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Suresh Krishnamurthy

FRESH investments can be considered in the stock of Sundaram Finance. The stock now trades at a dividend yield of 4.2 per cent.

Given that the dividend payout is only about 33 per cent and with profits growing, there is also the possibility of growth in dividends in the years ahead, making the stock attractive.

Modest showing

In 2001-02 and 2002-03, Sundaram Finance's profit performance was modest. In contrast, profits of other non-banking finance companies such as Cholamandalam Finance (CFL) and Ashok Leyland Finance surged ahead.

There are a few reasons for the relative lack of buoyancy in Sundaram Finance's profit growth.

For instance, the lacklustre asset growth, partly due to the declining contribution of leasing operations. Receivables rose only 8 per cent in 2001-02 affecting profit growth.

In 2002-03, receivable rose at a healthy 18 per cent, though the impact was undone by the provisioning for non-performing assets. Thus, the lower profit growth.

Narrowing spreads

Sundaram Finance's spreads have not improved as much as it has for the other companies. Had it improved, the impact of lower asset growth or rising provisions would have been muted.

In fact, Sundaram Finance's margins fell in 2001-02 and remained steady in 2002-03.

This can largely to be traced to the fact that Sundaram Finance has largely stuck to automobile financing, where the competition has really intensified with the entry of banks. The resultant drop in lending rates wiped out much of the benefits of lower borrowing rates.

The spreads of CFL and ALF, however, improved in both these years, what with both venturing into such high-spread areas as two-wheeler financing or into lending against shares. This helped them expand their margins.

Promise of improvement

There is promise of improvement in Sundaram Finance. In fact, its performance in the 2003-04 first quarter was encouraging.

The company reported a rise in profits of about 50 per cent. Rising disbursements and improved spreads contributed to the growth.

While the 50 per cent growth rate may be tough to sustain for the whole year, a robust rise in profits is on the cards.

This is because lending rates appear to have bottomed out. On the other hand, benefits in the form of lower rates for borrowing are continuing to flow in.

In addition, as the economy is set to grow faster, volume growth is likely. With provisions for non-performing assets also set to decline, profit growth can only improve compared to earlier years.

Value enhancement

Though profit growth seems set to improve, the low return on Sundaram Finance's net worth is an impediment to any significant re-rating of the stock.

This is the primary reason for the low price-to-book value ratio of the stock, of 0.6 times.

A significant improvement in return on net worth appears unlikely in the next couple of years.

It may happen over the longer term on the back of better performance of ventures such as Sundaram Asset Management Company and Royal Sundaram Alliance. As such, the discount to book value is likely to continue.

However, increased dividend payout could lead to improved valuation. Sundaram Finance's capital adequacy is now significantly high at 18 per cent.

Juxtaposed with the low return on net worth, the capital employed appears to be higher than required for the business.

In this context, any improvement in profit growth will translate into higher dividend payouts. This should give a fillip to the stock price.

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