Capital First Sector: NBFC/Small cap Initiating Coverage

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1 Sep16 Oct16 Nov16 Dec16 Jan17 Feb17 Mar17 Apr17 May17 Jun17 Jul17 Aug17 Sep17 Capital First Sector: NBFC/Small cap Initiating Coverage Sensex Nifty 31,159 9, Week High/Low 839/465 Bloomberg code Reuters code Issued Equity (shares in mn) Mkt. Cap in bn Mkt. Cap in bn USD CAPF IN CAPF.BO INR 72.0 $ 1.1 Avg. Daily Vol. ( 000) Avg. Daily Vol. (mn) INR 672/$10.3 Shareholding Jun16 Mar17 Jun17 Promoters(%) FII (%) DII (%) Others (%) Pledge (% of promoter holding) Performance% 1M 3M 6M CAPF Sensex Capital First Praveen I praveeni@chola.murugappa.com Relative Sensex (RHS) 27 September 2017 Price: INR September 2017 Target Price: INR 942 BUY Background: Capital First Ltd (erstwhile Future Capital Holdings Ltd) is a nondeposit taking NBFC with large focus on retail lending. Capital First provides loans to retail customers (in the form of secured and unsecured loans to small and medium enterprises (MSME), consumer durables loans, twowheelers loans and housing loans) and corporate customers (loans to real estate developers) on a selective basis. AUM (Asset under Management) stood at INR 198bn as of FY17 with a mix of Retail 93% and Wholesale 7%. The company has transformed into a large retail financing institution with operations in 264 locations across India and has financed over 4.1mn customers. Riding on multiyear growth opportunities Initiate with BUY Focus on 2W/CD segment to drive the growth CAFL started the Consumer durable and 2wheeler financing in and since then the business have scaled up substantially with 2W portfolio growing at a CAGR of ~64% over FY1417 and CD portfolio growing at a CAGR of 93% over FY1417 both contributing ~23% to the AUM. CAFL has tieups with more than ~5k dealers across geography to source the loans and with company laying more focus on CD/2W segment going forward, we expect the 2W & CD segment to grow at a CAGR of 38% & 41% (over FY1720E) respectively driven by revival in automobile industry and rising per capita income. Margins to expand driven by higher yields & lower COF NIMs have been improving in the past from ~5% in FY15 to 7.3% in FY17 helped by gradual increase in share of retail loan portfolio (~93% of AUM as of FY17). Going forward, NIMs are estimated to expand further to 8% by FY20E largely driven by improving yields on account of increase in share of highyielding portfolio (like CD/2W financing) and also benefitting from reduction in cost of funds on account of reducing the share of bank borrowings (from ~58% in FY17 to 39% in FY20E). Earnings growth to drive the return ratios higher CAFL is expected to benefit from the change in both asset and borrowing mix, with 24% AUM CAGR and benefit of margin expansion, we estimate NII to grow at a CAGR of 28% over FY1720E at INR 27.2bn. Given the Improvement in Cost/Income ratio from 50.6% in FY17 to 47.4% in FY20E coupled with stable asset quality and with all the required investments in technology and people in place, we expect CAFL to reap its results and grow its PAT at a CAGR of 33% over FY1720E at INR 5.6bn. Valuation For CAFL, MSME has remained a key focus area and it has created a niche for itself in the segment. Going forward with more focus laid on 2W/CD financing which remains highly underpenetrated offering growth potential, we expect a robust 24% CAGR (over FY1720E) AUM growth along with 70bps margin expansion. Considering such strong growth potential and the RoE improvement (from 11.9% in FY17 to 17.1% by FY20E) we initiate coverage on CAFL with a BUY rating and an 18month target price of INR 942 (an upside potential of 31%), assigning a P/BV of 2.6x of FY20E. Risks Weakness on the asset quality from the MSME segment, higher than estimated operating cost could put pressure on its RoA, leading to slower improvement in the ROE. Valuation Summary Y/E March ( INR mn) FY17 FY18E FY19E FY20E Net Interest Income 13,008 16,992 21,523 27,199 Other Income 3,394 4,645 6,048 7,621 Pre Provisioning Profit 8,103 11,154 14,245 18,319 PAT 2,389 3,376 4,347 5,583 EPS EPS growth (%) PE P /BV Dividend Yield (%) GNPA (%) NNPA (%) PCR (calc) ROA (%) ROE (%) CAR Tier I ROE/PBV

