.

STFCL has a comfortable earnings profile with annualised return on managed assets ratio (RoMA) of 2.1% as on September 30, 2018. For fiscal 2018, the company reported net profit of Rs 1,568 crore (+25% Y-o-Y) and RoMA of 1.6% driven by improved net interest margins amid lower borrowing costs though partially offset by higher credit costs due to increased provisioning requirements on transition to revised NPA norms. Owing to controlled borrowing costs,, the net interest margin for fiscal 2018 (CRISIL adjusted-calculated on total income net of interest expenses) improved to 7.28% from 6.72% in fiscal 2017. The company's operating expense ratio in fiscal 2018, though lower than its peers, increased to 1.6% due to rise in its employee costs as the company added almost 4934 new employees during the year to reach an employee strength of 23,819. Despite this, the company's cost to income ratio stood at a controlled 21.3% (22% in fiscal 2017).

As the company increasingly focuses on the relatively lower-yield and highly competitive new vehicle financing, there could be some pressure on margins in the future. However company's strong competitive position and relatively high yields in the pre-owned vehicle financing segment will ensure stable profitability than that of other CV financiers over the medium term.

In October, STFC terminated its corporate guarantee on bonds (with face value of Rs 650 crore and redemption value at maturity on June 28, 2019 of Rs 995 crore) that were issued by unlisted Shriram group company, SVL Limited (erstwhile Shriram Industrial Holdings Limited; ultimate holding company of the non-financial services/manufacturing businesses of the Shriram Group) and backed by shares of SVL Limited.

Weakness
* Modest asset quality
STFCL predominantly lends to the relatively riskier small road transport operators, first time users and first time buyers segments and hence has inherent weakness in borrower profile. STFCL has a modest asset quality in its core CV financing business with asset quality in the pre-owned financing business being relatively better than that in the new CV financing segment. respectively as on September 30, 2018. Per IGAAP, the corresponding GNPA and NNPA stood at 8.77% and 2.75% respectively as on September 30, 2018

STFCL' asset quality is linked to broader economic recovery and hence the likely pick-up in industrial activity and easing of infrastructure constraints are expected to result in higher capacity utilization of CVs, improve transporter's cash flows and ultimately lead to gradual recovery in asset quality. The company's track record in the vehicle financing business, understanding of the target customer segment and relationship based lending model will also support the same.

* Average, albeit improving resource profile with higher cost of borrowings than peers
STFCL has an average, though improving, resource profile. It has an established track record in raising retail borrowings which helps diversify its resource profile. However, its cost of borrowings continues to be higher than peers. Of the total debt of Rs 88202 crore (including securitisation) as on September 30, 2018, 29.2% were from debentures, 22.2% from term loans from banks, 10.3% from fixed deposits, 7.6% from commercial paper and 5.4% from sub-debt. The share of securitisation in the borrowings profile stood at 19.4% end September 2018 down from 21.3% in the corresponding period last year. The company's average annualized cost of borrowings (on average annual borrowings including securitization) stood at 9.0%. In view of the inflationary monetary environment leading to rising interest rates, the company's cost of borrowings is expected to increase in the near future. Ability to diversify resource profile and maintain competitive borrowing cost will remain key rating monitorables over the medium term.