Promoters have been buying continuously over last 2 months almost daily. When it started it looked undervalued buying, now its getting suspicious. Anyone has an idea wat’s cooking here?
Maybe they’ve got sm go-ahead for the 3-way merger.
Disc : Invested
Hi Shardhr,
You have put forward the investment thesis nicely comparing SCUF to Wells Fargo investment made by Buffett. One area where SCUF differs from Wells Fargo is the low cost liability franchise. Being a bank, Wells Fargo would have access to low cost and sticky deposits from customers. SCUF doesn’t have that and thus depends on the kindness of banks and debt markets for funding.
This I see as one of the biggest challenges and pain points for SCUF. Even though they have a strong grip on the asset side, the liability side of the business is weak.
Disclosure : Invested
Hi Puch,
Could you please share the Ambit report ?
I could not find it.
Regards
Thanks @BudFox for the feedback and sharing your thoughts. This is exactly the kind of disconfirmation I seek and VP members have always provided me this perspective on my investments.
Coming to your observation - My understanding is that yes, while the liability profile is at a disadvantage vis-a-vis banks, but in NBFCs - Shriram has one of the best liability mix and they were one of the first to move thr borrowings from CPs. The management had been prudently working towards this even before COVID hit. My understanding is that thr debt will be attractive to fixed-income investors compared to other options available to them in the low-interest regime.
In fact, if u see the ROE of the co., part of the reason it is depressed currently is the adequate capitalization that SCUF’s balance sheet as.
On the asset side, as u mentioned, the assets are solid and although there has been COVID impact, it doesn’t seem to be as severe for them.
Disc : Invested.
@shardhr
You are right that within NBFCs, liability profile of SCUF is much better. However, I was referring to the weakness with respect to 2 factors - (1) in comparison with Wells Fargo since you compared with that and (2) over a long period of time say 10-15 years, the dependence on banks and debt markets will always constrain SCUF. It’s like running a marathon with a bag of cement on your back. No doubt SCUF is well built and would sustain that but the absence of a low cost sticky liability franchise prevents SCUF from giving its best.
Management comments / concall takeaways
#Two wheeler and gold loan remain the focus area. Though continue to remain cautious
in SME, expecting to grow it 50‐60%qoq. Total sanctions/ disbursement at
Rs500mn/1.5bn under ECGS scheme to SME customers. Business during October
remains healthy with 1 Lakh Two Wheeler financed and Rs2.5bn of disbursement in
SME.
#Liquidity remained comfortable at Rs3.3bn as of June. Raised Rs31.5bn during the
quarter.
#Collection efficiency improved to 93% in September for SME/ 2W vs 95% pre covid. Of
the 1.5% of the customers who have not paid even a single EMI during moratorium,
almost two‐third has paid October EMIs.
#Less than 1% (Rs1.5bn) of customer base would need restructuring which includes
standalone hospitals; schools and residential hotels.
#Expect H2FY21 credit cost at 2.8‐3% vs 3.7% in H1.
#Increased focus on digitisation; No of digital transactions increased to 2.2mn from
1.8mn in Q1. Will help in bringing down the collection cost.
@ Shardhr
“The rule of thumb is that a Bank earning its cost of capital only sells at Book Value.”
Could you help me understand the link between cost of capital and the valuation multiple in terms of book value ? Didn’t understand this statement.
My 2 cents.
If it’s earning only is CoC back, then there won’t be any profits, let alone growth. So, the company won’t get any premium… Would sell at PBV only. Or even cheaper.
Suppose a bank has BV of Rs.10 and earnings of Rs.1 . Now, its ROE is 10%. If the Cost of equity( or expected return\ any metric that is used to denote ur threshold of a standard comparison for average and above-average businesses) is 10%, then basically the bank is earning only its Cost of equity and doesn’t deserve to sell more than its Book Value or at its Book Value hence the thumb rule of P\B = 1
A premium on Book Value will be given to banks which consistently have ROE upwards of 10%
Pardon me for my writing skills - a further detailed and concise explanation of this is given in the book - Value Investing: From Graham to Buffett and Beyond
I have a different opinion about the valuation here. Please check if I am making any error.
You mentioned that a bank earning its cost of capital should sell at book value. And SCUF should be valued at 1.3-1.6x BV since its ROE is 13-18%.
Let’s assume there is a Type I perpetual bond of book value Rs 1000. The coupon rate (ROE) is 10% and cost of capital (minimum expected return on equity) is also 10%. Assume that the bond pays out all earnings. The earnings for year 1 would be Rs 100 (1000*10%). In this case, intrinsic value of the bond would be 100/10% = 1000. So, the intrinsic value of Type 1 bond is 1x BV.
