Event update: Shriram Transport Finance (Downgrade to Neutral) - Cutting target multiple on concerns of inter-group transactions

We believe the valuation multiple of Shriram Transport (STFC) will de-rate with concerns emerging on inter-group transactions. We are cutting our target multiple by 30% to 1.8x following the disclosure that STFC has guaranteed the NCD of a loss-making group company SVL. We downgrade the stock to Neutral. STFC’s business growth, which recovered in 3Q18, continues to gain strength with 1Q19 likely to be a strong quarter. However, we believe concerns on inter-group dealings will overwhelm in the current environment where investors are putting a higher weightage on corporate governance following recent auditor resignations/ qualifications for many companies.

STFC disclosed a guarantee given to SVL in its recent annual report: In its recent annual report for FY18 STFC disclosed that it has guaranteed an NCD issued by SVL, a loss-making company belonging to the Shriram group. Initially in FY14, STFC had given a loan of an equal amount to SVL which was later refinanced through an NCD guaranteed by STFC in FY16. The principal value of the zero-coupon NCD is Rs6.5bn and with interest at 11.25% p.a. the total value is Rs8.7bn as of Mar-31, 2018. This translates into 7% of STFC’s BV for FY18 and 5% for FY20E. While the loan was given in FY14 and the guarantee in FY16, the disclosure was made only in the annual report for FY18, not in the earlier years.

STFC is confident that SVL will pay: STFC has clarified that SVL group has enough assets / resources to honour the payment of their loans. The Promoters of STFC are also addressing this with SVL Group to get the settlement of the dues on or before the due date, failing which, the Promoters /Promoter Group of these companies will address through alternate mechanisms to settle the dues. Mgmt indicated that while SVL will not default, in case it does fall short of funds, some other group company will pay.

Inter-group dealings are a concern: We believe the bigger issue for STFC here is lack of timely disclosures especially when SVL is loss-making. A similar issue had emerged in 2015 when STFC had to absorb the losses of its subsidiary, Shriram Equipment Finance.  With two big inter-group events happening in a short span of 3 years, we could see a long term multiple de-rating for the stock though the business cycle is strong right now.