Focus on productivity post transformation to provide upside over time; ‘Add’ rating retained with unchanged TP of Rs 1,650
Shriram Transport Finance (STFC) and SCUF have announced a merger to create the largest retail NBFC operating in the below-prime segment. We don’t find direct near term synergies due to diverse lines of businesses; the focus on productivity post business transformation will provide upside over time. Retain Add on STFC (Fair Value Rs 1,650; unchanged).
Shriram Capital and SCUF to amalgamate into STFC
Shriram Capital (SCL), Shriram City Union Finance (SCUF) and STFC have approved the scheme of amalgamation of SCL and SCUF into STFC, post demerger of all non-lending entities of SCL. Post the demerger of the non-lending entities, SCL will be left with only two holdings, viz. 26% stake in STFC and 33.9% stake in SCUF. Thus, for all practical purposes, this is a merger between STFC and SCUF, the merger of SCL into the listed entity has no real impact.
Shriram Housing will continue to remain a subsidiary (~85.02% holding). The proposed merged entity will be renamed as Shriram Finance and will have AUM of ~Rs 1.6 trn. Mgmt expects merger completion over 9-10 months.
Operational gains difficult to bake in
A wide geographic footprint, focus on cross-sell and likely synergy benefits (higher productivity of fixed infrastructure, better liquidity management, scope to improve credit rating, etc.) are primary drivers for the proposed scheme, according to mgmt. In a conference call, the mgmt highlighted that the merged entity will likely witness ~10% incremental PAT benefit net of merger cost (8% in first year and ~12-14% in second year) due to synergies of the proposed merger (mostly cross sell). ~70% of this benefit will be materialised due to higher business volumes led by focus on cross-selling to existing customers (~2.1 for STFC and ~4.3 mn for SCUF). Additionally, superior liquidity management, lower funding cost (~30-50 bps), higher cross-sell of third-party products (insurance), productivity improvement and marginal cost rationalisation (branch overlap of ~60-70) will aid PAT.
A back-of-the-envelope calculation suggests cross-sell volumes (average) have to be ~4-10% of FY2024e AUM to achieve the intended result. Our merged financials reflect the pro forma financials of STFC+SCUF; we have not factored in any significant improvement in operational or financial parameters (AUM growth, funding benefits, cost synergies, etc.) due to the merger in the immediate term.
Retain ADD on STFC
We retain Add rating on STFC. Our FV of Rs 1,650 (unchanged) captures 1.35X December 2023e book for the standalone business of the merged entity and 2.75X book multiple (reflecting higher growth runway) for the housing subsidiary. We assign a 10% holding company discount.
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