Take another case of a Type II bond where the book value is 1000, cost of capital is 10% but ROE is 15%. Since ROE>CoC, the bond should ideally retain all earnings and invest them at the higher ROE. Assume that the incremental earnings can’t be deployed and all of them are paid out. In that case, earnings for the first year would be Rs 150 (1000*15%) and earnings would remain constant every year. So, the intrinsic value of Type II bond would be 150 /10% = 1500 which is 1.5x BV.
Now take a Type III bond with a book value of 1000, RoE of 15% and cost of capital of 10%. Also assume that the bond pays out 33% of the earnings and retains 67% of the earnings every year which can be redeployed at RoE of 15%. The first year earnings would be 150 but then it would be 165 in the second year due to retained earnings and thus would continue to increase every year. This compounding would continue as long as the bond is able to absorb retained earnings at an ROE > cost of capital.
In this case, this Type III bond should be valued higher than 1.5x BV due to compounding of retained earnings. How much higher is a subjective matter depending on what rate and how long the earnings can compound. But it should be valued higher than the Type II bond which has a similar ROE but is paying out all the earnings.
Now assume SCUF is a bond. Which of the above cases does it resemble? In my view, it resembles a Type III bond and hence should be valued accordingly and not like a Type II bond.
That was well articulated. I agree with you that SCUF should resemble a Type III bond however due to inherent risks in a business than a bond, you can assign a higher discount rate to value it.
Discl.- Invested but gradually getting out.
What u mentioned makes perfect sense theoretically and yes SCUF has to be considered as a type III bond. However, it isn’t a perfect type III bond due to the following : -
The retained earnings aren’t guaranteed to earn 15% year-on-year. In some years the business will earn less due to business cycle conditions or general prudence on part of management to lend conservatively. In fact, the ROE range of 13-18% that we see now used to be in 20s till 2014-15.
Another thing to consider is the impact of financial leverage. While the leverage enables Banks\NBFCs to earn above the cost of capital, it carries the risk of being wiped out as well due to poor lending. The typical type III bond, which, as u mentioned, if ever existed will have the benefit of atleast first lien claim, which equity doesn’t.
The rule of thumb that I mentioned assigned zero value to future earnings growth on incremental capital. It provides a margin-of-safety to balance out the risks mentioned above.
The discount rate of 10% for SCUF is higher than that of a bond.
In the current scenario, a bond would be discounted at a much lower rate than 10%.
@shardhr
You are right SCUF is not a perfect bond. I did not say that SCUF is even a bond. No business is. I only explained with the help of a bond, my thoughts on reinvestment of retained earnings.
The ROE of SCUF is not guaranteed and it won’t remain constant. Our job is to conservatively estimate what the ROE might be over a business cycle. And that estimate would vary from person to person.
It’s true that lending business carries leverage and the risk of poor lending. But this risk has been minimized by being very selective about the lending business that one wishes to become a partner in. Business of SCUF has been proven over the last 15 years and a couple of cycles. Management is conservative and the business carries low leverage ratio. Had the business been unproven or the management been aggressive, a higher discount rate and a larger margin of safety wouldn’t compensate for it. One just needs to avoid it.
Your points make perfect sense. Taking them into consideration, I’ll now put across the fundamental concept wid more clarity : -
Without taking into consideration the future earnings growth and other qualitative factors into account, a Bank\NBFC should sell at a multiple of book value corresponding to its ROE over Cost-of-Capital i.e. if ROE is same as Cost of equity equal to 10%, it will sell at 1x Book value. A higher current ROE will warrant a higher P\B multiple.
Coming to SCUF - my cost price for it was at a P\B valuation below the corresponding expected multiple. Basically, I paid nothing for future growth and even 20-30% discount on current financials. Of course, that period was one of greater uncertainty and SCUF was at a risk of losing its book value.
( An imp consideration here is that I’m more of a quantitative value seeking investor and look for cheap price first. I don’t give much weightage to or try to dig into the qualitative factors that much)
P.S :- Plz add\correct the gaps in understanding, if any 
At this junction, post the recent run-up - STFC seems a better bet than SCUF now. Thr’s a separate thread on STFC bt I’m initiating the conversation here bcoz want to know SCUF holders views on the same.
My Analysis on the Merger on the PEL thread, Piramal Enterprises Ltd - #2078 by ashwind
Analysis file: ShriramAnalysis - Google Sheets
Had a query related to the taxation post merger. I used to hold Shriram city union for more than a year before the merger. After the merger with STFC, I sold the stock within a year (of the merger). Will the capital gains come under LTCG or STCG?
Thanks.