2 Company Overview Capital First Ltd (erstwhile Future Capital Holdings Ltd) is a nondeposit taking NBFC with large focus on retail lending. Capital First provides loans to retail customers (in the form of secured and unsecured loans to small and medium enterprises (MSME), consumer durables loans, twowheelers loans and housing loans) and corporate customers (loans to real estate developers) on a selective basis. AUM (Asset under Management) mix as of FY17 stood at Retail 93% and Wholesale 7%. Mr. Vaidyanathan, founded Capital First Ltd by first acquiring an equity stake in an existing NBFC, changing the business model from wholesale to retail focused lending and then executing a Management Buyout by securing an equity backing of INR 8.10 billion in 2012 from PE Warburg Pincus. The company has transformed into a large retail financing institution with operations in 264 locations across India and has financed over 4.1mn customers and built a loan assets of INR 214.1bn as of 1QFY18. Chronology of events 2005 Incorporated as Future Capital Holdings engaged in capital management and investing business 2012 Future Capital Financial Services, a wholly owned subsidiary of the company and a NBFC was merged with itself and divested forex business Capital First was formed as result of management buyout by reputed PE firm Warburg Pincus. In September 2012, Warpurg Pincus acquired 70% stake in the company for INR 8.1bn including fresh investment of INR 1bn into the company Capital First Home Finance Pvt. Limited (CFHFPL), a wholly owned subsidiary of Capital First Limited (CFL), received the Housing Finance Company (HFC) License from National Housing Bank (NHB) Capital First closed its broking business including securities broking, commodities broking and property services to focus on the core lending business focusing on the retail finance Company raised INR 1.78bn as fresh equity from Waarburg Pincus (INR 1.28bn) and HDFC Standard Life (INR 0.5bn). Company s housing finance subsidiary acquired HFC license from NHB Company raised INR 3bn of primary equity capital through QIP Number of customers financed since inception crosses 4mn. Company s housing finance subsidiary loan book crosses INR 6.1bn. Source Company, CSEC Research

3 Strong and experienced Board Name Profile Mr. V. Vaidyanathan Chairman and Managing Director Mr. N C Singhal Independent Director Mr. Hemang Raja Independent Director Mr. M S Sundara Rajan Independent Director Dr. Brinda Jagirdar Independent Director Mr. Dinesh Kanabar Independent Director Mr. Vishal Mahadevia Non Executive Director Mr. Narendra Ostawal Non Executive Director Mr. Apul Nayyar Executive Director Mr. Nihal Desai Executive Director He was earlier the MD and CEO of ICICI Prudential Life Insurance Co (2009) and an Executive Director on the Board of ICICI Bank (2006). He is an alumnus of Birla Institute of Technology and Harvard Business School and is a regular contributor on Financial and Banking matters in India and international forums. He has about 26+ years of experience in the Industry. Former Vice Chairman & Managing Director of SCICI Ltd. (Since merged with ICICI Ltd.). He holds Post graduate qualifications in Economics, Statistics and Administration and was awarded the united Nations Development Programme Fellowship for Advanced Studies in the field of Project Formulation and Evaluation, in Moscow and St. Petersburg. He has 55 years of experience in corporate sector. Former Managing Director & CEO of IL&FS Investsmart Ltd. He has served on the executive committee of the Board of the National Stock Exchange of India Limited and also served as a member of the Corporate governance Committee of the BSE Limited. He is an MBA from Abilene Christian university, Texas, with a major emphasis on finance and an Alumni of Oxford university, UK. He has a vast experience of over 35 years in financial services. Former Chairman & Managing Director of Indian Bank. He is a Post graduate in Economics from university of Madras with specialisation in Mathematical Economics, National Income and Social Accounting. He has a total experience of over 39 years in the Banking Industry. Former Chief Economist of State Bank of India. She is an independent consulting Economist with specialisation in areas relating to the Indian economy and financial intermediation. She is a Ph.D in Economics, university of Mumbai, M.S. in Economics from the university of California at Davis, USA, MA in Economics from Gokhale Institute of Politics and Economics, Pune and BA in Economics from Fergusson College, Pune. She has over 35 years of experience in banking industry. Former Deputy CEO of KPMG in India and Chairman of its Tax practice. Presently, he is the CEO of Dhruva Advisors LLP. He has handled some of the biggest tax controversies in India and has advised on complex structures for both inbound and outbound investments. He is a Fellow Member of the ICAI. He has over 25 years of experience advising some of the largest multinationals in India. He is the Managing Director & CoHead, Warburg Pincus India Private Ltd. Previously; he has worked with Greenbriar Equity group, Three Cities Research, Inc., and McKinsey & Company. He is a B.S. in Economics with a concentration in finance and a B.S. in Electrical Engineering from the university of Pennsylvania. He has 21 years of experience in Corporate sector across the globe. He is the Managing Director of Warburg Pincus India Private Limited. Earlier, he has worked with 3i India Private Limited (part of 3i group PLC, UK) and McKinsey & Company. He holds a Chartered Accountancy degree from ICAI and an MBA from IIM, Bangalore. He has 13 years of experience in consulting and private equity segment. Prior to Capital First, Apul has worked in leadership positions across companies like India Infoline (IIFL), Merrill Lynch and Citigroup. Apul is a qualified Chartered Accountant. He has Successfully concluded Global Program for Management Development (GPMD) from Ross School of Business, Michigan, USA. He has more than 18 years of experience in the Financial Services Industry. Prior to Capital First, Nihal has worked with Serco India as Managing Director and developed new markets for its core and new BPO business. With an Engineering degree in Computer Science and Post Graduate degree in management, he has been part of numerous management trainings from institutes like Wharton and IIMAhmedabad. He has more than 20 years of work experience in the Financial Services domain.

