– Strong growth in loan book
– Diversified asset book and liabilities
– Asset quality on the mend
– Auto slowdown and poor monsoon key risks
– Valuations reasonable
Mahindra & Mahindra Financial Services (M&M Fin) has seen its operating environment improve in the current fiscal. However, the automobile end-market, which forms a large chunk of its lending book, is on a slow lane. Against this backdrop, how should investors be positioned in this stock?M Fin (CMP: Rs 419, market capitalisation: Rs 25,900 crore) is a subsidiary (51.9 per cent) of Mahindra & Mahindra (M&M) and engaged in the business of financing purchase of new and pre-owned auto and utility vehicles, tractors, cars, commercial vehicles, construction equipment and SME financing. The company has 1,313 offices covering 27 states and five Union territories in India with over 5.91 million vehicle finance customer contracts.
Strong growth in assets
Business momentum remains strong, with assets under management growing by over 30 per cent as at December 31, 2018, driven principally by commercial vehicles, pre-owned vehicles as well as lending to small & medium enterprises (SME). Growth in disbursement was in excess of 24 per cent. Albeit the slowdown seen in the vehicle side of the business, the company remains confident of maintaining over 20 per cent growth in assets. The management isn’t too worried about its growth outlook and feels 20 per cent asset growth is achievable as most of the products financed are not aspirational but are driven by necessities.
Aset book – diversification leads to de-risking
The lending book remains diversified, thereby de-risking the business. The company remains deeply penetrated in the geographies they operate.
That essentially means that the slow growth in one product category can be compensated by other products to a large extent. For instance, while the first-hand automobile market is on a slow lane, the company is witnessing traction in the second-hand vehicle financing as well as construction equipment segments. The management feels that the competitive intensity is not very severe and the company is experiencing improvement in market share in almost every product segment.
Emerging stronger from the recent liquidity crisis
M&M Fin was unscathed in the recent liquidity crisis, although it experienced a short-term increase in its cost of funds. For instance, Q3 FY19 saw the lingering impact of the Infrastructure Leasing & Financial Services (IL&FS) crisis and tightness in liquidity.
However, the management mentioned that there was no funding constraint for M&M Fin, although they carried some excess liquidity as a precaution. End-market still looks good with no pressure on lending yields. Despite the challenges, the company was able to maintain its interest margin. The company has a diversified funding mix with over 40 per cent of funding accruing from a stable source like bank funding
Asset quality – decisively on the mend
Improvement in asset quality continues with the quarter witnessing a 10 per cent sequential decline in gross non-performing assets (NPAs). Gross and net NPAs at the end of the quarter stood at 7.7 per cent and 5.8 per cent, respectively. The management mentioned that although the headline gross NPA number may still look a tad elevated the underlying trend is strong.
On a 180-day past due basis, the underlying asset quality is at one of the best levels. The number of contracts under NPA is also on a decline. While the underlying asset quality has improved, provision cover (provision held against non-performing assets) has actually declined to 26.9 per cent in Q3 FY19 from 34.9 per cent YoY. The management, however, maintained that overall loss is close to its current coverage levels.
Eyeing three per cent RoA
On the back of improvement in net interest margin (NIM) as well as productivity and decline in provisions, the company is hopeful of reaching three per cent return on assets (ROA) in the next couple of years from the current 2.2 per cent level.
Subsidiary performance improving
Some of the company’s important subsidiaries are showing improvement. Mahindra Rural Housing (88.75 per cent stake) reported a 32 per cent growth in after-tax-profit for the first nine months of FY19 with a gradual improvement in asset quality. Mahindra Insurance Brokers (80 per cent stake) reported a 46 per cent growth in after-tax-profit for 9M FY19.
After a blistering pace of growth in the past, auto industry volumes appear to be on the slow lane, which could impact demand from its end customers. However, management still sees no signs of stress, with the cash flow of its rural customers improving on the back of an increase in infrastructure activities. For transporters, the change in axle load norms has resulted in better cash flow.
Erratic monsoon or any other event that negatively impacts income/cash flow in rural areas could impact asset growth as well as delinquency levels.
With its deep rural penetration, M&M Fin has carved a niche for itself. The diversification in the asset, as well as funding book, makes the business relatively de-risked and the marquee parentage insulates it from the funding issues that have engulfed the NBFC space in recent times. We see the company as a vintage player to wean away market share from the weaker competition. The decline in credit cost could be a earnings trigger going forward.
The stock has corrected by close to 11 per cent in the past three months. With most issues largely addressed, the weakness may be a perfect time to accumulate the stock for the long term.