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M&M Financial Services: Buy

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The company's spreads are one of the best in the industry at 11.7 per cent.

M. V. S. Santosh Kumar

With automobile and commercial vehicle makers making a big push into rural and semi-urban areas, credit needs in these markets are likely to explode. Mahindra & Mahindra Financial Services (Mahindra Finance), which funds tractors, utility vehicles and light commercial vehicles, thus appears to be a good investment option.

At the current price of Rs 677, the stock price discounts its adjusted book value for FY-12 by 2.6 times and estimated earnings by 11.8 times. While the stock fell in line with other NBFC peers over concerns of rising interest rates pressuring margins, the company's business may continue to grow at a high rate to make up for this. The spreads of the company are one of the best in the industry at 11.7 per cent. Mahindra Finance has done well in diversifying its lending base from M&M vehicles to other manufacturers, protecting itself from the risk arising out of any slippage in sales for the parent.

However, the stock may be suitable only for investors with a stomach for risk, given the higher risk nature of the asset book, especially as the non-performing assets of the company keep fluctuating. The gross NPA ratio of Mahindra Finance stood at 5.6 per cent, as of December 2010, as against 8.7 per cent in December 2009.

Business

Mahindra Finance currently has 537 branches — a majority of them present in the rural and semi-urban areas. Presence in such areas ahead of competitors helps in forging deals with dealers and manufacturers which are increasingly concentrating on these areas. Fee-income opportunities are also immense and Mahindra Finance, leveraging on its branch network, is providing insurance and mutual fund broking in rural areas too.

The advances book of Mahindra Finance has a 50:50 mix of Mahindra and non-Mahindra vehicles with reliance on the former reducing over the years.

The loan book after growing at a modest annualised rate of 13 per cent over the period FY07-FY10, witnessed a strong 45 per cent growth for the year ended December 2010, tracking the surge in automobile sales. Net profit grew at 38 per cent compounded annualised rate during FY07-FY10.

From here, a rising proportion of loans to commercial vehicle, construction equipment and pre-owned car segments could improve yields. The recent foray into housing markets and international auto financing may reduce concentration risks of the asset financing business. Mahindra Finance's housing arm offers immense opportunities going forward with a current outstanding portfolio of Rs 257 crore.

The current spreads of 11.7 per cent have moderated from March highs (13 per cent) due to rising cost of funds. However, the 50 bps hike in lending rates and focus on asset quality may help maintain the return on assets at over 3 per cent. The annualised return on assets for the nine-months ended December 2010 stood at 3.3 per cent. The maturity of Mahindra Finance's liabilities is longer than that of the assets, which will allow it to re-price its loans at a faster rate than its borrowings. This should protect spreads to some extent.

Asset quality

The lumpy nature of borrowers' cash flows at times tend to overstate the company's NPAs on the loan book, these tend to later get upgraded to standard assets. Asset quality ratio after provisioning stood at 1.1 per cent (Net NPA ratio). The company adopts more stringent provisioning norms than what is prescribed by the RBI.

Rising rural income levels and improved agriculture output too may improve asset quality further. The Mahindra Finance stock deserves a higher valuation due to its high levels of return on equity (20 per cent annualised for nine months ended December 2010), low leverage and expectation of high loan book growth.

Capital infusion not factored into our workings provides upside too. Mahindra Finance plans to raise as much as Rs 570 crore by March-end which would prop-up the net worth by around 20 per cent, in turn supporting a high loan book growth. Capital infusion would also ease the margin pressures. Part of the funding may also meet capital requirements of the promising housing finance business. As the market is volatile, investors can consider phasing out the purchases to protect from downside.

(This article was published in the Business Line print edition dated January 30, 2011)
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