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Rural dominance & normal monsoons – An ideal blend
Mahindra and Mahindra Financial Services (MMFS) is a subsidiary of Mahindra & Mahindra group, one of the largest business conglomerates in the country. MMFS is predominantly into rural, semi urban vehicle financing with advances at ~| 58,240 crore as on December 31, 2018 and wide customer base of 5.3 million. It is headed by Ramesh Iyer (MD, Vice Chairman), who has decades of experience in Indian financial sector. MMFS operates 1313 branches in 27 states servicing ~5.3 million customers.
Strong business momentum led by rural cash flow, high NIM
For MMFS, AUM has grown at 23% CAGR with volatile spells in FY09-18. AUM grew at 32% CAGR in 09-14, slowed down in FY15-17 to 10% and then revived to 16% in FY16-18 to | 55,100 crore. We expect AUM to grow at 20% CAGR in FY19-21E to | 94,996 crore. Robust infrastructure spends and recent farmer friendly schemes are expected to support rural cash flows. Current NIM at ~8% is expected to remain stable over the next two years as it has already moderated from highs of 9.2% in the past.
Operating leverage to kick in; productivity to improve ahead
As loan book growth picks up, we expect MMFS to benefit from expenses incurred on employee and branch expansion. Opex/AUM ratio is seen moderating by ~10 bps to 2.9% in FY21E. Likewise, CI ratio is expected to reduce from 39.7% in FY18 to 36.5% in FY21E.
RoA improvement led by steady asset quality, productivity
Post impact of bad monsoon, RoA revived from 1% in FY17 to 1.9% in FY18 and further to 2.3% in 9MFY19. Likewise, RoE improved from 6.4% in FY17 to 11.3% in FY18, on the back of strong NII growth at 16% YoY and reduction in CI ratio from ~42% to ~39% in FY18. With steady credit cost and stable yields, we expect RoA to improve further to 2.4% in FY21E.
Buoyancy in rural India to benefit; valuation to sustain, BUY
Buoyancy in rural India and MMFS’ focus on rural financing are expected to support valuations. MMFS has ingredients to sustainably command premium valuation - 1) rural reach providing huge opportunity with pricing power, 2) robust AUM growth (AUM, earnings CAGR of 20%, 25%, respectively, in FY18-21E), 3) higher rural income led by farm loan waivers and cash flow receipt during election, 4) strong management and 5) adequate risk management with limited losses. We value core auto business at 2.6x FY21E ABV (1.8x FY21E BV) and add | 50 as value for subsidiaries like housing that is picking up pace. Assuming 20% holding company discount in lieu of subsidiaries, we initiate coverage with BUY recommendation and a target price of | 500 per share.
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