4 Key Product Offering Shareholding Pattern Exhibit 1: Promoter Details Exhibit 2: Shareholding Pattern Dayside Investment Ltd 1.28% Others, 18.9% Promoters, 36.0% Bodies Corporate, 6.0% DII, 8.6% Cloverdell Investment Ltd, 34.73% FII/FPI, 30.6% Source: Company, CSEC Research Source: Company, CSEC Research

5 Company History Rebuilding the whole business model; backed by reputed investors In August 2010, Mr. Vaidyanathan (CMD) joined the company as Vice Chairman and Managing Director. He was previously with Citibank (10 years) and ICICI Group (10 years) and has helped them build their complete retail banking portfolio. Post joining CAFL, he planned to revamp the whole business model by shifting its focus from erstwhile wholesale lending to more granular retail lending. He exited from the noncore business (Forex) and launched retail financing product thereby brining down the share of wholesale book from ~90% in FY10 to ~7% in FY17. Launch of secured & unsecured MSME loans, financing Consumer durable goods & two wheelers and venturing into housing loan has helped CAFL build a strong retail book as the share of retail book has gone up from ~10% in FY10 to ~93% in FY17. Exhibit 3: AUM mix as of FY10 Retail book, 10% Exhibit 4: Transformed to Retail focused as of FY17 Wholesale book, 7% FY10 FY17 Wholesale book, 90% Retail book, 93% Source: Company, CSEC Research Source: Company, CSEC Research In FY12, Mr. Vaidyanathan (CMD) received the financial backing of Warburg Pincus (extremely reputed global PE investor) to provide exit to the erstwhile promoters (Future Group) as they invested INR 8.1bn (with INR 1bn as fresh capital infusion). Since then the company has raised capital multiple times subscribed by various investors like HDFC Standard life, Goldman sachs, GIC Singapore etc. Exhibit 5: History of CAFL Source: Company, CSEC Research

6 Investment Rationale Best in class asset quality When the new management team took over in FY11, cleaning up the balance sheet and improving the asset quality remained their top priority as they rebuilt the whole business model. Shifting of focus from wholesale lending to retail products (making the loan book more granular) helped them bring down the GNPAs from 3.73% in FY10 to 0.25% in FY11 and since then the asset quality has remained healthy with GNPAs well below ~2% despite the AUM growing at a robust pace of 39% CAGR over FY1117. Also, when compared to peers, the company has best asset quality among other NBFCs. 4.0% 3.0% 2.0% 1.0% 0.0% Exhibit 6: Wellmaintained Asset quality 3.7% 1.1% 0.9% 0.7% 0.3% 0.4% 0.1% 0.1% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 GNPA (%) Source: Company, CSEC Research Exhibit 7: CAFL s GNPL best among peers as of FY % 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1.0% 1.7% 2.6% 6.7% 7.7% 9.0% CAFL BAF Repco SCUF LTFH MMFS Source: Company, CSEC Research Over the period the company has been recognizing NPLs as per regulatory requirements, however, it has been conservatively providing for bad loans and writingoff loans when recovery becomes doubtful. Consequently, the transition of NPL recognition from 150dpd to 120dpd in 1QFY17 and from 120dpd to 90dpd in 1QFY18 has been smooth as the credit costs has remained stable at 6070bps per quarter despite the GNPA figures shootingup from 0.9% in FY17 to 1.7% in 1QFY18 making no material impact on the profitability of the company. Exhibit 8: Healthy NPA trend at 90dpd NPA recognition 2.00% 1.74% 1.71% 1.52% 1.59% 1.65% 1.72% 1.50% 0.7% Exhibit 9: Credit cost as a % of AUM 0.7% 0.7% 0.6% 1.00% 0.50% 1.21% 1.13% 0.97% 1.00% 1.00% 1.04% 0.6% 0.6% 0.6% 0.00% 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 GNPA (%) NNPA (%) 0.5% 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 Source: Comapny, CSEC Research Source: Company, CSEC Research

7 Welldiversified loan book CAFL has presence across business segments offering welldiversified loan products with focus on MSME and consumer finance. The retail segment includes MSME / LAP (~42% of AUM), unsecured business loan (~18% of AUM), Consumer durable loans (~13% of AUM) and 2wheeler (~10% of AUM). On the wholesale book which forms ~7% of AUM, CAFL offers loans to real estate developers (largely from Mumbai with loan tenure of 34years) and few corporate loans on selective basis. Growing urbanization, rising per capita income, increasing middleclass population and huge market opportunity in MSME segment provides a multiyear growth opportunity for CAFL. Wholesale loans, 19% 2Wheeeler, 5% Consumer durables, 4% Unsecured Loans, 5% Exhibit 10: AUM mix as of FY14 Others, 12% MSME (LAP), 55% Source: Company, CSEC Research Exhibit 11: Transformed to Retail focused as of FY17 Wholesale loans, 7% 2Wheeeler, 10% Consumer durables, 13% Unsecured Loans, 18% Others, 10% MSME (LAP), 42% Source: Company, CSEC Research CAFL looks to balance risk, growth and profitability dynamics by focusing on highyielding segments such as 2wheeler finance, consumer durable finance and business loans. On the other hand, relatively lowyielding MSME (LAP) business with longer loan tenure will provide the stability. Going forward, we expect AUM to grow at a CAGR of 24% over FY1720E. Exhibit 12: AUM to grow at a CAGR of 24% over FY1720E; AUM mix as of FY20 Others, 11% Wholesale loans, 4% MSME (LAP), 31% 2Wheeeler, 15% Consumer durables, 18% Unsecured Loans, 21% Source: Company, CSEC Research

