Shriram Finance Ltd stock, already trading at a lifetime high, gained another 3.7% on Friday to ₹902 after it announced MUFG Bank Ltd will buy 471 million shares at ₹840 per share in the company through a preferential allotment. The transaction gives MUFG a 20% stake.
There are good reasons for MUFG to choose Shriram Finance over other banks and non-banking finance companies (NBFCs). Private banks in India are subject to a voting rights cap of 26% for a shareholder, whereas there is no such cap for NBFCs. Moreover, banks also suffer from the handicap of complying with cash reserve ratios, statutory liquidity ratios, and priority sector lending requirements, which pull down their return on assets (RoA). Sure, banks have the advantage of access to low-cost deposits, mainly Casa (current account savings account), but that has not enabled them to beat the RoA of most leading NBFCs.
Within NBFCs, Shriram emerges as a preferred choice, as there is potential to increase its stake in the future to gain management control without having to deal with a promoter who owns a majority stake. Take the case of Cholamandalam Investment and Finance Co., where the Murugappa group has a 49% stake. The promoter stake in Shriram is just 25%, most of it owned by Shriram Capital, which in turn is owned by an employee trust.
Key Takeaways
- Shriram’s low promoter stake makes it a prime target for MUFG to potentially seek management control in the future.
- The deal highlights the appeal of the NBFC model over private banks, as it avoids voting caps and CRR/SLR requirements.
- Tier-1 capital will jump from 20% to 36%, setting the stage for a potential credit rating upgrade.
- MUFG is entering Shriram at a notable discount compared to its closest peer, Cholamandalam.
- The interest savings from debt replacement are expected to offset the 25% equity dilution.
For Shriram Finance’s shareholders, the deal is positive. The capital infusion will strengthen the balance sheet with tier-1 capital increasing from 20% to 36% based on the Q2FY26 data. It may also help in securing a rating upgrade from agencies from the current level of AA+, which could result in lower borrowing costs.
For MUFG, the deal has been struck at an attractive valuation. If the dividend discounting model, which is similar to discounted cash flow (DCF) for non-lending companies, is used for valuing lending companies, it leads to more complications than DCF, as there is a problem of forecasting the quantum and timing of dividend payout ratio.
Shriram vs Cholamandalam
Even if the entire book value of a lending company is in cash, book value cannot be seen in isolation and has to be seen in conjunction with return on equity (RoE). Book value multiplied by RoE gives earnings per share (EPS). So, effectively, it is EPS that matters, with the price-to-earnings (P/E) ratio indicating the potential return on investment.
Shriram and Cholamandalam are comparable peers with market capitalization at ₹1.7 trillion and ₹1.4 trillion, respectively. Shriram quotes at a P/E of 13x, as per Bloomberg consensus FY28 estimates, lower than Cholamandalam’s 17x. While it’s true that Shriram’s earnings CAGR is likely to be lower at 18% over FY26-28, versus 25% for Cholamandalam, the differential growth rate has been captured in the valuation till FY28.
While the Bloomberg consensus estimate may not have factored in the impact of the deal, the equity dilution is unlikely to have an adverse effect on valuation. Even if fresh equity funds worth ₹40,000 crore do not fetch an average yield on loans at 18% and are utilized to substitute the borrowed funds that cost about 9% per annum (based on Q2FY26), interest savings should add about ₹2,700 crore worth of profit-after-tax (assuming tax rate of 25%) in FY27. The incremental profit after tax will be about 24% of the current FY27 consensus estimate. Thus, the 25% equity dilution could only have a marginal impact on the EPS.
