Indostar Capital IPO seems decent buy

Experienced management will expand offerings such as vehicle finance and drive growth; valuation appears reasonable

The initial public offering (IPO) of equity from Indostar Capital Financeh is opening on Wednesday. It comprises a new issue of shares up to ~7 billion and an Offer for Sale of up to 20 million shares. Most on the Street find it attractive, on the back of expansion into new loan segments, a strong and experienced management and cheap stock valuation.

The loan book has grown at an annual average of 30 per cent during FY13-17 and stood at ~51.7 billion as of endDecember 2017. This is more than healthy. The net interest margin (NIM) as a percentage of interest earning assets has also improved every year, from six per cent in 2014-15 to 6.9 per cent during April-December 2017.

Despite the surge since 2016-17 in the gross non-performing assets (NPAs or bad loans) ratio, Indostar’s asset quality was comfortable at 1.7 per cent as of end-December. Likewise, revenue growth has slowed in recent years but this is largely due to lower income on deposits and fee income.

Also, interest rates have been moving lower until recently, thereby impacting revenue growth. The growth in core interest income on its loan portfolio, however, has been in excess of 18 per cent.

Vehicle finance

Beside corporate, SME (small and medium enterprises) and housing finance, Indostar recently forayed into vehicle finance (used commercial vehicles). This is likely to be a focus area, along with the wholesale segment (more than 75 per cent of the loan book) in the future. Analysts say this would help Indostar expand its loan book at a fast pace by FY19 and thereafter. The support of a strong management would augur well.

R Sridhar, vice-chairman and chief executive officer, was the managing director at Shriram Transport Finance, dominant in the used vehicle finance business. This is helping in investors’ and analysts’ belief in the growth prospects. “Sridhar’s past experience with Shriram creates an edge for Indostar as the company is expanding its vehicle finance business,” says Arun Kejriwal, director of Kejriwal Research and Investment Services.

More, financing of used commercial vehicles (CVs) is more profitable as compared to new ones. The spreads on used CVs (seven to nine per cent) are more than those on new vehicles (three to five per cent). Investors, though, should not keep high expectations, given the early phase the business is into and the competitive environment, which might restrict margins to some extent.

Indostar’s target customers for its vehicle finance are mainly those already owning CVs, resulting in a very niche market. However, it would get help in containing the asset quality problem, as there will be a credit history available. The management does not see any headwinds in terms of demand. Lower penetration of used CV financing (around 40 per cent), an expected migration of the share from unorganised lenders (which charge very high interest) to organised players, and the replacement cycle for CVs would support its focus.

Overall, though, it might be a while before Indostar makes meaningful inroads into financing of used CVs, given the nature of business and costs involved. Another risk is the higher proportion of wholesale business that comprises sub-investment grade (credit rating lower than BBB) customers. Also, a third of the wholesale book is accounted for by real estate projects.

Hence, how the company manages its wholesale segment’s asset quality at the current level is a key thing to watch. A large share of the wholesale book also means the loss of a big client could impact the loan book.

Valuation

On a post-issue basis, the IPO is priced reasonably at about two times its book value, as of December. “Given the NIM level, return on equity and assets and future earnings visibility, mainly due to vehicle finance, the valuation is very attractive as compared to peers,” says Rajesh Gupta at SBICAP Securities.

The valuations partly capture the slow growth rate in revenue and return ratios, the latter being due to investment in new businesses. Overall, long- term investors could subscribe to the offer.