8 (Units in mn.) INR in bn Focus on CD/2W financing to drive the growth CAFL started the Consumer durable and 2wheeler financing in and since then the business have scaled up substantially and CAFL is now among the well recognized players in such segments. CAFL has a robust technology platform to make a thorough assessment of borrower profile and be able to provide credit decision instantly on feeding the customer s data in the system. Along with the speed (such low TAT), the technology platform enables rigorous underwriting as supported by the fact that the company has a best in class asset quality. CAFL offers finance for new two wheelers to both salaried and selfemployed customers with tenure of ~24 months, average ticket size of INR 53,000, LTV of ~72% and is not captive to any particular OEM. It has tie up with ~2,000 dealers across the country for sourcing of 2W loans. CAFL s 2W portfolio has grown at a CAGR of ~64% over FY1417 to form ~10% of AUM vs. 5% in FY14. Exhibit 13: AUM in 2W segment to grow at a CAGR of 42% over FY1720E FY14 FY15 FY16 FY17 FY18E FY19E FY20E In terms of numbers, India is the 2 nd largest 2W market in the world next to China. However, 2W penetration in India is well below other countries like Malaysia and Sri Lanka. Over FY1217, the 2W industry recorded a sluggish growth with a CAGR of ~6%. However, going forward, ICRA estimates the sales in 2W segment to grow in double digit over FY1719E. With the company s focus on 2W/CD Segment, we expect the AUM in 2W segment to grow at a CAGR of ~41% over FY1720E driven by revival in the automobile industry coupled with the fact of such low penetration compared to other nations. Exhibit 14: Lower level of 2W Penetration Exhibit 15: Sales in 2W segment to pickup % 7.9% 2.9% 3.0% 10.0% 10.0% 6.9% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0 Malaysia Sri Lanka Italy India Brazil China FY13 FY14 FY15 FY16 FY17 FY18E FY19E 0.0% No. of 2W per 1K persons 2 wheelers Growth Source: data.gov.in, CSEC Research Source: ICRA, CSEC Research

9 INR in bn CAFL finances consumer durable goods like TVs, Fridge, Washing machine, Air conditioners, Mobiles etc with tenure of ~12months, average ticket size of INR 22,000 and LTV of ~77%. It has tie up with ~5,000 dealers across the country for sourcing of CD loans. CAFL offers interest free loans to customers, just like its competitor Bajaj Finance and pockets yield via subvention from the manufacturer. This segment fetches higher yields (IRR of ~22%) to the company and also involves higher operating expenses as higher collection efforts are required due to small ticket size and large number of customers leading to higher costs. Exhibit 16: AUM in CD segment to grow at a high CAGR of 38% over FY1720E FY14 FY15 FY16 FY17 FY18E FY19E FY20E Despite Consumer electronic business growing significantly in the past the penetration levels of white goods in India have remained significantly lower when compared globally. E&Y estimates the consumer electronics market to grow to USD 29bn by FY20 (CAGR of 19%) from USD 10bn in FY14. On the other hand, IMF estimates that India s per capital GDP to grow at a CAGR of 8.1% over This, along with rising urbanization and rise in middleclass population provides a multiyear growth opportunity for CAFL. Exhibit 17: Market size in India (INR in bn) Exhibit 18: Low Market Penetration vs. Global % 90.0% 85.0% 89.0% % 70.0% 60.0% 70.0% 60.0% 60.0% % 40.0% 30.0% 20.0% 10.0% 8.8% 21.0% 3.0% E 2015E 2016E 2020P 0.0% WM Fridge AC TV Washing Machine Refridgerator AC TV Source: E&Y report, CSEC Research India Global avg Source: E&Y report, CSEC Research

10 Exhibit 19: Increase in Per capita Income (in USD) Exhibit 20: Growth in Urbanization 3,000 2,500 2,000 1,500 1, ,430 1,522 1,496 1,508 1,627 1,808 2, E India's Per capita Income (USD) Urbanization rate in India Source: IMF, CSEC Research Source: McKinsey, CSEC Research CAFL offers loyalty cards for the repeat customers to allow hasslefree purchase of CDs in the future. CAFL has issued more than ~1.5mn cards so far. Cards contribute to revenue, both in the form of other income (as cards are chargeable) and also in the form of interest income from the future business. CAFL s CD portfolio has grown at a CAGR of 93% over FY1417 to form ~13% of AUM as of FY17 vs. 4% in FY14. Going forward, we expect AUM in CD segment to grow at a CAGR of 38% over FY1720E driven by rising demand of white goods led by rise in middleclass population, Increase in Per capita Income, growth in Urbanization etc.

