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In the midst of transformation, yield moderation a concern

Stark NIM compression and elevated credit costs lead to a weak quarter

* Mahindra & Mahindra Financial (MMFS)’s 1QFY24 PAT grew 58% YoY to INR3.5b (23% miss). Net Total Income (reported NII) stood at INR16.7b (6% miss) and rose 7% YoY while PPoP at ~INR10b (5% miss) grew 6% YoY.

* Annualized credit costs of ~2.5% (PY: 3.9%) were higher than expectations and included ~INR3.3b in write-offs and ~INR2.0b in provisions.

* In 1QFY24, the yields (calc.) moderated ~45bp QoQ while CoF (calc.) rose ~20bp, leading to a margin contraction of ~50bp QoQ. This yield moderation, in our view, was primarily due to the rising proportion of PrimeX customers and stronger growth in Cars/Utility Vehicles. Management guided for a product-mix change and gradual re-pricing in incremental disbursements that should lead to a gradual expansion in yields.

* We estimate NIM to moderate to 7.7% in FY24 (PY: 8.3%) and then expand ~20bp YoY to 7.8% in FY25.

* MMFS has made a good progress towards its Mission 2025 targets across AUM growth, asset quality, and RoA. With process enhancements across sourcing, underwriting and collections, we expect asset quality improvement to sustain and now model lower credit costs of ~1.6%/1.7% in FY24/FY25.

* We cut our FY24E EPS by ~2% to factor in a higher NIM compression. We model an AUM and PAT CAGR of 19% and 20% over FY23-FY25E for an FY25 RoA and RoE of 2.3% and 15.4%, respectively.

* Prior to this quarter, MMFS had managed to reduce the volatilities in its asset quality and earnings performance by implementing a series of strategic initiatives designed to foster stability through streamlined operations and enhanced risk management. However, the company would need to get its act together to reduce the volatilities in its yields and credit costs to sustain investor confidence in its transformation journey. Retain BUY with a revised TP of INR370 (premised on 2.3x FY25E BVPS).

* Key risks: a) Margin compression because of slight change in customer mix and higher Cars/UVs in the product mix, b) higher exposure to rural India will keep it vulnerable to any uneven monsoon distribution and c) slowdown in vehicle demand due to macro challenges.

Key takeaways from the management commentary

* There is no drastic shift away from the earn-and-pay customer segment. Faster growth in pre-owned vehicles will offset any margin compression.

* Management guided that PrimeX segment will not be more than 10-12% of the customer mix. Compression in NIM from PrimeX customer base will be more than offset by lower opex and credit costs.

* It will take one more year for the PCR across different stages to decline further. Product/Customer mix change will also aid lower PCR.

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