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 108,931 crore as on December 31, 2019, up ~5% Y-o-Y, although on a sequential basis, the AUM growth has remained almost flat from Rs 108,120 crore last quarter.

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 the largest portion of AUM at ~69% as on December 31, 2019. Passenger vehicles formed another 22.5% of AUM. The share of portfolio under Shriram Equipment has been completely run off. The composition of AUM has remained largely unchanged with the pre-owned vehicle loan book at Rs 92625 crore as on December 31, 2019 and comprising 85% of the AUM, marginally higher than the 83% as of March 31, 2019. The new vehicle portfolio growth slowed down with this segment degrowing by 13.4% Y-o-Y and its share in AUM stood at 10% as on December 31, 2019. While STFCL's growth will continue to be driven by pre-owned vehicle financing business, the new vehicle segment also remains a key focus area of the company in spite of competition from banks and NBFCs.

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 843 rural centres as on December 31, 2019. Owing to increased demand for pre-owned vehicles in deep rural areas, the company has been increasing its presence in rural and semi urban areas to maintain its niche presence. End December 2019, the total branches stood at 1714 of which 48% were in rural areas. In the last one year the company has been adding new branches, majority of which are the satellite branches outside the semi-urban centres. Consequently, the share of rural AUM has also risen to 40% of total AUM as on December 31, 2019 as against 36% end December 2018.

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 17783 crore and an adjusted gearing of 5.2 times as on December 31, 2019. CRISIL believes that STFCL's capitalisation will remain comfortable over the medium term, given its demonstrated ability to access markets. The company's tier I and total capital adequacy ratio also were comfortable at 16.82% and 20.68% respectively as on December 31, 2019, well above the statutory minimum.

STFCL has a comfortable earnings profile with annualised return on average managed assets (RoMA) of 2.8% for the nine months ended December 31, 2019 as against 2.5% last fiscal. While the borrowing costs have been increasing over the past year, the company has been able to pass on the higher costs and has been able to sustain its Net Interest Margins at around 7% (calculated on average managed assets). Amidst the improvement in the asset quality in the nine months ended December 31, 2019, the credit costs too improved to 2.0% as against 2.3% for fiscal 2019. 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.

Weaknesses
* 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. STFCL's asset quality (per I-GAAP) registered some improvement with gross stage 3 assets improving to 8.7% as against 8.8% as of December 2018. The company's credit cost (calculated on average managed assets) stood at 2.0% (annualized) for the nine months ended December 31, 2019 as compared to 2.3% for fiscal 2019. The analysis of vintage wise static pool data shows recovery / roll-back of around 50-60% from peak 90+ reached for a particular disbursement vintage.

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 93,009 crore (including Direct Assignment) as on December 31, 2019, around 30% was from debentures/subordinate debt, 16% from bank loans, 13% via public deposits, 13% via foreign currency borrowings, 26% via securitization and others at around 2%. The average annual borrowing costs stood at 9.3% (annualized) for the nine months ended December 2019. Ability to diversify resource profile and maintain competitive borrowing cost will remain key rating monitorables over the medium term.