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Benefitting from the strong sectoral tailwinds | Mission 2025 on track

* Mahindra & Mahindra Financial (MMFS) has managed to reduce the volatilities in its asset quality and earnings performance by implementing a series of strategic initiatives. These actions were designed to foster stability through streamlined operations, optimized cost structures, improved asset quality, reduced credit costs and enhanced risk management capabilities. These initiatives have also helped it expand its business volumes within the affluent rural and semi-urban (RUSU) customer segment.

* Unless the monsoons play havoc, the rural segment would experience an improvement in cash flows driven by the surge in economic activities due to the upcoming elections. This anticipated surge will generate robust demand for vehicles deployed for commercial-cum-personal uses. In addition, the synergies between the parent Mahindra & Mahindra (M&M) and MMFS have improved, thus aiding healthy loan growth.

* MMFS has implemented a range of underwriting rule engines to streamline its processes and strengthen the asset quality. By leveraging advanced data analytics, the company effectively identifies customers who have exhibited a volatile behavior in the past. This enables the management to take better underwriting decisions.

* MMFS has made a good progress towards its “Mission 2025” targets across parameters such as AUM growth, asset quality, NIM and RoA. We model an AUM/PAT CAGR of 20% each over FY23-FY25E with an RoA/RoE of 2.3%/15.0% in FY25E. Reiterate BUY with a TP of INR400 (premised on 2.5x FY25E P/BV). Monsoons playing spoilsport (due to the EL-Nino impact) in the near-term is the biggest risk to our thesis.

Visible improvement in asset quality; credit costs at ~2% over FY25E

* MMFS has invested in improving itslegal toolkits, which has enabled better recoveries and customer settlements. The company can now effectively leverage its legal capabilities to pursue resolutions in stressed accounts.

* As of FY23, its 30+dpd stood at 10.4% reflecting a notable ~11pp improvement over the last four quarters. This wasmainly driven by the company's ability to achieve resolutions in deep NPA buckets as well as the discipline to prevent slippages into higher buckets.

* Given better customer selection (by culling the most vulnerable segment) and implementation of initiatives to monitor early-warning signals and equip the field collection team with data insights, we expect that the asset quality volatility will subside significantly. We now model credit costs of ~1.7%/1.9% over FY24/FY25.

Margin compression to moderate; opex to decline from FY25

* MMFS is gradually shifting its product mix towards higher-yielding segments viz. SME loans and pre-owned vehicles that would aid improvement in yields. Given that MMFS is now targeting M&M’s urban vehicle segment and the RUSU affluent segment, organic yields could be under pressure. However, this will be offset by lower opex and credit costs on such customers.

* With a pause in rate hikes by the RBI, CoF is likely to peak in FY24 while improvement in yields should curb margin compression effectively. We expect margin to moderate ~20bp in FY24 and expand thereafter by ~10bp in FY25.

* We believe that MMFS is only half-way through the transformation journey that it has embarked upon over the last 12 months. Deployment of a central processing unit can bring in more consistency in underwriting and TAT.

* Major tech-stack upgradation will be effected over the next 12-18 months. While this would keep opex elevated in FY24, it has the potential to unleash material improvement in throughput, turnaround and operating efficiencies once it has been fully deployed by the latter half of FY25.

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