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The Security I Like Best

The Security I Like Best

To some readers, the title of this article might ring a bell. I accept I have stolen this idea from one of the greatest investors of our times – Warren Buffett. In 1951, he had written a marvellous article on Government Employees’ Insurance Company – GEICO. He liked the security so dearly that later on, he decided to buy majority stake in the same.

The wisdom in the stock market says never fall in love with a stock. The simple reason being they cannot love you back! Over the past few weeks, I have been researching about a company with which I seem to have fallen in love with – contrary to the stock market wisdom.

The company which I am in love with is Sundaram Finance. The company was founded by late Santhanam in 1954. It is one of the largest NBFCs (non-banking financial corporation), having a pan-India presence with 583 branches. It has interests in various fields, ranging from hire purchase business and equipment leasing to housing finance. The subsidiaries include a home finance joint venture with BNP Paribas, an asset management company and several other businesses. It has a joint venture named Royal Sundaram Alliance Insurance Company, which is growing faster than the industry average.

One of the important things to take note while buying a security is the management. Sundaram’s management has a tremendous track record in terms of growth, dividend payout, corporate governance and all other aspects a shareholder can think of. From 1954 till date, there had not been a single year it did not pay dividend. This shows the attitude of the promoters – if one cannot deploy excess cash in profitable ventures, better to return the same to the shareholders. In fact, the compounded annual growth rate (CAGR) of the dividend being paid out (in absolute terms) has been a staggering 19.8% over the past 9 years. Plus, the company issues bonus shares quite frequently. Another way to gauge the quality of management is said to be equity dilution. The management has never diluted its equity stake holding since the IPO in 1972.

To make things easier for readers, it is prudent to quantify things. The top line of the standalone business has growth at 15.4% over the past 5 years. However, the consolidated business has grown at a CAGR close to 19%. The cost of finance and administrative cost have been increasing at 17% though, when seen as a percentage of the top line (excluding other income). It has been decreasing at a CAGR of 1.5%. The PAT, on a standalone basis, has been growing at 28%, and not many companies have been able to do the same during the past 5 years. The pre-tax earnings margins have been consistently increasing from 20% to almost 30% over the past 5 years.

Also, financing is not about how aggressively one lends but how carefully one lends. The company continues to have superior asset quality with gross NPA (non-performing assets) and net NPA of 1.23% and 0.45%, respectively. In fact, its average net NPA for the past 5 years is 0.4%. The net interest margin (NIM) has been improving constantly without a deterioration of asset quality, which is quite remarkable. Over the years, the firm has been tapping cheap finance (reduces cost of funds), through issue of commercial paper, instead of term financing or bank finance.

One often finds it difficult to put a value on the subsidiary companies. Sundaram BNP Paribas Home Finance Ltd is a subsidiary and has been growing at a phenomenal rate. It has outstanding loans of Rs 7,112 crore, which is on par with Gruh Finance (a subsidiary of HDFC Ltd) that has outstanding loan book of Rs 7,009 crore. Gruh’s NPAs are also comparable since Sundaram BNP has gross and net NPAs of 1.53% and 0.46%, respectively, while Gruh Finance has gross and net NPAs of 0.27% and 0%, respectively. The earnings of both the companies go neck and neck. Since Gruh Finance is trading at a market capitalisation of Rs 7,500 crore approximately, one can put a similar value to Sundaram’s housing finance subsidiary. Since the parent company has 50% holding in the subsidiary, one can put an approximate value of Rs 3,000 crore for this subsidiary. The stupendous valuation of the subsidiary is not being valued by the market – this is one of the compelling reasons to own this company.

Another piece of wisdom which I have received is – you either get good news or good equity prices, you rarely get both of them together. With all the talk of a revival in the Indian economy, good news has been pouring in. Hence prices of securities, in general, have gone up – with a market capitalisation of Rs 10,000 crore. It is definitely not the cheapest stock around at a multiple of more than 3x in terms of book value, close to 17x price-earnings ratio, market capitalisation to sales of 2.4x. With all the given parameters, the stock does not look cheap. However, as Charlie Munger taught Warren Buffett, it is sensible to pay up for quality when the duo bought See’s Candy in 1972.

Everything in life has risks attached to it and it more so in equity markets. One of the main risks involves the market not valuing the subsidiary companies appropriately – that’s why we see a lot of companies demerge their subsidiaries. The asset quality might deteriorate, which will impact the overall company. As one of my friends very rightly mentioned, all PSU banks look cheap on the valuation front till they announce their NPA figures. Moreover, the success and earnings growth of a company largely depend on the overall economy. Hence, a significant slowdown in the Indian economy will have an impact on the earnings of the company.

Overall, Sundaram Finance is a business which, I understand, has a good economic moat, is run by an able and competent management and most importantly, is available at a sensible price tag. However, let me caution the readers – Rome was not built in a day and so aren’t great companies. Hence, one should stay invested in the company for the long term in order to reap the benefits.

Disclaimer: Author is a shareholder of Sundaram Finance Ltd.