Highlights:
– 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 capitalization: Rs 25,900 crore) is a subsidiary (51.9 percent) 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 and over 5.91 million vehicle finance customer contracts.
Strong growth in assets
Business momentum remains strong, with assets under management growing by over 30 percent as of December 31, 2018, driven principally by commercial vehicles, pre-owned vehicles, and lending to small & medium enterprises (SMEs). Growth in disbursement was over 24 percent. Despite the slowdown in the vehicle side of the business, the company remains confident that it is maintaining over 20 percent growth in assets. The management isn’t too worried about its growth outlook. It feels that 20 percent 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 its operating geographies. That essentially means that other products can compensate for the slow growth in one product category to a large extent. For instance, while the first-hand automobile market is on a quiet lane, the company is witnessing traction in the second-hand vehicle financing and 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 more substantially from the recent liquidity crisis
M&M Fin was unscathed in the current 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, management mentioned that there was no funding constraint for M&M Fin, although they carried some excess liquidity as a precaution. The 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 percent of funding coming from a stable source like bank funding.
Asset quality – decisively on the mend
Improvement in asset quality continues, with the quarter witnessing a 10 percent sequential decline in gross non-performing assets (NPAs). Gross and net NPAs at the end of the quarter stood at 7.7 percent and 5.8 percent, respectively. Management mentioned that although the headline gross NPA number may still look 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 the decline. While the underlying asset quality has improved, provision cover (provision held against non-performing assets) has declined to 26.9 percent in Q3 FY19 from 34.9 percent YoY. Management, however, maintained that overall loss is close to its current coverage levels.
Eyeing three percent RoA
Improvements in net interest margin (NIM) and productivity and a decline in provisions have led the company to hope to reach a three percent return on assets (ROA) from the current level in the next couple of years.
Subsidiary performance improving
Some of the company’s essential subsidiaries are showing improvement. Mahindra Rural Housing (88.75 percent stake) reported a 32 percent growth in after-tax profit for the first nine months of FY19, with a gradual improvement in asset quality. Mahindra Insurance Brokers (80 percent stake) reported a 46 percent growth in after-tax profit for 9M FY19.
Investment risks
After a blistering pace of growth in the past, auto industry volumes appear to be in the slow lane, impacting the demand from its end customers. However, management still sees no signs of stress, with the cash flow of its rural customers improving due to an increase in infrastructure activities. The change in axle load norms has resulted in better cash flow for transporters. An erratic monsoon or any other event that negatively impacts income/cash flow in rural areas could affect asset growth and delinquency levels.
Outlook
With its deep rural penetration, M&M Fin has carved a niche. The diversification in the asset and funding book makes the business relatively de-risked, and the marquee parentage insulates it from the recent funding issues that have engulfed the NBFC space. We see the company as a vintage player to wean away market share from the weaker competition. The decline in credit cost could be an earnings trigger in the future. The stock has corrected by close to 11 percent in the past three months. With most issues primarily addressed, the weakness may be a perfect time to accumulate the stock for the long term.