11 MSME Segment; tapping the opportunity MSMEs are widely dispersed across sectors of the economy, producing diverse range of products and services to meet demands of local as well as global markets. The contribution of MSMEs (both manufacturing & Service) in GVA is at 33.3%. Contribution to manufacturing output is at 33% and 45% in exports. With about ~36.2mn MSME enterprises employing 80.5mn people, it shows the valuable contribution that the MSME sector is making in the economy, both in terms of service and manufacturing. (MSME Annual report) Exhibit 21: MSME Contribution to Indian economy Source: MSME Annual report, CSEC Research About 78% of the MSMEs are selffinanced with about only ~2% of them are financed by financial institutions. This indicates the underpenetration and challenge of providing adequate financing to MSMEs. IFC in its report MSME finance market in India estimated the total requirement of Credit to MSME sector at ~INR 32.5tn (both debt & equity). The total debt requirement of MSMEs after considering the formal bank credit of INR 7.9tn (as of FY14) stands at ~INR 19tn. With such huge shortfall of credit, it leaves immense opportunity for the NBFCs. From Money Lenders, 1% From Financial Institution, 2% Exhibit 22: MSME s source of finance From SHG, 1% Donations, 11% Assistance from Govt., 7% Self Finance, 78% Source: MSME Annual Report, CSEC Research

12 INR in tn Exhibit 23: IFC s estimate of finance gap in MSME sector Total finance demand Entrepreneur's Contribution Bank Credit Total Equity gap Total Debt gap Source: IFC s MSME finance market in India report, CSEC Research Government has also marched ahead with its financial inclusion drive. Through the budget, it has announced proposals to promote the Small and Medium Enterprise sectors in the country. It has proposed the doubling of the refinancing capability of Small Industries Development Bank of India (SIDBI) from INR 50billion to INR100billion per year, increasing the credit limit for Pradhan Mantri Mudra Yojana (PMMY) and a reduction in income tax rates for smaller companies. These measures will facilitate the growth of the MSME segment. For MSMEs it gets difficult to obtain credit from the bank given the challenges like lack of documentation for credit appraisal, lower ticket size, higher credit costs etc. On the other hand, it is well suited for NBFCs like CAFL given the reasons like high levels of staffing (better customer service & Lower turnaround time), flexibility in terms of Credit appraisal and repayment schedule (standardized process with banks), smaller ticket size financing (banks favor large ticket size as credit appraisal is much easier) etc. MSME financing (LAP) has remained a key focus area for CAFL so far as it accounts for 42% of the over AUM. CAFL focuses on urban customers in tier 1 & 2 cities and caters to lowertomid section of the ticket size (Average ticket size of INR 7.4mn). Approximately 85% of the loan book is sourced through direct selling agents (DSA). LAP book has largely supported the AUM growth so far, but going forward given the rising competition, recent asset quality worries post demon and increasing pricing pressure the company has increased its focus more towards 2wheeler and Consumer durable segment which should further help diversify the loan book. To eliminate the risk of loan loss, the company generally lends at LTV of 45% at origination with a maximum permissible limit of ~65%. In the Unsecured lending segment, CAFL has significantly scaled up the share in overall AUM from 1% to 18% currently, implying a 98% CAGR over FY1417. The company offers loan at an average ticket size of INR 2m with tenure of 3 years and yields in the range of 18%19%. Going forward in the medium term, the company expects to maintain the share of unsecured loans to AUM at ~2022%.

13 250 Exhibit 24: AUM in LAP & Unsecured loans to grow at a CAGR of 18% over FY1720E FY14 FY15 FY16 FY17 FY18E FY19E FY20E LAP (INR in bn.) Unsecured (INR in bn.) Growing Home loans while defocusing wholesale business CAFL offers home loans in the affordable housing segment through its subsidiary (Capital first home finance), catering primarily to selfemployed urban customers in the outskirts of Tier I & II cities with an average ticket size of INR 11.5mn. The loan book size is relatively small in this segment at INR 9.6bn as of 1QFY18. However, the company intends to grow the book from current levels of ~4% of AUM to ~8% of AUM by FY19. We expect home loan & other segment book to grow at a CAGR of 29% over FY1720E largely driven by government s thrust on affordable housing. In August 2010, Mr. Vaidyanathan (CMD) joined the company and revamped the whole business model by shifting its focus from erstwhile wholesale lending to more granular retail lending. He launched retail financing product thereby brining down the share of wholesale book from ~90% in FY10 to ~7% in FY17. The company has completely defocused real estate financing and currently provides only corporate loans on selective basis. We expect the share of wholesale book further decline to 5% by FY20E. Exhibit 25: Growing in Home loan and other segment Exhibit 26: Wholesale book on declining trend FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY14 FY15 FY16 FY17 FY18E FY19E FY20E Home loan & Others (INR in bn.) Wholesale book (INR in bn.)

