KRChoksey has issued a "BUY" recommendation on Cholamandalam Investment and Finance Company Ltd. (CIFC), with a target price (TP) of Rs1,531, indicating an 18.5% potential upside from the current market price (CMP) of Rs1,292. This rating reflects strong Q2FY25 performance, solid asset quality, and a well-balanced portfolio focused on diversification. CIFC’s asset growth in segments like home loans and LAP (Loan Against Property) continues to support its expansion. However, cautious optimism prevails due to minor asset quality pressures, and the management’s focus remains on quality improvement and operational efficiency.

Key Highlights of CIFC’s Q2FY25 Performance

Robust Growth in Net Interest Income (NII)
Cholamandalam’s NII for Q2FY25 rose by 34.6% year-over-year (YoY), reaching Rs27,128 million, a 3.7% increase over KRChoksey’s estimates. The rise is largely due to CIFC’s strong lending momentum and yield management, leading to a 7.5% Net Interest Margin (NIM). The NIM, stable compared to last year, is likely to remain steady in H2FY25 due to the company’s effective cost controls and strategic adjustments across product lines.

Growth in Pre-Provision Operating Profit (PPOP)
CIFC’s Pre-Provision Operating Profit for Q2FY25 amounted to Rs19,221 million, a 35.3% YoY increase, backed by strong NII and non-interest income. Despite a slight rise in cost-to-income ratio to 40.6%, CIFC’s efficient cost management and revenue per employee focus have supported robust earnings growth, even as operating expenses have risen by 39.0% YoY due to branch expansions and workforce additions.

Asset Quality and Credit Costs

Temporary Pressures on Asset Quality
The company’s asset quality faced temporary pressure, with Stage 3 assets increasing from 2.62% in June to 2.83% in September 2024, while Gross NPA rose to 3.78% from 3.62%. CIFC expects improvements in Q4FY25 as collection cycles benefit from seasonal factors such as the festive period and post-harvest collections. The coverage ratio stood at 44.5% in September, slightly down from 45.5% in June, while credit costs are projected to taper off to an annualized 1.3% by the year-end.

Increased Delinquencies in Vehicle Finance
Vehicle finance, particularly small commercial vehicles (SCV), saw increased delinquencies, impacted by seasonal and economic factors, including extended monsoons and reduced rural demand. CIFC has responded by expanding its collections team across high-risk segments, including SCV, SME, and consumer loans, to proactively manage credit risk.

Disbursement Trends and AUM Growth

Rising AUM and Diversified Portfolio
As of September 30, 2024, CIFC’s Assets Under Management (AUM) rose by 32.5% YoY to Rs1,646,420 million, while disbursements for Q2FY25 grew by 12.9% YoY, reflecting CIFC’s strategic focus on long-term products. Despite a slower growth projection for FY25E at around 25%, CIFC remains well-positioned in vehicle finance, LAP, and home loans, with the latter gaining traction due to expansion into non-South Indian markets.

Vehicle Finance and LAP Performance
Vehicle finance disbursements reached Rs123,360 million in Q2FY25, a 9.2% YoY increase, despite sluggish demand in the commercial vehicle segment. LAP disbursements surged 34.6% YoY to Rs42,950 million, with AUM for the segment up 40.9% YoY. This growth was fueled by demand for SME-focused loans and longer loan tenures, supporting CIFC’s asset expansion strategy.

Strategic Expansion and Product Innovation

Focus on Affordable Housing and Diversification
CIFC’s home loan disbursements increased 15.7% YoY to Rs18,230 million, with growth accelerating in non-South regions. The focus on affordable housing, particularly in self-construction loans, continues to drive this segment. CIFC has adopted a diversified approach across geographies, extending its reach in under-penetrated areas to capitalize on rising demand for affordable housing and LAP products.

Consumer and Small Enterprise Loans (CSEL)
The CSEL segment witnessed 70.6% YoY growth in AUM to Rs144,750 million, with CIFC limiting its unsecured lending to 10% of total AUM. This measured approach to CSEL, combined with digital lending partnerships, allows CIFC to balance risk and growth within the unsecured loan category, particularly for SMEs and equipment finance.

Financial Metrics and Long-Term Guidance

Improvement in Key Financial Ratios

Net Profit: For Q2FY25, net profit stood at Rs9,631 million, a 26.3% YoY increase, driven by improved NII and cost efficiency.
Yield on Advances: Yield on average advances rose by 43 basis points YoY, reaching 14%, with NIM stable at 6.6%.
Capital Adequacy: CIFC’s capital adequacy ratio remained robust at 19.5%, with a Tier 1 capital of 15%, well above regulatory requirements, enabling the NBFC to withstand future market challenges.
Forecasted Financial Ratios for FY26E:

RoA/ RoE: Projected to reach 2.2% and 19.0%, respectively, by FY26E, reflecting CIFC’s focus on profitability and operational efficiency.
Asset Growth: AUM is expected to grow at a CAGR of 26.1% between FY24 and FY26E, with profitability following suit at 26.2% CAGR.

Valuation and Analyst Recommendation

Valuation and Revised Target Price
KRChoksey has reduced its EPS forecast for CIFC by 7.4% for FY25E and 8.7% for FY26E, primarily due to higher credit costs related to the growth of the CSEL business. The adjusted valuation assigns a Price to Adjusted Book Value (P/ABV) multiple of 5.5x (down from 6.3x) based on an estimated FY26E BVPS of Rs278.3, resulting in a target price of Rs1,531 per share.

Conclusion and Investment Outlook

Investment Thesis for Cholamandalam Investment & Finance
CIFC’s steady operating performance and diversified portfolio make it a favorable investment for those seeking moderate growth in the NBFC sector. Despite temporary asset quality pressures, the firm’s operational efficiency and strategic expansion, particularly in vehicle finance and LAP, position it well for long-term gains. The stock remains a BUY, with an upside potential of 18.5% from the CMP, anchored by CIFC’s resilience in navigating economic cycles and maintaining a balanced portfolio.

Investors may monitor CIFC’s AUM growth, NIM stability, and collection efficiency in high-risk segments as key indicators of performance in upcoming quarters.