Shriram Finance must walk the talk to maintain top retail NBFC spot

The four-decade-old Shriram Group’s flagship company, Shriram Transport Finance Company Ltd, has played a key role in defining vehicle financing in India, building a large network in an unorganized market. Its main business, pre-owned commercial vehicle financing, helped many first-time borrowers as well as driver-turned-owners.

Now, the company is aiming to position itself as a diversified financial services provider and better compete with the likes of Bajaj Finance while continuing to focus on its largest lending segment.

The change is because of the completion of the company’s merger with two group entities. Shriram City Union Finance and holding company Shriram Capital have merged into Shriram Transport. It now claims to be India’s largest retail non-banking financial company with a diversified loan book of Rs 1.7 trillion, putting Bajaj Finance in the second place.

While shares of Shriram City Union Finance have been delisted, those of Shriram Transport are expected to soon trade as a merged entity, named Shriram Finance.

The merger, which was announced in December last year, has been an overhang on the shares. So far in 2022 (till Dec. 14 closing), shares of Shriram Transport rose over 13%, lower than 44% and 59% gains in Cholamandalam Finance and M&M Financial, respectively. As regulatory approvals for the merger trickled in, shares of Shriram Transport have been on the uptick.

The focus has now shifted to integration and realizing synergies, which had been the stated objectives of this amalgamation, although there is a near-term overhang of stake sales by investors such as Piramal Enterprises, which owns an 8.4% stake in the merged entity. 

Diversification

Vehicle financing, including commercial and passenger vehicles as well as two-wheelers, accounts for nearly 83% of total assets under management of Shriram Finance. The management’s long-term plan is to achieve a 60:40 product mix between vehicle and non-vehicle finance. The diversification strategy of Shriram Finance hinges on increasing volume in the underpenetrated markets and is not led by new product launches.

Shriram Finance has 2,875 branches serving over 6.7 million active customers with minimal overlap, hence providing scope to cross-sell products, according to Shriram Finance’s latest investor deck. The branch network is divided into five units, each to be manned by an executive responsible for team-building, training, and skilling staff in lead generation and credit underwriting. Each geographical unit will run its own balance sheet. The upper management remains the same, ensuring continuity. Y.S. Chakravarti, who was Shriram City’s Managing Director and Chief Executive Officer, will be heading Shriram Finance as MD and CEO, while Umesh Revankar, who headed the vehicle finance NBFC, has been named as the executive vice-chairman.

Just before the merger, small enterprise finance made up 42% of Shriram City’s AUM. The operations were largely focused on Tamil Nadu, Andhra Pradesh, Telangana, and Maharashtra. The post-merger plan is to use Shriram Transport’s branch network to roll out small and medium enterprises loan as well as personal loans and gold loans. The idea is to meet all the lending requirements of the local businesses. Along with lending products, the plan is to also cross-sell programs combining insurance, broking and AMC businesses of the group.

Analysts say the company’s product roll-out strategy will be keenly watched out for because achieving operational synergies is easier said than done. For instance, branches servicing customers opting for commercial vehicle loans are usually on the outskirts, near a particular hub, while consumer-facing branches are more in the commercial market with higher visibility. The gold loan business is specialised in nature, requiring higher marketing spend and customer engagement because of intense competition not just among NBFCs but also banks.

While a large base in the subprime customer segment is Shriram Finance’s key strength, it needs to constantly remodel itself because its peers are also making inroads in this segment using data analytics.

Growth opportunties

Nonetheless, analysts are upbeat about the combined company’s growth prospects because of a favorable business lending cycle and opportunities. They also expect Shriram Finance to meet the guided 15% growth in assets under management while keeping bad loans under check.

MSME is one of the crucial segments for non-bank lenders like Shriram Finance. With a vast distribution network in the unbanked areas coupled with unconventional credit underwriting practices, NBFCs have been more agile in their product offering compared to banks. According to a recent joint report by the Confederation of Indian Industry and KPMG, outstanding credit of NBFCs to the MSME sector stood at Rs 3.6 trillion as of June 2022. It also said that credit opportunity in the MSME market is estimated at Rs 40 trillion.

Similarly, in commercial vehicle financing, where Shriram Finance has built deep expertise, there are growth opportunities. The government’s focus on infrastructure building could possibly lead to higher capital expenditure in areas like logistics, transportation, distribution, and warehousing. All these are favorable to CV financiers.

Harnessing the growth opportunities and execution of the diversification amid competition from peers as well as banks is crucial for Shriram Finance’s profitability metrics. This would also help the company achieve a targeted industry-leading return on assets and return on equity of around 3% and 16%, respectively. 

Shriram Finance is spending Rs 400-500 crore on the merger. This can be somewhat mitigated by lowering operational costs further through a data and tech-driven approach, analysts said. Leveraging technology will help in smoother execution, and enhance productivity while delivering a delightful customer experience.

The company has also built a super app called ‘Shriram OneApp’, to bring all products offered by the Shriram group on one platform.

AAA tag

The merger has addressed the reservations of rating agencies as well as the debt market that the business of Shriram Transport was monoline in nature. With the merger, the loan book has become diversified. 

Shriram Transport is rated AA+ and hence the same rating will be given to Shriram Finance.

The management is hopeful that rating agencies will review the merged business. If the upgrade comes through, Shriram Finance will be an AAA rated entity, which could further lower the cost of borrowing by 40-50 basis points. The average cost of borrowing was 8.6% in the first half of FY23.  

In addition, the AA rated Shriram City Union’s liabilities of about 30,000 crore will be repriced at a higher rating because of the merger.

The AAA rating would bring Shriram Finance on par with Bajaj Finance and Housing Development Finance Corp, and improve overall investor perception.

Moreover, Shriram Transport is among the 16 non-bank lenders to be featured in the upper layer by the Reserve Bank of India based on the central bank’s scale-based regulation, somewhat akin to the “too-big-too-fail” tag given to banks. By extension of the merger, Shriram Finance would also be on the list.

The bank-like regulation entails enhanced disclosure and maintenance of liquidity buffers by lenders because their failure could lead to systemic risk. Such enhanced disclosures come with a cost but they bring non-bank lenders closer to banks in the eyes of investors. For NBFCs, they are also seen as providing an opportunity to fulfill their banking aspirations, analysts said.

For now, Shriram Finance’s management has ruled out any such plan. The focus is on reaching a certain size before even thinking of applying for a bank licence.

This is what investors would also want.