14 85% 85% 75% 58% 50% 44% 39% Change in borrowing mix to bring down COF CAFL has placed significant reliance on bank borrowings up till FY16 and has now slowly started raising funds via NCDs and CPs. As a result, the share of bank borrowings has come down from 85% in FY14 to ~58% in FY17. The company enjoys AAA rating which would help them raise funds from the debt markets at competitive rates. Given the falling interest rate scenario coupled with CAFL s intention to bring down the reliance on bank borrowing, we estimate the share of bank borrowings to fall to ~39% by FY20E thereby fetching them results in terms of reduced cost of funds (COF). We expect the COF to fall from current levels of 8.9% as of FY17 to 7.9% by FY20E. Exhibit 27: Change in borrowing mix Exhibit 28: Declining Cost of funds 120% 100% 80% 15% 15% 25% 42% 50% 56% 61% 9.5% 9.0% 9.3% 8.8% 8.9% 60% 40% 20% 0% FY14 FY15 FY16 FY17 FY18E FY19E FY20E Bank Borrowings Market Borrowings 8.5% 8.0% 7.5% 7.0% 8.4% 8.1% 7.9% FY15 FY16 FY17 FY18E FY19E FY20E Margins to expand driven by higher yields & lower COF NIMs have been improving in the past from ~5% in FY15 to 7.3% in FY17 helped by gradual increase in share of high yielding retail loan portfolio (~93% of AUM as of FY17). Going forward, NIMs are estimated to expand further to 8% by FY20E largely driven by improving yields on account of increase in share of highyielding portfolio like CD/2W financing and also benefitting from reduction in cost of funds on account of reducing the share of bank borrowings. Exhibit 29: Improving yields with change in asset mix 19.0% 18.5% 18.5% 18.2% 18.0% 18.0% 17.8% 17.5% 17.0% 16.8% 16.5% 16.1% 16.0% 15.5% 15.0% 14.5% FY15 FY16 FY17 FY18E FY19E FY20E 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Exhibit 30: NIMs to improve further 7.6% 7.8% 8.0% 7.3% 5.8% 5.0% FY15 FY16 FY17 FY18E FY19E FY20E

15 INR in bn Financial Outlook Growth in AUM driven by focus on 2W/CD CAFL s AUM has grown at a CAGR of 27% over FY1417 largely driven by scaling up of loan book in unsecured lending business (MSME). Going forward, we expect the AUM to grow at a CAGR of 24% over FY1720E to stand at INR 377bn largely driven by CD/2W lending business while we estimate a steady growth in the MSME segment. On the other hand we expect the wholesale book to remain muted given the fact that the company is defocusing from the segment. Exhibit 31: AUM to grow at a CAGR of 24% over FY1720E FY14 FY15 FY16 FY17 FY18E FY19E FY20E Strong NII growth supported by margin expansion CAFL is expected to benefit from the change in asset mix as NIMs are estimated to expand to 8% by FY20E largely driven by improving yields on account of increase in share of highyielding portfolio like CD/2W financing and also benefitting from reduction in cost of funds on account of reducing the share of bank borrowings. With 24% AUM CAGR and benefit of margin expansion, we estimate NII to grow at a CAGR of 28% over FY1720E at INR 27.2bn. 30,000 Exhibit 32: NII to grow at a CAGR of 28% over FY1720E 27,199 25,000 20,000 15,000 13,008 16,992 21,523 10,000 5,000 5,363 8,181 FY15 FY16 FY17 FY18E FY19E FY20E

16 Improving profitability to drive the return ratios higher With more focus laid on CD/2W financing, which typically involves higher operating expenses as higher collection efforts are required due to small ticket size and large number of customers leading to higher costs, we estimate the Opex to average AUM to pick up slightly from current levels of 4.6% in FY17 to 4.8% by FY20E. However, Cost/Income ratio is expected to improve from 50.6% in FY17 to 47.4% in FY20E. On the asset quality, we expect it to remain stable while we estimate the credit cost to slightly inchup from 2.5% in FY17 to 2.9% in FY20E given the company s focus on CD/2W financing which typically involves higher delinquency rate. With all the required investments in technology and people in place, we expect CAFL to reap its results and grow its PAT at a CAGR of 33% over FY1720E at INR 5.6bn. Exhibit 33: Opex to avg. AUM to inch up slightly 6.0% 5.0% 4.6% 4.7% 4.8% 4.8% 4.0% 3.6% 3.6% 3.0% 2.0% 1.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Exhibit 34: Credit cost to AUM to inch up 2.9% 2.7% 2.8% 2.5% 1.7% 1.0% 0.0% FY15 FY16 FY17 FY18E FY19E FY20E 0.0% FY15 FY16 FY17 FY18E FY19E FY20E Exhibit 35: PAT to grow at a CAGR of 33% Exhibit 36: Return ratios to improve 6,000 5,000 4,000 3,000 2,000 1,000 1,143 1,662 2,389 3,376 4,347 5, % 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 17.1% 15.5% 13.7% 11.9% 10.1% 8.3% 1.1% 1.3% 1.5% 1.7% 1.8% 1.9% FY15 FY16 FY17 FY18E FY19E FY20E FY15 FY16 FY17 FY18E FY19E FY20E RoA RoE

