Mahindra and Mahindra Financial Services: BUY

Strong presence in rural and semi-urban areas and a diversified loan portfolio have helped Mahindra and Mahindra Financial Services (MMFin) deliver strong growth, in spite of the economic slowdown.

A subsidiary of Mahindra and Mahindra (M&M), the company is in the business of financing new and second-hand utility vehicles, tractors, cars, commercial vehicles, and construction equipment. Nearly half of its lending finances other manufacturers’ vehicles.

The company’s loan book grew by a robust 37 per cent in 2012-13, well above rivals such as Sundaram Finance (7 per cent) and Shriram Transport Finance (23 per cent).

As a consequence, the net interest income grew by 36 per cent in 2012-13. MMFin commands best-in class net interest margins (NIMs) in the range of 9-9.5 per cent that is expected to remain stable due to falling borrowing cost.

At the current price of Rs 264, the stock trades at 2.8 times the expected book value for the next year, which is at a premium to Sundaram Finance (2.5 times) and Shriram Transport Finance (1.9 times).

While on a relative basis the stock seems expensive, the premium valuation is justified by a diversified loan portfolio and higher NIMs.

With expected earnings growth of 18-20 per cent for the next two years, the stock looks attractive even at these levels. However, taking into account the lingering macro concerns, we advise investors to invest with a two-to-three year time horizon.

De-risked

Mahindra and Mahindra Financial Services began its operations in 1993, financing only M&M vehicles. However over the years, it has been able to de-risk its loan portfolio and cater to other manufacturers as well. This opened up opportunities in newer segments such as cars, commercial vehicles and construction equipment financing. The company’s distribution network spans across 657 branches in 25 states.

This, in turn, has helped the company reduce its dependence on any single segment or manufacturer. For instance, in 2012-13, the company increased its share of lending significantly to the M&M’s UV segment, and reduced its exposure to the ailing commercial vehicle segment. The share of UV segment in the total assets financed increased from 26 per cent in 2011-12 to 31 per cent in 2012-13. As a result, lending to this segment grew by a robust 46 per cent, backed by the underlying growth in the M&M’s UV sales.

Aside from this, other segments, such as cars, which recorded lower sales, still grew by 12 per cent, due to deeper penetration by financing cars of new manufactures and increase in market share.

High margins to sustain

The company’s loan book has grown by 39 per cent annually over FY 2011- FY 2013. For the current fiscal, while loan growth is expected to moderate from these levels, the company’s diversified business model, should still deliver close to 24 per cent growth over the next two years.

MMFin has a well diversified funding mix as well. The company’s borrowing is spread across, bank loans (51 per cent), non-convertible debentures (25 per cent), deposits (11 per cent) and securitisation (12 per cent). It has also been able to maintain a prudential asset liability match throughout the year.

This means that the duration of borrowings matches with that of loans, thus reducing asset liability risks. The company’s NIMs have been impressive in the range of 9-9.5 per cent, the best among its peers such as Shriram Transport Finance and Sundaram Finance, which are in the range of 7 per cent.

In a declining interest rate scenario, the company should be able to reduce its cost of funds as close to 51 per cent of its borrowing is from banks. This will aid in stabilising margins this fiscal. Also, the company is looking at the opportunity in the second-hand vehicle financing space, which is a high-margin business.

Well-guarded asset quality

MMFin has been able to deliver consistent asset quality in spite of growing macro concerns. The company has, in fact, been able to bring down its delinquencies over the past few years. In 2009-10, the company’s gross non-performing assets (GNPA) stood at 6.4 per cent of loans, which has significantly come down to 3 per cent currently. The company has been able to achieve this through a conservative Loan to Value (LTV) ratio (70 per cent currently), strong collections and sound credit appraisal system.

However, stringent asset classification norms may impact the provisioning cost for the company in the current fiscal. Currently, the loans whose instalments are overdue for 180 days or more are classified as NPAs. The Usha Thorat committee has proposed to bring it down to 90 days for NBFCs in a phased manner, at par with banks. This may lead to higher provisioning costs.

The capital adequacy for the company is at 19.7 per cent for 2012-13, well above the statutory mandated requirement of 15 per cent. The company has sufficient capital cushion to drive growth over the next two years. The company has been able to maintain healthy returns, with the return on assets at a 4 per cent in 2012-13 and return on equity at 23.5 per cent. While the returns may moderate by 30-50 basis points on account of additional provision, it will still remain amongst the best within the NBFC space.

Subsidiaries

MMFin is also in the business of insurance broking and rural home finance through its subsidiaries. In 2012-13, the company sold 15 per cent of its stake in the insurance broking business to Inclusion Resources for Rs 80 crore. The business made a profit of Rs 34 crore in 2012-13.

Mahindra Rural Housing Finance provides home loans in rural and semi-urban areas The loan book in 2012-13 stood at Rs 879 crore, up from Rs 535 crore in the previous year. The profit stood at Rs 20 crore for the business. While both businesses are profitable, they currently contribute close to 5 per cent of the consolidated profit.

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