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* Recovery delayed; liquidity a top priority
In light of the current COVID-19 climate in India, we hosted a conference call with Mahindra & Mahindra Financial Services (MMFS) for an update on the current impact of the virus and recent regulatory measures. In the current uncertain environment, liquidity and collections remain the key focus area for the company. Growth is likely to be muted, at least in 1HFY21. With uncertainty surrounding revenue growth, the company’s key focus would be on rationalizing operating expenses to maintain profitability. Overall, we have cut estimates by 50%+ for FY21–22 to factor in sharp moderation in growth and higher credit cost, with the impact partially negated by a fall in opex. With the sharp cut, ROE is likely to be muted at 7–8%. Furthermore, we sharply cut target price to INR200 (1x FY22 BV).
* Business recovery to be further delayed; rural economy to pick up first
With the transition to BS6 having just commenced, auto volumes were expected to be muted in 1HFY20 and recover thereafter. However, post the impact of COVID-19, recovery is likely to be delayed, especially in segments such as cars and CVs. The tractor segment may witness earlier recovery, given the expectation of a good Rabi crop harvest in April–May and normal monsoons. According to management, the rural economy would bounce back first, given that casual labor has migrated back to villages from cities post the COVID outbreak.
* Liquidity to take precedence over disbursements in near-to-medium term
The company has decided to grant a moratorium to all customers who are not NPL. Management expects 80–85% of retail customers to avail the moratorium. The company has INR40b worth of liquidity on its BS, with an additional INR15b in undrawn lines. This would be sufficient to meet debt and other obligations over the next six months. Management clearly articulated that, over the next six months, the focus would be on maintaining liquidity rather than on disbursements. Given delayed business recovery coupled with management’s priority to conserve liquidity rather than disbursements, we have cut our FY20–22E loan book CAGR estimates from 13% earlier to ~2% currently. Downside risk to our estimates stems from a longer-than-expected lockdown across regions and continued weakness in underlying product sales. Our auto analyst expects flat volume growth of 4–5% YoY depending on product categories. However, the moratorium extended to customers is likely to support FY21 AUM; hence, repayment rates would reduce in FY21.
* RBI measures to help lower cost of funds; securitization volumes to decline
Certain banks have initiated discussions with the company regarding availing RBI’s TLTRO program to subscribe to its bonds. While the quantum of this money would not be significant in the overall scheme of things, it is likely to cost ~7%, i.e. ~150bp lower than its current weighted average cost of funds. Management expects the liability mix to remain largely stable, barring marginal decline in the share of securitized assets.
* Targeting reduction in expense ratio
Given the stress on demand as well as asset quality, management focus is on narrowing the expense ratio to maintain profitability. Key levers comprise a) increasing variable employee expenses from 20% of fixed salary to 30% of fixed salary, b) renegotiating rental agreements c) migrating from 80–85 regional offices to 5–6 large service centers, and d) lowering dealer incentives. While the aim is to lower the expense ratio from 3% currently to 2% over the next 12 months, we have not factored this in our estimates.
* Uncertain asset quality outlook; increase FY21–22 credit cost by ~200bp
Collections, which were healthy up to mid-March, dried up in the second half of the month. As most customers are expected to avail the moratorium, we do not foresee a meaningful change in the GNPL ratio in 4QFY20 or 1QFY21. However, the real impact of the lockdown would be witnessed in 2QFY21 and beyond. Management has guided to a 200bp increase in the GNPL ratio to 9% over the medium term. It is relevant to note that during previous crises (2007–09 and 2013–15), the GNPL ratio increased 300–400bp, while credit cost increased 130–180bp. We have sharply increased our credit cost estimate by 200bp for FY21–22. We have also raised our estimate for 4QFY20 to factor in 15 days of loss of collections (in a seasonally strong quarter) and expect prudent provisioning by management for COVID 19.
Valuation and view
While MMFS’ performance in FY20 was marred by slowing growth and rising credit cost, the company was expected to recover in FY21, led by robust tractor demand. However, with the impact of COVID-19, recovery is likely to be further delayed, probably to FY22. In our view, over the next two years, MMFS would deliver a ~2% loan CAGR, while credit cost would rise to 4.0% in FY21 and 3.5% in FY22 from 2.8% in FY20E. Margins may improve modestly as the company would benefit from a benign interest rate environment. We have cut our estimates by 53–50% to factor in sluggish loan growth and an increase in provisions. We maintain Buy, with a revised target price of INR200 (1.0x FY22 BV).
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