17 Adequate capital for a years; might raise capital in 2 years Since the takeover of the new management the company has been able to raise capital on several occasions with the most recent being in December 2016 wherein it raised INR 3.4bn via preferential issue of shares to GIC taking the tier I ratio to 16% as of FY17. The company is well capitalized but given the growth rate it might look to raise capital in the next couple of years Exhibit 37: Well capitalized; might raise capital in medium term FY15 FY16 FY17 FY18E FY19E FY20E

18 Jan13 Mar13 May13 Jul13 Sep13 Nov13 Jan14 Mar14 May14 Jul14 Sep14 Nov14 Jan15 Mar15 May15 Jul15 Sep15 Nov15 Jan16 Mar16 May16 Jul16 Sep16 Nov16 Jan17 Mar17 May17 Jul17 Sep17 Jan13 Mar13 May13 Jul13 Sep13 Nov13 Jan14 Mar14 May14 Jul14 Sep14 Nov14 Jan15 Mar15 May15 Jul15 Sep15 Nov15 Jan16 Mar16 May16 Jul16 Sep16 Nov16 Jan17 Mar17 May17 Jul17 Sep17 Valuation: For CAFL, MSME has remained a key focus area and it has created a niche for itself in the segment. Going forward with more focus laid on 2W/CD financing which remains highly underpenetrated offering growth potential, we expect robust AUM growth to continue along with margin expansion on account of change in portfolio mix and lower cost of funds on account of change in borrowing mix. We estimate a 24% CAGR in AUM coupled with margin expansion of 70bps and stable asset quality which will lead to improvement in RoA/RoE from 1.5% / 11.9% in FY17 to 1.9% / 17.1% by FY20E. Considering such strong growth potential and the RoE improvement we initiate coverage on CAFL with a BUY rating and an 18month target price of INR 942 (an upside potential of 31%), assigning a P/BV of 2.6x of FY20E Exhibit 38: P/BV 1 Year forward P/BK 1Yr Fwd Std Dev 1 Std Dev 1 Std Dev 2 Std Dev 2 Avg Source: Bloomberg, CSEC Research 30.0 Exhibit 39: P/E 1 Year forward P/E 1Yr Fwd Std Dev 1 Std Dev 1 Std Dev 2 Std Dev 2 Avg Source: Bllomberg, CSEC Research

19 Risks: Failure to maintain asset quality as the share of unsecure lending has increased to ~18% of AUM. Competition could increase given the company s focus on highyielding CD/2W financing Lower than estimated growth in AUM. Higher than estimated increase in cost could impact return ratio. Peer comparison: Company NIM Cost/Income ROA ROE FY18E FY19E FY18E FY19E FY18E FY19E FY18E FY19E Capital First Bajaj Finance Shriram City Union M&M Fin service Dewan Housing Fin Company Tier1 P/E P/BV Div Yield (%) FY18E FY19E FY18E FY19E FY18E FY19E FY18E FY19E Capital First Bajaj Finance Shriram City Union M&M Fin service Dewan Housing Fin *Bloomberg Consensus estimates

20 Financials Income Statement (Abstract) INR(million) Per Share Ratios Particulars FY 17 FY18E FY19E FY20E Particulars FY 17 FY18E FY19E FY20E Interest income 24,615 30,516 37,961 47,036 Interest expense 11,607 13,525 16,438 19,836 Net interest income 13,008 16,992 21,523 27,199 Growth (%) Other income 3,394 4,645 6,048 7,621 Total Income 16,402 21,637 27,572 34,821 EPS (Rs) Earnings growth (%) PPP* / Share (Rs) BV / share (Rs) Adj BV / Share (Rs) Div / Share (Rs) Op. Expenses 8,299 10,482 13,327 16,502 Preprovision Profit 8,103 11,154 14,245 18,319 Growth (%) Provisions 4,529 6,114 7,744 9,969 PBT 3,574 5,040 6,502 8,350 Provision for Tax 1,184 1,665 2,154 2,766 PAT 2,390 3,376 4,348 5,584 Growth (%) Key Ratios % Particulars FY 17 FY18E FY19E FY20E Gross NPLs Net NPLs Capital Adequacy Tier I CAR Yield on Advances Balance Sheet (Abstract) INR(million) Particulars FY 17 FY18E FY19E FY20E Equity Capital Reserves & Surplus 22,064 25,132 29,128 34,337 Net worth 23,038 26,107 30,102 35,311 Borrowings 141, , , ,454 Growth (%) Other liabilities 35,471 39,572 46,455 53,250 Total Liabilities 176, , , ,703 Cash & Balances 15,936 20,594 25,242 31,157 Advances 149, , , ,350 Growth (%) Investments 2,587 3,218 3,987 4,915 Fixed assets Other assets 7,431 9,731 11,886 14,493 Cost of Funds Net Interest Margin (AUM) Cost / Income Provision/ Loans Tax rates ROA ROE Valuation Ratios Particulars FY 17 FY18E FY19E FY20E P / E P / PPP* P / BV P/ABV $ Dividend Yield Total Assets 176, , , ,703 Growth (%) * PPP Pre Provisioning Profit $ Book value adjusted for uncovered loan losses

