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Rural distress still much lower than in urban centers
We attended the business update call of M&M Financial Services (MMFS) and remain convinced that the demand recovery in the auto sector has got further prolonged because of the Covid-19 situation in India. Important takeaways from the call were 1. Asset quality is likely to deteriorate given the current lockdown and the three-month moratorium on term loans 2. Demand for H&MCVs would come down further but tractors and 2W demand can pick in the coming quarters 3. MMFS has strong liquidity on its balance sheet with which it can comfortably discharge its liabilities and fixed cost obligations for the next six months 4. Rural still remains more resilient and will be the quickest to recover when a semblance of stability comes back. Our SoTP-based valuation leads to a revised target price of Rs205 (earlier: Rs365). Upgrade to BUY.
* Pre-owned vehicles, tractors and three-wheelers can support demand: Even after the lockdown is lifted, we do not expect customers to immediately start investing in a new vehicle. Farm cash-flows in rural India will improve by mid-May and rural centers will lead the demand for pre-owned vehicles, tractors and three-wheelers.
* Embarking on an ambitious overhaul in its opex structure: MMFS guided that it will be using the lean period (for disbursements and customer repayments) to optimize its cost structure. This would be achieved through a combination of productivity gains, exploring various partnership models with OEMs, dealers and customers and also by converting its regional offices into large service centers. However, we feel that the guided levels of 2% (opex to AUM) will be bit of a stretch.
* Asset quality deterioration and higher credit costs: As per current RBI directive, the moratorium remains in force until May 2020. We expect the asset quality to deteriorate in Q2FY20 and Q3FY20 with consequent higher credit costs. We now estimate ~51% higher credit costs in FY21E.
* Liquidity position remains very comfortable: MMFS disclosed that it has Rs40bn in liquid investments and another Rs15bn in sanctioned and undrawn lines. MMFS does not plan to avail the moratorium on its term loans from banks. Under the assumption that both incremental disbursements and customer repayments will be low, it expects to be able to discharge its liabilities anfd other fixed cost obligations comfortably for the next six months even with no new sanctions.
* Valuations and target price: We now model NII/PPoP/PAT CAGR of 8%/7%/18% over FY20E-FY22E. We estimate a standalone loan-book CAGR of ~11% over FY20E-FY22E. Our SoTP-based valuation (Table 1) leads to a target price (TP) of Rs205 (earlier: Rs365). At our TP, the stock will trade at 0.9x FY21E consolidated P/BV. Upgrade to BUY (from HOLD). Key downside risks include further extension of lockdown in India which will prolong the demand recovery in the auto sector. Customer repayments after the moratorium period will be a key monitorable.
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