21 ing Call Morning Call December 28, March 2017 DISCLOSURES/ APPENDIX I. ANALYST CERTIFICATION I, Praveen. I hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report, (2) No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report by Cholamandalam Securities Limited or its Group/associates companies. (3) has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. Disclosure of Interest Statement Analyst holding in the stock Served as an officer, director or employee Update No No II. ISSUER SPECIFIC REGULATORY DISCLOSURES, Unless specifically mentioned in Point No. 9 below: 1. The Research Analyst(s), Cholamandalam Securities Limited (CSL), Associate of Analyst or his relative does not have any financial interest in the company(ies) covered in this report. 2. The Research Analyst, CSL or its associates or relatives of the Research Analyst associates collectively do not hold more than 1% of the securities of the company (ies) covered in this report as of the end of the month immediately preceding the distribution of the research report. 3. The Research Analyst, his associate, his relative and CSL do not have any other material conflict of interest at the time of publication of this research report. 4. The Research Analyst, CSL and its associates have not received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in this report, in the past twelve months. 5. The Research Analyst, CSL or its associates have not managed or comanaged in the previous twelve months, a private or public offering of securities for the company (ies) covered in this report. \ 6. CSL or its associates have not received compensation or other benefits from the company(ies) covered in this report or from any third party, in connection with the research report. 7. The Research Analyst has not served as an Officer, Director or employee of the company (ies) covered in the Research report. 8. The Research Analyst and CSL has not been engaged in market making activity for the company(ies) covered in the Research report. 9. Details CSL, Research Analyst and its associates pertaining to the companies covered in the Research report: Sr.No. Particulars Yes/No Whether compensation has been received from the company(ies) covered in the Research report in the past 12 No 1 months for investment banking transaction by CSL Whether Research Analyst, CSL or its associates or relatives of the Research Analyst associates collectively hold No 2 more than 1% of the company(ies) covered in the Research report Whether compensation has been received by CSL or its associates from the company(ies) covered in the Research No 3 report CSL or its associates have managed or comanaged in the previous twelve months a private or public offering of No 4 securities for the company(ies) covered in the Research report 5 Research Analyst, his associate, CSL or its associates have received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in the Research report, in the last twelve month No 10. There are no material disciplinary action that been taken by any regulatory authority impacting equity research analysis activities. STOCK RATINGS BUY : The stock's total return is expected to exceed 15 % over the next 12 months. OUT PERFORMER: The stock's total return is expected to be within 515% over the next 12 months. MARKET PERFORMER : The stock's total return is expected to be between 5% to +5% over the next 12 months. UNDER PERFORMER: The stock's total return is expected to be between 15% to 5% over the next 12 months. SELL: The stock's total return is expected to more than 15% over the next 12 months.

22 III. DISCLAIMER The information and opinions contained herein have been compiled or arrived at, based upon information obtained in good faith from sources believed to be reliable. Such information has not been independently verified and no guaranty, representation of warranty, express or implied, is made as to its accuracy completeness or correctness. This document is for information purposes only. This report is based on information that we consider reliable, but we do not represent that it is accurate or complete, and one should exercise due caution while acting on it. Descriptions of any company or companies or their securities mentioned herein are not complete and this document is not, and should not be construed as an offer or solicitation of an offer to buy or sell any securities or other financial instruments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. 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23 RESEARCH Sathyanarayanan M Consumption sathyanarayananm@chola.murugappa.com Mugilan K Auto Ancillary, Technicals mugilank@chola.murugappa.com Praveen I Banking & Financial Services praveeni@chola.murugappa.com Ashish M Associate IT ashishm@chola.murugappa.com Sreedevi Kandipan Cement & Pharmaceuticals sreedevik@chola.murugappa.com INSTITUTIONAL SALES Venkat Chidambaram Head of FII Business & Corporate Finance* venkatc@chola.murugappa.com Lakshmanan T S P Chennai lakshmanantsp@chola.murugappa.com Kishore K Ganti Mumbai kishorekg@chola.murugappa.com Bhavesh Katariya Mumbai bhaveshgk@chola.murugappa.com Sudhanshu Kumar Institutional Equities* sudhanshuk@chola1.murugappa.com Balaji H Compliance Officer balajih@chola.murugappa.com *Employees of Business Partner RCCR